Stockman (3) Great Depression

In his book The Great Deformation, David Stockman gives some interesting background on the 1930s Depression. He argues that Ben Bernanke does not understand its cause.

The Great Depression was not caused by the banking crisis. The US depression was rooted in the collapse of global trade, not in some flaw of capitalism or any of the other uniquely domestic afflictions on which the New Deal programs were predicated.

The American economy had been thoroughly internationalised after 1914, and had grown in leaps and bounds as a great export machine and prodigious banker to the world. While it lasted, the export boom of 1914-29 generated strong gains in domestic incomes, which in turned fuelled the post-war rise of the new durables industries like autos and home appliances. The tremendous expansion of export and durables output also triggered the greatest capital spending boom in history. Auto production capacity rose from under 2 million units in 1920 to nearly 6 million in 1929, while completely new industries like radios and washing machines were born almost overnight.

The American economy had been supersized for continuous expansion of exports, but that was its Achilles heel. When international trade collapsed after 1929, the manufacturing and capital goods industries collapsed rapidly.

A crucial element in the expansion of American exports was the $10 million of foreign bonds underwritten by Wall Street. This was the equivalent of $1.5 trillion in today’s values. It was these extensive borrowings which allowed many American export customers to finance their purchases, not unlike the Chinese have been funding the purchase of their exports during the last decade.

The problem was that this growth was not sustainable. When the stock market crashed, this financial fuelled chain of economic expansion snapped and violently unwound. Sales of author dropped like a stone from 5.3 million units in 1929 to 1.4 million vehicles in 1932. This 75% drop in auto sales cascaded through the auto supply chain with devastating impact. The collapse of these growth industries caused a huge cut back in business investment.

The Depression was not caused by a mysterious disappearance of domestic demand as the Keynesian model claims. It was caused by this massive contraction of international trade. After 1929, politicians and bankers all over the world made the problem worse, by raising barriers to trade and financial transfers.

The New Deal pushed pulled and reshuffled the supply of the domestic economy, but it could not regenerate the external markets upon which post -1914 American prosperity had vitally depended.