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An Economic History of New Zealand in the Nineteenth and Twentieth Centuries

John Singleton, Victoria University of Wellington, New Zealand

Living standards in New Zealand were among the highest in the world between the late nineteenth century and the 1960s. But New Zealand’s economic growth was very sluggish between 1950 and the early 1990s, and most Western European countries, as well as several in East Asia, overtook New Zealand in terms of real per capita income. By the early 2000s, New Zealand’s GDP per capita was in the bottom half of the developed world.

Table 1:
Per capita GDP in New Zealand
compared with the United States and Australia
(in 1990 international dollars)

US Australia New Zealand NZ as
% of US
NZ as % of
Austrialia
1840 1588 1374 400 25 29
1900 4091 4013 4298 105 107
1950 9561 7412 8456 88 114
2000 28129 21540 16010 57 74

Source: Angus Maddison, The World Economy: Historical Statistics. Paris: OECD, 2003, pp. 85-7.

Over the second half of the twentieth century, argue Greasley and Oxley (1999), New Zealand seemed in some respects to have more in common with Latin American countries than with other advanced western nations. As well as a snail-like growth rate, New Zealand followed highly protectionist economic policies between 1938 and the 1980s. (In absolute terms, however, New Zealanders continued to be much better off than their Latin American counterparts.) Maddison (1991) put New Zealand in a middle-income group of countries, including the former Czechoslovakia, Hungary, Portugal, and Spain.

Origins and Development to 1914

When Europeans (mainly Britons) started to arrive in Aotearoa (New Zealand) in the early nineteenth century, they encountered a tribal society. Maori tribes made a living from agriculture, fishing, and hunting. Internal trade was conducted on the basis of gift exchange. Maori did not hold to the Western concept of exclusive property rights in land. The idea that land could be bought and sold was alien to them. Most early European residents were not permanent settlers. They were short-term male visitors involved in extractive activities such as sealing, whaling, and forestry. They traded with Maori for food, sexual services, and other supplies.

Growing contact between Maori and the British was difficult to manage. In 1840 the British Crown and some Maori signed the Treaty of Waitangi. The treaty, though subject to various interpretations, to some extent regularized the relationship between Maori and Europeans (or Pakeha). At roughly the same time, the first wave of settlers arrived from England to set up colonies including Wellington and Christchurch. Settlers were looking for a better life than they could obtain in overcrowded and class-ridden England. They wished to build a rural and largely self-sufficient society.

For some time, only the Crown was permitted to purchase land from Maori. This land was then either resold or leased to settlers. Many Maori felt – and many still feel – that they were forced to give up land, effectively at gunpoint, in return for a pittance. Perhaps they did not always grasp that land, once sold, was lost forever. Conflict over land led to intermittent warfare between Maori and settlers, especially in the 1860s. There was brutality on both sides, but the Europeans on the whole showed more restraint in New Zealand than in North America, Australia, or Southern Africa.

Maori actually required less land in the nineteenth century because their numbers were falling, possibly by half between the late eighteenth and late nineteenth centuries. By the 1860s, Maori were outnumbered by British settlers. The introduction of European diseases, alcohol, and guns contributed to the decline in population. Increased mobility and contact between tribes may also have spread disease. The Maori population did not begin to recover until the twentieth century.

Gold was discovered in several parts of New Zealand (including Thames and Otago) in the mid-nineteenth century, but the introduction of sheep farming in the 1850s gave a more enduring boost to the economy. Australian and New Zealand wool was in high demand in the textile mills of Yorkshire. Sheep farming necessitated the clearing of native forests and the planting of grasslands, which changed the appearance of large tracts of New Zealand. This work was expensive, and easy access to the London capital market was critical. Economic relations between New Zealand and Britain were strong, and remained so until the 1970s.

