Revival in early 1930
The New York stock market leveled off in the first few months of 1930… and so did a variety of other indicators, including industrial production, imports, and employment. Employment actually picked up from the December level. Prices continued to decline in a number of commodities – cocoa, coffee, rubber hides, silks, copper, tin – during the first quarter, but less precipitously than in the closing three months of 1929. On May 1 President Hoover stated that the United States was not through its difficulties but that he was convinced that the country had passed the worst. Correct on the first score, he could hardly have been more wrong on the second.
On one view of the depression, the continued revival of international long-term lending was vital. Those who blamed the depression on the preceding boom or inflation were typically not moved to make lending easy. They thought it necessary to put the system through the wringer, to liquidate the mistakes of the past and eliminate dead wood. Their ranks included such economists as Robbins and Hayek and, in the US government, the secretary of the Treasury, Andrew Mellon. Opposing them were many differing schools of thought, ranging from monetarists, market stabilizers, and interventionists to planners, all of whom thought it useful, however, to bolster rather than liquidate markets. The issue is fundamental. In a stabilized world, a recession in one part of the world economy is balanced by expanded lending by the depressed country. This finances balance-of-payments deficits of other countries and enables investment to be maintained. Britain operated such a mechanism in the years before 1914; it was unable to do so after 1929. The United States cut its spending on the products of the rest of the world. But neither it nor France proved able or willing to maintain the system with loans.
It is not entirely clear why this was so…
One reason was that many potential borrowers had lost their creditworthiness. Bankruptcy, default, currency depreciation, political coups, and especially falling commodity and asset prices made many domestic businesses and foreign countries unattractive risks for loans. Interest rates declined on relatively safe commercial paper in the United States and held steady for government bonds. From Augustv1930 the yield on second-rate corporate bonds (Baa) started upward.
The conference to settle the details of the tariff truce, proposed in 1929 as a holding action while the tariff reductions agreed to in principle at the World Economic Conference in 1927 were worked out, finally convened in February 1930. The time was not propitious. The Smoot-Hawley Tariff Act had passed the House of Representatives in May 1929 and was under intensive study in the Senate….
Let us agree that the Smoot-Hawley Tariff Act, after taking retaliation into account, was a deflationary force. The real failure, then, was in leadership. Hoover can perhaps be forgiven for thinking of agricultural tariffs in the 1928 presidential campaign. Tariffs were, as Schumpeter put it, “the household remedy” of the Republican party. The error was in treating it as a sovereign remedy, given to all who asked.
In finishing the narrative for this chapter of his book on the Great Depression, Kindleberger describes the disequilibrium of debt deflation. He says that credit came to a halt because falling prices meant assets did not support new lending while the lack of lending caused asset prices to fall further. He says that:
“the process remains puzzling. Did the decline in lending emanate from the demand or the supply side? The rapid reduction in interest rates suggests the former, but the New York capital market may well have been rationed, as London was unwilling to lend at lower rates because of the dubious prospects for debt service in a world of falling prices. Would a more experienced capital market have carried through a sustained revival of lending in recession, whereas New York, having overdone it in one direction, now overdid it in the other? The decline in prices and the halt of the precarious revival of long-term lending in the spring of 1930 are critical in the length and depth of the depression, as they led to the financial crisis of 1931. Their explication is still unclear, although they had nothing to do with the money supply.”
I say no; a more experienced capital market would have made no difference in 1930 and 1931. What invariably happens is that large trade imbalances become a flashpoint during periods of economic weakness. Nationalism takes over as ‘out-groups’ are blamed for economic trouble. Protectionism and trade conflict, then, are inevitable unless policy makers find a way to revive the economy. And if protectionism results in retaliation and lower economic growth, expect debt deflation to take hold until substantially more credit writedowns are taken and asset prices like property and stocks can again be supported by a conservative forecast of the stream of income they will throw off.
Source: “The Slide to the Abyss”, The World In Depression – Charles P. Kindleberger