LECTURE 6:

THE GREAT CRASH AND ITS CONSEQUENCES

1. U.S. New Capitalism of 1920s.

2. Europe returns to Gold Standard.
3. The 1929 Crash
4. Policy Responses
5. John A. Hobson
6. John Maynard Keynes
7. Ralph Hawtrey
8. Josef Schumpeter

1. U.S. ‘New Capitalism’ of 1920s.

U.S. economy revives during the First World War. Brief recession in
1920-1921, Federal Reserve discovers open market operations.
then boom:
Saint-Simon’s/Central bankers’ dream of stabilised financial system
encouraging economic growth; new industries (motor vehicle,
electronics, pharmaceuticals);

(Simon Kuznets later showed new industries matched by decline of

old industries: Minor investment boom ended in 1926.)
But the stock market (and housing etc.) boomed.
2. Europe returns to Gold Standard.
Europe sinks into financial instability and depression.
European financial problem:
War debts (British Government debt/GDP rose from 30% in
1913 to 130% in 1918); German reparations needed to repay
debts.
Revolution, Weimar Republic and hyper-inflation.
1925, U.K. joins other European countries on Gold Standard at pre-
World War I parity (forcing losses on South African gold-mining):
Export problem (to get trade surplus and acquire reserves to service
gold-based debt) → attempts to reduce wages.
Gold standard effectively backed by reparation claims on Germany.
But those who had income and wealth benefitted from cheap imports:
era of high unemployment and great concentrations of wealth.

BUT ALL COUNTRIES CANNOT HAVE EXPORT SURPLUS

Total of global trade must balance at 0.

3. The Stock Market Crash

Rise in interest rates precipitates? causes? stock prices to fall, October
1929.
Role of ‘brokers loans’ in supporting prices.
Effects on Credit & Corporate Finance
Fall in stock market prices left NY banks with bad loans to brokers;
Investment trusts & insurance companies left with reduced assets.
Companies unable to issue new bonds/stocks or borrow from banks;
i.e., cash flow/liquidity from financial market operations dries up.
Firms depend solely on sales income for cash flow.

The Great Depression

U.S. banks call in farm loans, secured on land. Farmers’ ruin → bank
failures (no-one to buy repossessed farms from banks).
Industrial & agricultural crisis → commercial crisis.
Smoot-Hawley Act of 1930 raised tariffs against imports.
Fall in U.S. imports spreads crisis to other countries: Japan invades
Manchuria 1932.

4. Policy Responses
Herbert Hoover cuts government spending to balance budget;
but also public works & protection (Smoot-Hawley Act).
After 1930 election, Roosevelt introduces New Deal:
Price cartels to support prices;
Labour protection to support wages;
Government expenditure programmes: public works;
Strict bank regulation: Bank Holiday followed by Glass-Steagall Act
of 1934 separates investment banking (issuing & trading stocks) from
commercial banking (taking deposits, making loans).
Unemployment falls, and then rises again after 1936.

In Europe: Nazi Germany & Fascist Italy rearm: ‘Business fascism’

of support for business, while suppressing labour unions.
1931: Britain goes off gold standard: interest rates come down.
France stays on until Popular Front government of 1936.
In Russia/Soviet Union – Five Year Plans promote industrialisation.
Spanish Civil War and the struggle for the future of capitalism.

5. John A. Hobson (1858-1940)

Depression caused by unequal distribution of income & wealth.
Concentrations of wealth/income → excessive saving → speculative
inflation in financial markets + underconsumption.
Solution: redistribution of income & wealth + government support for
industrial investment/new technology.
Limited influence on academics. Large influence in U.S.
(Echoed in contemporary Post-Keynesian ‘wage share’ and
‘financialisation’ criticisms).

6. John Maynard Keynes (1883-1946)

Initial view: financial markets are naturally unstable.
In The General Theory of Employment, Interest and Money (1936)
argued that:
- In a capitalist economy, total output and employment are
determined by the level of investment (Marx’s ‘accumulation of
capital’); but
- Stock market is a ‘casino’ and an unreliable guide to investment;
- Interest rates need to be kept low to encourage investment
(‘euthanasia of the rentier’);
- Adequate investment could ensure full employment; but
unlikely, because of ‘uncertainty’ so fiscal stimulus (deficit
spending by government) needed, i.e.,
- Managed capitalism.

7. Ralph Hawtrey (1879-1971)

Hawtrey, author of the ‘Treasury View’ in 1930s:
- Government borrowing squeezes out saving required for
investment (‘crowding out’);
- Govt. should therefore aim for fiscal surplus (to generate surplus
‘savings’ for business);
- A general fall in wages & prices increases the value of money
→ higher expenditure and employment (‘workers’ friend’
argument for wage reductions); i.e., output and employment
are inversely related to the real wage.
Ineffectiveness of monetary policy.

8. Josef Schumpeter (1883—1950)

In U.S. Josef Schumpeter + Austrians (Hayek, Mises, Rothbard)
supported ‘liquidationist’ view of Andrew Mellon (Hoover’s Treasury
Secretary):
‘Liquidate labor; liquidate stocks; liquidate farmers; liquidate real
estate … it will purge the rottenness out of the system. High costs of
living and high living will come down. People will work harder, live a
more moral life. Values will be adjusted and enterprising people will
pick up from less competent people.’ Weak banks ‘should be weeded
out’.
Schumpeter & ‘liquidationists’ opposed New Deal for preventing
price adjustments that would bring about full employment.

Austrian view: Low interest rates caused excessive investment of

1920s.
Excess capacity needed to be eliminated by depression.
Schumpeter: severity of the 1930s crisis due to coincidence of Kitchin
(short-term), Juglar (9 year investment), Kuznets (15-year
demographic), and Kondratieff (50-year technological) cycles.