Between the mid-1870s and mid-1890s, New Zealand was adversely affected by weak export prices, and in some years there was net emigration. But wool prices recovered in the 1890s, just as new exports – meat and dairy produce – were coming to prominence. Until the advent of refrigeration in the early 1880s, New Zealand did not export meat and dairy produce. After the introduction of refrigeration, however, New Zealand foodstuffs found their way on to the dinner tables of working class families in Britain, but not the tables of the middle and upper classes, as they could afford fresh produce.

In comparative terms, the New Zealand economy was in its heyday in the two decades before 1914. New Zealand (though not its Maori shadow, Aotearoa) was a wealthy, dynamic, and egalitarian society. The total population in 1914 was slightly above one million. Exports consisted almost entirely of land-intensive pastoral commodities. Manufactures loomed large in New Zealand’s imports. High labor costs, and the absence of scale economies in the tiny domestic market, hindered industrialization, though there was some processing of export commodities and imports.

War, Depression and Recovery, 1914-38

World War One disrupted agricultural production in Europe, and created a robust demand for New Zealand’s primary exports. Encouraged by high export prices, New Zealand farmers borrowed and invested heavily between 1914 and 1920. Land exchanged hands at very high prices. Unfortunately, the early twenties brought the start of a prolonged slump in international commodity markets. Many farmers struggled to service and repay their debts.

The global economic downturn, beginning in 1929-30, was transmitted to New Zealand by the collapse in commodity prices on the London market. Farmers bore the brunt of the depression. At the trough, in 1931-32, net farm income was negative. Declining commodity prices increased the already onerous burden of servicing and repaying farm mortgages. Meat freezing works, woolen mills, and dairy factories were caught in the spiral of decline. Farmers had less to spend in the towns. Unemployment rose, and some of the urban jobless drifted back to the family farm. The burden of external debt, the bulk of which was in sterling, rose dramatically relative to export receipts. But a protracted balance of payments crisis was avoided, since the demand for imports fell sharply in response to the drop in incomes. The depression was not as serious in New Zealand as in many industrial countries. Prices were more flexible in the primary sector and in small business than in modern, capital-intensive industry. Nevertheless, the experience of depression profoundly affected New Zealanders’ attitudes towards the international economy for decades to come.

At first, there was no reason to expect that the downturn in 1929-30 was the prelude to the worst slump in history. As tax and customs revenue fell, the government trimmed expenditure in an attempt to balance the budget. Only in 1931 was the severity of the crisis realized. Further cuts were made in public spending. The government intervened in the labor market, securing an order for an all-round reduction in wages. It pressured and then forced the banks to reduce interest rates. The government sought to maintain confidence and restore prosperity by helping farms and other businesses to lower costs. But these policies did not lead to recovery.

Several factors contributed to the recovery that commenced in 1933-34. The New Zealand pound was devalued by 14 percent against sterling in January 1933. As most exports were sold for sterling, which was then converted into New Zealand pounds, the income of farmers was boosted at a stroke of the pen. Devaluation increased the money supply. Once economic actors, including the banks, were convinced that the devaluation was permanent, there was an increase in confidence and in lending. Other developments played their part. World commodity prices stabilized, and then began to pick up. Pastoral output and productivity continued to rise. The 1932 Ottawa Agreements on imperial trade strengthened New Zealand’s position in the British market at the expense of non-empire competitors such as Argentina, and prefigured an increase in the New Zealand tariff on non-empire manufactures. As was the case elsewhere, the recovery in New Zealand was not the product of a coherent economic strategy. When beneficial policies were adopted it was as much by accident as by design.

Once underway, however, New Zealand’s recovery was comparatively rapid and persisted over the second half of the thirties. A Labour government, elected towards the end of 1935, nationalized the central bank (the Reserve Bank of New Zealand). The government instructed the Reserve Bank to create advances in support of its agricultural marketing and state housing schemes. It became easier to obtain borrowed funds.

An Insulated Economy, 1938-1984

A balance of payments crisis in 1938-39 was met by the introduction of administrative restrictions on imports. Labour had not been prepared to deflate or devalue – the former would have increased unemployment, while the latter would have raised working class living costs. Although intended as a temporary expedient, the direct control of imports became a distinctive feature of New Zealand economic policy until the mid-1980s.

