Thursday, July 20, 2006
Causes of the Great Depression
I had a lousy night, and I'm not up to tackling writing projects today, so here's a quick write-up on the cause of the Great Depression. I don't know whether this idea has been mentioned before or not (perhaps it has a long bibliography) so I thought I'd write it up:
As I was reading a compilation of history essays about the nineteen-twenties, “Ain't We Got Fun?” edited by Barbara H. Solomon, I was struck by a large change in consumer behavior in the Roaring Twenties... the spread of product advertising, and the installment plan; fueled by (and fueling) increases in prosperity for ordinary people the like of which we've never seen in our lifetimes: “By 1923 factory workers were averaging twice the cash income they they had earned in 1914.” (page one) Apparently, this widespread acceptance of consumer credit represented an ethical sea change at the time. On page three of the introduction, the editor states that: “Prior to the 1920s the public had held generally negative attitudes toward credit purchasing. Young people were warned against burdening themselves with a lifetime of debt... In the Twenties all that was turned around... Millions of ready buyers were convinced that there was no need to deprive themselves of the magnificent new appliances...” She goes on to say that 15 percent of goods were sold on installment plans, which doesn't count other sources of loans for merchanise.
I wonder if this didn't contribute heavily to the Depression to come – two effects would have helped precipitate it. First, in a one-time shift, a huge number of purchases were moved forward by years, creating the illusion of enormous economic growth; but only an illusion because people weren't necessarily spending more over their lifetimes, it was only that a mass of people chose to spend sooner, creating a burst of growth that couldn't be sustained and didn't represent a growth in productivity or production. That acceleration of spending forward in time may have been trailing to an end by the time the decade was out. Secondly, this change in spending habits also represented a massive drop in savings. In previous decades, when hard times hit, nearly everybody had a substantial cash reserve. Even if they weren't consciously saving for bad times, the ethic passed down to everyone by their parents insisted that this was how one saved up for fairly large household purchases. Therefore, previously, during bad times consumer spending didn't instantly dry up – there was money for at least some goods, although larger purchases would be hit hard. That previous pattern was one which businesses and banks had great experience with, and could well plan for. But the new economy was just different. In a downturn, demand could now become very elastic indeed, plummeting earthward with astounding speed as large blocks of consumers found themselves without any ability to spend, period, since they now had no savings. Now, nearly the whole economy was on the roller-coaster.
Of course, this wasn't the first “Depression”. The very word “Depression” was introduced because it didn't sound quite so bad as the term “Recession”, since that had been used during the last memorable downturn around 1870. But those economic reversals were shorter, and not the same order of catastrophe. The Great Depression turned out to be a whole different sort of beast.
In time, arguably, other factors have ameliorated the greater elasticity of the consumer economy caused by consumer credit – Roosevelt introduced an equal and opposite countervailing force, the forward collection of taxes through payroll deductions during World War II as a cash grab; and increased (relatively inelastic) government spending has smoothed out some bumps as well. Now and then the Federal Reserve changes interest rates in the correct direction, too. In the Thirties, responsible officials understood before the crash that they “should” increase interest rates to curb enthusiasm, but by the time this was clear to them, it was also quite clear that there would likely be a very sharp downturn if they did increase interest rates, and that it was they who would be blamed for the resulting recession, and no-one else. They declined that honor, and let the problem build.
As I was reading a compilation of history essays about the nineteen-twenties, “Ain't We Got Fun?” edited by Barbara H. Solomon, I was struck by a large change in consumer behavior in the Roaring Twenties... the spread of product advertising, and the installment plan; fueled by (and fueling) increases in prosperity for ordinary people the like of which we've never seen in our lifetimes: “By 1923 factory workers were averaging twice the cash income they they had earned in 1914.” (page one) Apparently, this widespread acceptance of consumer credit represented an ethical sea change at the time. On page three of the introduction, the editor states that: “Prior to the 1920s the public had held generally negative attitudes toward credit purchasing. Young people were warned against burdening themselves with a lifetime of debt... In the Twenties all that was turned around... Millions of ready buyers were convinced that there was no need to deprive themselves of the magnificent new appliances...” She goes on to say that 15 percent of goods were sold on installment plans, which doesn't count other sources of loans for merchanise.
I wonder if this didn't contribute heavily to the Depression to come – two effects would have helped precipitate it. First, in a one-time shift, a huge number of purchases were moved forward by years, creating the illusion of enormous economic growth; but only an illusion because people weren't necessarily spending more over their lifetimes, it was only that a mass of people chose to spend sooner, creating a burst of growth that couldn't be sustained and didn't represent a growth in productivity or production. That acceleration of spending forward in time may have been trailing to an end by the time the decade was out. Secondly, this change in spending habits also represented a massive drop in savings. In previous decades, when hard times hit, nearly everybody had a substantial cash reserve. Even if they weren't consciously saving for bad times, the ethic passed down to everyone by their parents insisted that this was how one saved up for fairly large household purchases. Therefore, previously, during bad times consumer spending didn't instantly dry up – there was money for at least some goods, although larger purchases would be hit hard. That previous pattern was one which businesses and banks had great experience with, and could well plan for. But the new economy was just different. In a downturn, demand could now become very elastic indeed, plummeting earthward with astounding speed as large blocks of consumers found themselves without any ability to spend, period, since they now had no savings. Now, nearly the whole economy was on the roller-coaster.
Of course, this wasn't the first “Depression”. The very word “Depression” was introduced because it didn't sound quite so bad as the term “Recession”, since that had been used during the last memorable downturn around 1870. But those economic reversals were shorter, and not the same order of catastrophe. The Great Depression turned out to be a whole different sort of beast.
In time, arguably, other factors have ameliorated the greater elasticity of the consumer economy caused by consumer credit – Roosevelt introduced an equal and opposite countervailing force, the forward collection of taxes through payroll deductions during World War II as a cash grab; and increased (relatively inelastic) government spending has smoothed out some bumps as well. Now and then the Federal Reserve changes interest rates in the correct direction, too. In the Thirties, responsible officials understood before the crash that they “should” increase interest rates to curb enthusiasm, but by the time this was clear to them, it was also quite clear that there would likely be a very sharp downturn if they did increase interest rates, and that it was they who would be blamed for the resulting recession, and no-one else. They declined that honor, and let the problem build.
