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Some Inconvenient Facts About Fiscal Austerity

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Andrew Mellon's infamous advice to Hoover is as good now as it was in 1932: "Liquidate labor, liquidate stocks, liquidate the farmer, and liquidate real estate."

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The 94% annihilation of private fixed investment spending flowed from the same cause. There was a legitimate investment boom in American industry during the 1920s -- especially in capacity to produce the new technologies of automobiles, radio, electric power, and consumer appliances. But by 1929, the Fed had created such a massive bubble on Wall Street that corporations could obtain both equity and debt capital virtually for free. Consequently, industry got massively overbuilt, speculative real estate development was rampant, and inventory accumulation reached precarious levels. Indeed, so great was the over-investment that "payback" time came with a vengeance: During 1932-1934, total private fixed investment including business equipment, structures, and residential housing averaged less than $2 billion per year -- or just 3% of GNP compared to 16% at the 1929 peak.

Finally, Main Street Americans were introduced to the twin wonders of consumer installment credit and stock market margin accounts during the 1920s. When the public's new-found enthusiasm for autos, appliances, and home goods couldn't be funded by these new lines of credit, winnings from the stock market were available to make up the difference. While buying durables and stocks on credit is not an original sin, a central bank policy that caused consumers to plunge off the deep end into unaffordable debt possibly is. In any event, after the music stopped in late 1929, durable goods purchases virtually ceased through the mid-1930s.

In short, the Great Depression had nothing to do with fiscal policy mistakes because the "fisc" in question was self-evidently too small to make a difference. Instead, it was the product of a classic boom and bust cycle that originated in the inflationary finance policies of central banks -- first to fund the carnage of WWI with printing-press money and then to layer on the speculative merriment of the Roaring Twenties.

When viewed in this framework, it's also evident that nostrums about the Great Depression offered by the non-Keynesian catechisms are equally off the mark. The monetarists, following the teachings of Uncle Milton (Friedman), say that the Fed caused the depression. And it did -- but by means of its inflationary monetary policies of 1917-1927, not on account of its stinginess in the provision of money after October 1929. In fact, the Fed was reasonably "easy" in its management of the monetary base after the stock market crash, permitting it to grow by 3% per year during the descent into the Great Depression from late 1929 to January 1933. Thus, the fact that the stock of money fell by nearly 25% during the same period wasn't due to a policy mistake by the Fed in its provision of reserves; rather, the Fed found itself "pushing on a string" in the face of massive loan liquidation owing to defaults and working capital contraction -- the same headwinds thwarting the Fed's hyperactive money string pushing today.

As for the supply-siders, it should be noted that neither Herbert Hoover nor the supply side patron saint, Treasury Secretary Andrew Mellon, committed the heresy of raising the tax burden, either. In 1929 Federal revenues were 3.7% of GNP and declined to 3.2% in 1932. Moreover, with his tax-cutting days of the 1920s long behind him and the reality of a classic boom and bust cycle everywhere evident, the patron saint remained as cogent as ever. In his infamous advice to Hoover in 1932, Mellon admonished: "…liquidate labor, liquidate stocks, liquidate the farmer, and liquidate real estate… ." His advice is as good now as it was then.
No positions in stocks mentioned.

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