The doctrine of “insulationism” was expounded during the 1940s. Full employment was now the main priority. In the light of disappointing interwar experience, there were doubts about the ability of the pastoral sector to provide sufficient work for New Zealand’s growing population. There was a desire to create more industrial jobs, even though there seemed no prospect of achieving scale economies within such a small country. Uncertainty about export receipts, the need to maintain a high level of domestic demand, and the competitive weakness of the manufacturing sector, appeared to justify the retention of quantitative import controls.

After 1945, many Western countries retained controls over current account transactions for several years. When these controls were relaxed and then abolished in the fifties and early sixties, the anomalous nature of New Zealand’s position became more visible. Although successive governments intended to liberalize, in practice they achieved little, except with respect to trade with Australia.

The collapse of the Korean War commodity boom, in the early 1950s, marked an unfortunate turning point in New Zealand’s economic history. International conditions were unpropitious for the pastoral sector in the second half of the twentieth century. Despite the aspirations of GATT, the United States, Western Europe and Japan restricted agricultural imports, especially of temperate foodstuffs, subsidized their own farmers and, in the case of the Americans and the Europeans, dumped their surpluses in third markets. The British market, which remained open until 1973, when the United Kingdom was absorbed into the EEC, was too small to satisfy New Zealand. Moreover, even the British resorted to agricultural subsidies. Compared with the price of industrial goods, the price of agricultural produce tended to weaken over the long term.

Insulation was a boon to manufacturers, and New Zealand developed a highly diversified industrial structure. But competition was ineffectual, and firms were able to pass cost increases on to the consumer. Import barriers induced many British, American, and Australian multinationals to establish plants in New Zealand. The protected industrial economy did have some benefits. It created jobs – there was full employment until the 1970s – and it increased the stock of technical and managerial skills. But consumers and farmers were deprived of access to cheaper – and often better quality – imported goods. Their interests and welfare were neglected. Competing demand from protected industries also raised the costs of farm inputs, including labor power, and thus reduced the competitiveness of New Zealand’s key export sector.

By the early 1960s, policy makers had realized that New Zealand was falling behind in the race for greater prosperity. The British food market was under threat, as the Macmillan government began a lengthy campaign to enter the protectionist EEC. New Zealand began to look for other economic partners, and the most obvious candidate was Australia. In 1901, New Zealand had declined to join the new federation of Australian colonies. Thus it had been excluded from the Australian common market. After lengthy negotiations, a partial New Zealand-Australia Free Trade Agreement (NAFTA) was signed in 1965. Despite initial misgivings, many New Zealand firms found that they could compete in the Australian market, where tariffs against imports from the rest of the world remained quite high. But this had little bearing on their ability to compete with European, Asian, and North American firms. NAFTA was given renewed impetus by the Closer Economic Relations (CER) agreement of 1983.

Between 1973 and 1984, New Zealand governments were overwhelmed by a group of inter-related economic crises, including two serious supply shocks (the oil crises), rising inflation, and increasing unemployment. Robert Muldoon, the National Party (conservative) prime minister between 1975 and 1984, pursued increasingly erratic macroeconomic policies. He tightened government control over the economy in the early eighties. There were dramatic fluctuations in inflation and in economic growth. In desperation, Muldoon imposed a wage and price freeze in 1982-84. He also mounted a program of large-scale investments, including the expansion of a steel works, and the construction of chemical plants and an oil refinery. By means of these investments, he hoped to reduce the import bill and secure a durable improvement in the balance of payments. But the “Think Big” strategy failed – the projects were inadequately costed, and inherently risky. Although Muldoon’s intention had been to stabilize the economy, his policies had the opposite effect.

