A Distant Mirror: Credit contraction, monetary policy and commodity prices during the Great Depression John Kemp Reuters 3 January 29
BORROWING BOOM IN 192s. FOLLOWED BY DE-LEVERAGING IN 193s U.S.$ bn 35 3 25 2 15 1 5 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Private sector net debt of which, Corporate net debt Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
U.S.$ mn 1, BEFORE THE CRASH, ROARING TWENTIES SAW HUGE RISE IN DEBT, EQUITY ISSUANCE 9, 8, 7, 6, 5, 4, 3, 2, 1, 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Net issue of new securities (minus retirements) Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
U.S.$ mn 7, RECORD MARGIN LOANS TO FUND EQUITY PURCHASES, DOUBLING 1926-1928, ONE MANIFESTATION OF RAPID FINANCIAL INNOVATION AND INCREASED RISK APPETITE 6, 5, 4, 3, 2, 1, 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Brokers' loans to fund purchase of equities (192-1938) Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
U.S.$ mn 25, ONCE DOWNTURN UNDERWAY, BANKS RESPOND BY SHRINKING BALANCE SHEETS BANK ASSETS FALL 3 PERCENT 193-1934 2, 15, 1, 5, 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Commercial bank assets in the United States Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
U.S.$ mn 25, CONTRACTION HITS REGULAR COMMERCIAL LOANS HARDEST, BANKS SHIFT BALANCE SHEETS TO CASH AND MARKETABLE ASSETS 2, 15, 1, 5, 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Cash Investments Loans Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
U.S.$ mn 9, VOLUME OF BANK LOANS SHRINKS 5 PERCENT BETWEEN 1929 AND 1933 8, 7, 6, 5, 4, 3, 2, 1, 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Outstanding loans and advances by commercial banks in the United States Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
Number, U.S.$ mn 4,5 RESTRICTIVE CREDIT POLICY AND SLUMPING ECONOMY TRIGGER UNPRECEDENTED WAVE OF BANK FAILURES 4, 3,5 3, 2,5 2, 1,5 1, 5 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Number of banks suspended Volume of deposits in suspended institutions Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
Per cent 1 DURING 1933, MORE THAN 8 PERCENT OF ALL BANK DEPOSITS ARE "SUSPENDED" (ie FROZEN) 9 8 7 6 5 4 3 2 1 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Deposit suspensions as percentage of total bank deposits Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
COLLAPSING CONFIDENCE IN THE BANKING SYSTEM DRIVES STRONG PREFERENCE FOR CASH RATHER THAN BANK DEPOSITS U.S.$ bn 6 5 4 3 2 1 192 1921 1922 1923 1924 1925 1926 1927 1928 1929 193 1931 1932 1933 1934 1935 1936 1937 1938 1939 194 Currency held by public Bank deposits Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
DEMAND FOR LIQUIDITY BECOMES EXTREME, DEPOSITS SHRINK EVEN AS CASH DEMAND RISES 12 1 8 6 4 2 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Ratio of bank deposits to currency in circulation Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
US$ bn MONEY SUPPLY CONTRACTS 2-25 PER CENT, INTENSIFYING DOWNWARD PRESSURE ON BUSINESS ACTIVITY AND PRICES 18 16 14 12 1 8 6 4 2 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 M1 (Currency + demand deposits) M2 (Currency + demand deposits + time deposits) Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
Per cent INTENSE DEMAND FOR SAFE, LIQUID INSTRUMENTS DRIVES SHORT-TERM TREASURY BILL RATES CLOSE TO ZERO 8 7 6 5 4 3 2 1 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Yield on 3mth Treasury bills Commercial paper rates for 4-6 mth paper Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
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 1 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 1Yr Aaa Corp Bonds 5Yr Aaa Corp Bonds 1Yr Corp Aaa Bonds Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
Per cent SHARP EASING IN NEARBY RATES ONLY GRADUALLY REFLECTED IN BACK END 8 7 6 5 4 3 2 1 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Commercial paper rates for 4-6 mth paper Yield on 1Yr Aaa-rated corp bonds Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
U.S.$ mn 6, FED STANDS BY AS MONEY SUPPLY AND BANK CREDIT COLLAPSE, NO REAL INCREASE IN FED'S BALANCE SHEET BEFORE 1934-1935 5, 4, 3, 2, 1, 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Consolidated Balance Sheet of the Federal Reserve Banks Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
