(To appreciate today's depression within the context of the last one must first understand the last depression. Here is a most cogent description by the Wise Citizen King. - AM)
The King Report
M. Ramsey King Securities, Inc.
February 11, 2008
We want to take a moment and disabuse our readers of the propaganda that has been spewed for years, ‘if only the Fed had pumped more credit after the 1929 Crash, there would not have been depression.’
This is patently wrong. The Fed and NY Fed went Bernanke after the 1929 Crash and pumped as much credit as it legally could until late 1931 when a global gold run handcuffed the Fed. Interest rates then increased, but for only two quarters.
We pulled out an old reference book over the weekend, Economics and Public Welfare - A Financial and Economic History of the United States, 1914-1946, by Benjamin M. Anderson, a professor who taught at Harvard, Columbia and Cal, and was Chase Bank’s economist from 1920-1939. Professor Anderson notes the Fed and NY Fed aggressively expanded credit after the ’29 crash until they exhausted their ability to create credit in Q3, 1931.
By Q3 1931 the Fed had bought as much collateral they could – the US government only had about $3B of debt issued. This was before FDR created the welfare state and budget deficits generated large issuance of US government debt. And at that time, US law forbade Fed repoing of most instruments.
The stuff hit the fan in 1931, when a series of global crises created global depression. First, Kredit Anstalt went bankrupt on May 12, 1931. Austria collapsed on May 29, 1931. A foreign run on Germany commenced just three days later. The runs of Austria and Germany’s gold supply precipitated an international effort to bail them out in July 1931.
After the international bailout effort failed, a run on England commenced on July 13, 1931. On September 20, 1931, England abandoned the gold standard. Sweden abandoned the gold standard on September 27, 1931. The first run on the US’s gold supply commenced after England’s abandonment.
The run on the US gold supply devastated banking reserves and by law sharply reduced Fed reserves and its ability to create credit. Glass-Steagall mandated that Federal Reserve Notes would be backed 40% by ‘free’ gold. All the Fed’s gold was ‘free’ gold.
“Moreover, Federal Reserve notes were not created by the Federal Reserve banks…they were obligations of the government of the United States issued not by but through Federal Reserve banks. They were issued to the Federal Reserve banks by the government.”
Poignantly, Professor Anderson pens a sub-chapter as, Reckless Buying of Government Securities in 1930 Made for Money Market Tension in Winter of 1931-1932.
“The Federal Reserve System was gambling, using dangerous devices to stave off and unpleasant liquidation, and hoping for a return of the prosperity which was “just around the corner. They succeeded in making cheap money. They succeeded in bringing about a further expansion of bank credit against securities. [Sound familiar?]
But the Federal Reserve System also succeeded in bringing the banking system of the United States into and extremely vulnerable position, tragically revealed when the foreign run on our gold came in late 1931, and when depositors, fearful of individual banks, were taking cash out of these banks and hoarding it.” (p. 263)
Foreigners repatriated gold and other securities from US banks. US citizens and businesses hoarded cash,which produced a cataclysmic collapse in system reserves – sound familiar? We are back to the future.
Interest rates increased in Q4 1931 to Q2 1932 due to the above-mentioned factors. Treasury notes,which had declined from 4.58% in September 1929 to 0.41% by July 1931, increased to 2.41% by December 1931 and 2.42% by May 1932. Commercial paper went from 6.25% in September 1929 to 2% by July 1931. The rates then increased to 4% by December 1931 and declined to 2.75% - 3.5% by May
1932. The Fed shot all its bullets and that fact precipitated a global run on gold and securities in 1931.
One chapter in the book is, The Consequences of Cheap Money Policy in the United States Down to the Summer of 1927. (Five years of cheap money policies)
A long period of egregiously easy money precipitated stock bubbles in the ‘20s and the past 10 years.When the bubbles burst, the Fed created even more cheap credit until the global financial system revolted.