Economic Reform, 1984-2000

Muldoon’s policies were discredited, and in 1984 the Labour Party came to power. All other economic strategies having failed, Labour resolved to deregulate and restore the market process. (This seemed very odd at the time.) Within a week of the election, virtually all controls over interest rates had been abolished. Financial markets were deregulated, and, in March 1985, the New Zealand dollar was floated. Other changes followed, including the sale of public sector trading organizations, the reduction of tariffs and the elimination of import licensing. However, reform of the labor market was not completed until the early 1990s, by which time National (this time without Muldoon or his policies) was back in office.

Once credit was no longer rationed, there was a large increase in private sector borrowing, and a boom in asset prices. Numerous speculative investment and property companies were set up in the mid-eighties. New Zealand’s banks, which were not used to managing risk in a deregulated environment, scrambled to lend to speculators in an effort not to miss out on big profits. Many of these ventures turned sour, especially after the 1987 share market crash. Banks were forced to reduce their lending, to the detriment of sound as well as unsound borrowers.

Tight monetary policy and financial deregulation led to rising interest rates after 1984. The New Zealand dollar appreciated strongly. Farmers bore the initial brunt of high borrowing costs and a rising real exchange rate. Manufactured imports also became more competitive, and many inefficient firms were forced to close. Unemployment rose in the late eighties and early nineties. The early 1990s were marked by an international recession, which was particularly painful in New Zealand, not least because of the high hopes raised by the post-1984 reforms.

An economic recovery began towards the end of 1991. With a brief interlude in 1998, strong growth persisted for the remainder of the decade. Confidence was gradually restored to the business sector. Unemployment began to recede. After a lengthy time lag, the economic reforms seemed to be paying off for the majority of the population.

Large structural changes took place after 1984. Factors of production switched out of the protected manufacturing sector, and were drawn into services. Tourism boomed as the relative cost of international travel fell. The face of the primary sector also changed, and the wine industry began to penetrate world markets. But not all manufacturers struggled. Some firms adapted to the new environment and became more export-oriented. For instance, a small engineering company, Scott Technology, became a world leader in the provision of equipment for the manufacture of refrigerators and washing machines.

Annual inflation was reduced to low single digits by the early nineties. Price stability was locked in through the 1989 Reserve Bank Act. This legislation gave the central bank operational autonomy, while compelling it to focus on the achievement and maintenance of price stability rather than other macroeconomic objectives. The Reserve Bank of New Zealand was the first central bank in the world to adopt a regime of inflation targeting. The 1994 Fiscal Responsibility Act committed governments to sound finance and the reduction of public debt.

By 2000, New Zealand’s population was approaching four million. Overall, the reforms of the eighties and nineties were responsible for creating a more competitive economy. New Zealand’s economic decline relative to the rest of the OECD was halted, though it was not reversed. In the nineties, New Zealand enjoyed faster economic growth than either Germany or Japan, an outcome that would have been inconceivable a few years earlier. But many New Zealanders were not satisfied. In particular, they were galled that their closest neighbor, Australia, was growing even faster. Australia, however, was an inherently much wealthier country with massive mineral deposits.

Assessment

Several explanations have been offered for New Zealand’s relatively poor economic performance during the twentieth century.

Wool, meat, and dairy produce were the foundations of New Zealand’s prosperity in Victorian and Edwardian times. After 1920, however, international market conditions were generally unfavorable to pastoral exports. New Zealand had the wrong comparative advantage to enjoy rapid growth in the twentieth century.

Attempts to diversify were only partially successful. High labor costs and the small size of the domestic market hindered the efficient production of standardized labor-intensive goods (e.g. garments) and standardized capital-intensive goods (e.g. autos). New Zealand might have specialized in customized and skill-intensive manufactures, but the policy environment was not conducive to the promotion of excellence in niche markets. Between 1938 and the 1980s, Latin American-style trade policies fostered the growth of a ramshackle manufacturing sector. Only in the late eighties did New Zealand decisively reject this regime.

Geographical and geological factors also worked to New Zealand’s disadvantage. Australia drew ahead of New Zealand in the 1960s, following the discovery of large mineral deposits for which there was a big market in Japan. Staple theory suggests that developing countries may industrialize successfully by processing their own primary products, instead of by exporting them in a raw state. Canada had coal and minerals, and became a significant industrial power. But New Zealand’s staples of wool, meat and dairy produce offered limited downstream potential.