U.S.$ mn 3, FED LENDING TO THE BANKING SYSTEM REMAINS STUBBORNLY UNCHANGED 1929-33, CENTRAL BANK REFUSES TO BOOST MONEY SUPPLY THROUGH QUANTITATIVE EASING 25, 2, 15, 1, 5, 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Federal Reserve Credit Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
U.S.$ mn 25, LIQUIDITY PILES UP IN FEDERAL RESERVE COMMERCIAL BANKS INCREASE EXCESS RESERVE BALANCES RATHER THAN RAISE LENDING 2, 15, 1, 5, 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Commercial bank reserves with the Federal Reserve System Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
Index Jan 192 = 1 NO SUSTAINABLE RECOVERY IN FARM PRICES UNTIL SECOND WORLD WAR, BUT FARM PRICES HAD BEEN TRENDING LOWER SINCE END OF FIRST WAR 25 225 2 175 15 125 1 75 5 25 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Winter wheat Cotton Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
Index Jan 192 = 1 ENERGY PRICES FALL, BUT RECOVERY UNDERWAY FROM 1934 AND PREVIOUS PRICE LEVEL MOSTLY REGAINED BY 1938 25 225 2 175 15 125 1 75 5 25 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Coke Gasoline Crude oil Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
Index Jan 192 = 1 SHARP GAINS IN METAL PRICES DURING 1936-1937 (STEEL RISES 25 PER CENT IN 1937) FED RAISES RESERVE REQUIREMENTS AMID FEAR EXCESS LIQUIDITY IS DRIVING INFLATION 25 225 2 175 15 125 1 75 5 25 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Steel (billet) Copper Lead Zinc Source: US Census Bureau, Historical Statistics of the United States Printed: 2/2/29
MANUFACTURING OUTPUT AND CONSUMER PRICES 192-1953 INDEX JAN 192 = 1 4 35 3 25 2 15 1 5 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Manufacturing Output Consumer Prices Source: Federal Reserve System, Bureau of Labor Statistics Printed: 2/2/29
CONSUMER AND WHOLESALE PRICES 192-1953 INDEX JAN 192 = 1 2 175 15 125 1 75 5 25 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Consumer Prices Producer Prices Source: Bureau of Labor Statistics Printed: 2/2/29
CYCLICAL RECOVERY AND INTEREST RATES 192-1953 LHS MANUFACTURING INDEX JAN 192 = 1, RHS INTEREST RATES PER CENT 4 16 35 14 3 12 25 1 2 8 15 6 1 4 5 2 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Manufacturing Output FRBNY Discount Rate (RHS) FRBNY advances to banks (RHS) FRBNY other loans secured on US government obligations (RHS) Source: Federal Reserve System Printed: 2/2/29
TIGHTENING OF RESERVE REQUIREMENTS IN 1937-1938 DRAINS $3 BILLION OF EXCESS RESERVES FROM SYSTEM, CONTRACTS CREDIT, AND TRIGGERS SECOND DOWNTURN 4 5 35 45 3 4 25 35 2 3 15 25 1 2 5 15 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 1 Manufacturing Output (LHS) Reserve Requirement (RHS) Source: Federal Reserve System Printed: 2/2/29
SHARE PRICES 192-1953 DOW JONES INDUSTRIAL AVERAGE JAN 192 = 1 4 16 35 14 3 12 25 1 2 8 15 6 1 4 5 2 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 Manufacturing Output Dow Jones Industrial Average FRBNY Discount Rate (RHS) Source: Dow Jones and Co Printed: 2/2/29
FED ABANDONS CONVENTIONAL POLICY AFTER 1934 SWITCHES FROM DISC'NT RATE (COST OF MONEY) TO RESERVE REQ'MENT (QTY OF MONEY) 3. 28. 26. 24. 22. 2. 18. 16. 14. 12. 1. 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 16 14 12 1 8 6 4 2 Fed Reserve Requirements (LHS) FRBNY Discount Rate (RHS) FRBNY advances to banks (RHS) FRBNY other loans secured on US government obligations (RHS) Source: Federal Reserve System Printed: 2/2/29
FED ABANDONS CONVENTIONAL POLICY AFTER 1934 SWITCHES FROM DISC'NT RATE (COST OF MONEY) TO RESERVE REQ'MENT (QTY OF MONEY) 3. 28. 26. 24. 22. 2. 18. 16. 14. 12. 1. 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 16 14 12 1 8 6 4 2 Fed Reserve Requirements (LHS) FRBNY Discount Rate (RHS) FRBNY advances to banks (RHS) FRBNY other loans secured on US government obligations (RHS) Source: Federal Reserve System Printed: 2/2/29
FED ABANDONS CONVENTIONAL POLICY AFTER 1934 SWITCHES FROM DISC'NT RATE (COST OF MONEY) TO RESERVE REQ'MENT (QTY OF MONEY) 3. 28. 26. 24. 22. 2. 18. 16. 14. 12. 1. 192 1922 1924 1926 1928 193 1932 1934 1936 1938 194 1942 1944 1946 1948 195 1952 16 14 12 1 8 6 4 2 Fed Reserve Requirements (LHS) FRBNY Discount Rate (RHS) FRBNY advances to banks (RHS) FRBNY other loans secured on US government obligations (RHS) Source: Federal Reserve System Printed: 2/2/29