Canada also took advantage of its proximity to the U.S. market, and access to U.S. capital and technology. American-style institutions in the labor market, business, education and government became popular in Canada. New Zealand and Australia relied on, arguably inferior, British-style institutions. New Zealand was a long way from the world’s economic powerhouses, and it was difficult for its firms to establish and maintain contact with potential customers and collaborators in Europe, North America, or Asia.

Clearly, New Zealand’s problems were not all of its own making. The elimination of agricultural protectionism in the northern hemisphere would have given a huge boost the New Zealand economy. On the other hand, in the period between the late 1930s and mid-1980s, New Zealand followed inward-looking economic policies that hindered economic efficiency and flexibility.

References

Bassett, Michael. The State in New Zealand, 1840-1984. Auckland: Auckland University Press, 1998.

Belich, James. Making Peoples: A History of the New Zealanders from Polynesian Settlement to the End of the Nineteenth Century, Auckland: Penguin, 1996.

Condliffe, John B. New Zealand in the Making. London: George Allen & Unwin, 1930.

Dalziel, Paul. “New Zealand’s Economic Reforms: An Assessment.” Review of Political Economy 14, no. 2 (2002): 31-46.

Dalziel, Paul and Ralph Lattimore. The New Zealand Macroeconomy: Striving for Sustainable Growth with Equity. Melbourne: Oxford University Press, fifth edition, 2004.

Easton, Brian. In Stormy Seas: The Post-War New Zealand Economy. Dunedin: University of Otago Press, 1997.

Endres, Tony and Ken Jackson. “Policy Responses to the Crisis: Australasia in the 1930s.” In Capitalism in Crisis: International Responses to the Great Depression, edited by Rick Garside, 148-65. London: Pinter, 1993.

Evans, Lewis, Arthur Grimes, and Bryce Wilkinson (with David Teece), “Economic Reform in New Zealand 1984-95: The Pursuit of Efficiency.” Journal of Economic Literature 34, no. 4 (1996): 1856-1902.

Gould, John D. The Rake’s Progress: the New Zealand Economy since 1945. Auckland: Hodder and Stoughton, 1982.

Greasley, David and Les Oxley. “A Tale of Two Dominions: Comparing the Macroeconomic Records of Australia and Canada since 1870.” Economic History Review 51, no. 2 (1998): 294-318.

Greasley, David and Les Oxley. “Outside the Club: New Zealand’s Economic Growth, 1870-1993.” International Review of Applied Economics 14, no. 2 (1999): 173-92.

Greasley, David and Les Oxley. “Regime Shift and Fast Recovery on the Periphery: New Zealand in the 1930s.” Economic History Review 55, no. 4 (2002): 697-720.

Hawke, Gary R. The Making of New Zealand: An Economic History. Cambridge: Cambridge University Press, 1985.

Jones, Steve R.H. “Government Policy and Industry Structure in New Zealand, 1900-1970.” Australian Economic History Review 39, no, 3 (1999): 191-212.

Mabbett, Deborah. Trade, Employment and Welfare: A Comparative Study of Trade and Labour Market Policies in Sweden and New Zealand, 1880-1980. Oxford: Clarendon Press, 1995.

Maddison, Angus. Dynamic Forces in Capitalist Development. Oxford: Oxford University Press, 1991.

Maddison, Angus. The World Economy: Historical Statistics. Paris: OECD, 2003.

McKinnon, Malcolm. Treasury: 160 Years of the New Zealand Treasury. Auckland: Auckland University Press in association with the Ministry for Culture and Heritage, 2003.

Schedvin, Boris. “Staples and Regions of the Pax Britannica.” Economic History Review 43, no. 4 (1990): 533-59.

Silverstone, Brian, Alan Bollard, and Ralph Lattimore, editors. A Study of Economic Reform: The Case of New Zealand. Amsterdam: Elsevier, 1996.

Singleton, John. “New Zealand: Devaluation without a Balance of Payments Crisis.” In The World Economy and National Economies in the Interwar Slump, edited by Theo Balderston, 172-90. Basingstoke: Palgrave, 2003.

Singleton, John and Paul L. Robertson. Economic Relations between Britain and Australasia, 1945-1970. Basingstoke: Palgrave, 2002.

Ville, Simon. The Rural Entrepreneurs: A History of the Stock and Station Agent Industry in Australia and New Zealand. Cambridge: Cambridge University Press, 2000.

Citation: Singleton, John. “New Zealand in the Nineteenth and Twentieth Centuries”. EH.Net Encyclopedia, edited by Robert Whaples. February 10, 2008. URL http://eh.net/encyclopedia/an-economic-history-of-new-zealand-in-the-nineteenth-and-twentieth-centuries/

Harold Adams Innis

Robin Neill, University of Prince Edward Island

Harold Innis has been called “the first Canadian-born social scientist to achieve an international reputation” and “the father of Canadian Economic History.” He was the second president of the Economic History Association (1942-1944) and the fifty-fourth President of the American Economic Association (1951). He has been credited with joint authorship of the Staple Theory of Canadian Economic Development (W.T. Easterbrook, 967, p. 261). In a backhanded posthumous complement a Keynesian said of him that he led the Canadian economics profession down the wrong path for fifteen years.

Innis’s influence in Canadian social science was pervasive in the pre-Keynesian period. His studies of the fur trade, the cod fisheries, and the mining and forest frontiers broke new ground, and provided an economic underpinning for the Laurentian School of Canadian historians. His students, W.T. Easterbrook, Hugh G.J. Aitken, Albert Faucher, and two of the then famous four Saskatonians, Vernon C. Fowke and Kenneth A.H. Buckley, are still cited in current Canadian economic history texts. The building-of-the-Canadian-nation histories that typified the Laurentian School have lost some of their appeal. Regional and community histories are now more frequently celebrated. Close reading of Innis, and particularly of Fowke (R.F. Neill, 1999), however, shows the two to have made a greater contribution in this regard than one would surmise from reading the general texts that draw on their work.

Innis’s influence in economic history in general has been considerable. His reworking of the “vent for surplus” theory of economic development, that is the “staple,” “primary products” or “export base” theory of economic development, was extended by Douglass North in applications to regional development in the United States, and to the experience of what were then called underdeveloped countries. Subsequently it was elaborated in generalized export-base models used to describe the experience of newly industrializing countries.

Innis’s contribution to historical economics, we have to assume, was noted. His success in the profession would indicate that it was. But that sort of Old Institutional, historical theorizing fell out of fashion after the Second World War. Neither Innis’s “cyclonics” nor J.M Clark’s “non Euclidian economics” had any formal standing in the period following general acceptance of Keynesian macroeconomic theory. Nonetheless, Innis had some influence beyond economic history. His most celebrated student, Harry G. Johnson, referred back to Innis as his “greatest teacher in economics” (Johnson and Johnson, 1978, p. 234).

The studies of communication media that characterized the so-called “later Innis” were not understood by, or, better, were outside the grasp of, economists preoccupied with positivistic testing of neoclassical, neo-Keynesian, and Monetarist-New Classical hypotheses. The root of the media studies can be traced back to the work of nineteenth-century historical economists, such as J.K. Ingram, who had much to say about “the prevalent mode of thinking” that shaped the nature of economic theory in any given period (Ingram, 1888, p. 2-3). Innis’s studies of communication media were an attempt to specify one causal factor in changes in the prevalent mode of thinking. His approach gave him grounds for assessing the economics profession itself.

He was not alone in this. J.J. Spengler, whose work also emerged from 1930s discussion of the nature of economics, also adopted an “external” approach to the history of economics (Spengler, 1940). This approach has had considerable acceptance among historians of economic thought, and it has been taken up by intellectual historians in general. Indeed, it gained high fashion following Michel Foucault’s discussion of the biased information environments that he called “epistemes,” and following Jacques Derrida’s emphasis on the linguistic context of all knowledge, both of which were related to analyses of prevalent modes of thinking.

Harold Adams Innis was born on November 5, 1894, in Otterville, Ontario, the first born of William Anson and Mary (Adams) Innis. His parents worked a hundred-acre farm outside of Otterville in Oxford County. At age eleven Harold was admitted to the Otterville high school. Two years later, in the fall of 1908, he began commuting twenty miles to the Woodstock Collegiate Institute. After graduation, he taught grade school for a year and then registered at McMaster University in Hamilton at the western end of Lake Ontario. The First World War interrupted his education. Upon graduating from McMaster, in the spring of 1916, he enlisted in the Canadian Army. By Christmas his group, the 69th Battery, was on the front in France. By the end of July, Innis had been wounded and sent to England for convalescence. During his stay in England he studied for a Master’s degree through a wartime institution called Khaki College. On arrival back in Canada he passed the examination for an M.A. in Economics. Disappointment over what he had learned was a major motivation in his enrolling in the doctoral program at the University of Chicago, a Baptist institution appropriate for one raised strictly in that faith.

When Innis arrived at Chicago there was considerable dissent in the United States with respect to the tenets of neoclassical economic theory. Its fundamental assumptions were being questioned by the Institutionalist Thorstein Veblen and by his student and colleague, John R. Commons. Some of the controversy was brought to Innis’s attention by his mentors, C.W. Wright and C.S. Duncan, but his most effective contact with current economic thought was through Frank H. Knight, who was then an instructor at Chicago. Knight’s skepticism captured Innis’s imagination and drew him into a small, informal group, including Carter Goodrich, Morris Copeland, W.B. Smith, J.W. Angel, and, of course, Knight himself. Their discussions focused on the nature and implications of Veblen’s critique of received economic doctrine.

Innis returned to Canada in 1920 to take a position in the Department of Political Economy at the University of Toronto. With the exception of its redoubtable Head, James Mavor, the Department was young and aware that it had the economics of Canada still to discover. Mavor had attempted an introduction to Canadian economic history, but had left it unfinished. C.R. Fay, the economic historian, was at Toronto in those years, and was aware that there was something to be done. He and Innis became life long friends in their mutual endeavor to see that it did. V.W. Bladen, recently arrived from Oxford, was pulled into the effort by Innis who insisted that Bladen could not understand the economics of Canada unless he personally visited every part of it.

The first fifteen of Innis’s years at Toronto were a difficult but fruitful time. He was not always understood, and, at one point, he was withdrawn from teaching a course because he pursued its subject “along too radical lines.” Still, his efforts began to produce results with the 1930 publication of his own introduction to Canadian economic history, The Fur Trade of Canada. Following the 1929 stock market crash, the Canadian Political Science Association was reestablished. Innis was deeply involved. A year earlier, with the help of the Bladens, he initiated a periodical, Contributions to Canadian Economics. The publication provided a medium for the Canadian Political Science Association, and its success in that capacity was a major factor in the Association’s decision to launch the Canadian Journal of Economics and Political Science. Innis’s contributions to the literature on Canadian economic history, and his involvement in the institutionalization of economics brought public recognition. In 1934 he was elected fellow of the Royal Society of Canada. He was promoted to Full Professor rank in 1936. He was an invited member of the Nova Scotia Royal Commission of Economic Enquiry in 1933. In 1937 he was appointed Head of the Department of Political Economy at the University of Toronto, and he remained Head until his death in 1952. From 1947 until 1952 he was Dean of Graduate Studies at Toronto, and had, in the meantime been a member of a Federal Royal Commission on Transportation. These public appointments say much for his influence on the economics profession in Canada, but they are not the end of it. He took a personal interest in the politics of the Department of Economics and Political Science at the University of Saskatchewan, which was headed by his student and close friend George Britnell. Perhaps his greatest influence was exercised through Canada’s Social Science Research council of which he was Chairman in 1945-46, and Chairman of the Grants-in-Aid Committee for its first nine years. Funds then available to assist research in the social sciences were minuscule by later standards, but none were allocated without Innis’s concurrence. He met regularly with Anne Bezanson, another sometime president of the EHA, who represented the Carnegie Foundation. Together they poured over names and projects related to social science research in Canada. In recommending reorganization of the Canadian Social Science Research Council in 1968, Mabel Timlin stated that in the beginning elaborate organization was not needed because Innis knew everyone.

For all his involvement in the institutionalization of economics in Canada, Innis did not withdraw from contacts in the United States. He was involved in the founding of the Economic History Association and the launching of the Journal of Economic History. He was the Association’s second president, and was deeply involved with the Committee on Research in Economic History, sponsored by the Social Science Research Council of the United States. It was these activities that brought Innis into close contact with American economic historians, Arthur H. Cole, Anne Bezanson, Robert B. Warren, and Earl J. Hamilton. At the same time Innis continued his interest in the general debates over the nature of economics in the United States, reviving his interaction with Frank Knight and eventually leading to his presidency of the American Economics Association in 1951. Innis has been the only president of the Economic History Association or the American Economic Association never to become an American citizen.

The lines of cleavage in the 1930s American debate over the nature of economics are now being clarified (Yonay, 1998; Morgan and Rutherford, 1998). One was drawn over the extent to which the values of elites should direct government economic policy. Another was drawn over the role of values in social science in general, but, particularly, in economics. With respect to these cleavages, Innis found himself in opposition to Frank Underhill and the socialist League for Social Reconstruction, which was active at the University of Toronto. Knight opposed the interventionist economics of the New Deal “brains trust” economist Guy Rexford Tugwell. Neither Innis nor Knight was well disposed towards the rise of Keynesian macroeconomics. Innis found it to be too interventionist given what he thought to be the unreliable state of the economics on which it was based. Perhaps it was for this reason that, from 1943 to 1947, Innis had an open invitation from the University of Chicago, where other, now famous, dissenters were gathering (Kitch, 1983).

Harold Innis died November 8, 1952. He was at the peak of his career. He had been invited to give the Beit Lectures in Imperial History at Oxford in 1949. While in England he was invited to give the Cust Lecture at Nottingham, and he spoke at the University of London. His thesis was, perhaps, not clearly presented, and not well received. Still, he continued to develop it over the succeeding years, leaving behind a body of writing well ahead of its time in intellectual history, and well off from contemporary paradigms in economics.

Selected Publications of Harold Innis: Books and Collections of Articles

A History of the Canadian Pacific Railway. London: P.S. King, 1923; Toronto: University of Toronto Press, 1971.

The Fur Trade in Canada: An Introduction to Canadian Economic History. New Haven: Yale University Press, 1930.

Peter Pond: Fur Trader and Adventurer. Toronto, 1930.

Select Documents in Canadian Economic History, Volume 1 (1497-1783), Volume 2 (1783-1885), co-edited with A.R.M. Lower. Toronto: University of Toronto Press, 1929 and 1933.

Problems of Staple Production in Canada. Toronto: University of Toronto Press, 1933.

Settlement and the Mining Frontier. Toronto: University of Toronto Press, Toronto, 1936.

The Cod Fisheries: The History of an International Economy. New Haven: Yale University Press, 1940.

Political Economy and the Modern State. Toronto: University of Toronto Press, 1946.

Empire and Communications. Oxford: Clarendon Press, 1950.

The Bias of Communication. Toronto: University of Toronto Press, 1951.

Changing Concepts of Time. Toronto: University of Toronto Press, 1952.

Essays in Canadian Economic History, ( M.Q. Innis, editor). Toronto: University of Toronto Press, 1956.

The Idea File of Harold Adams Innis, (introduced and edited by William Christian). Toronto: University of Toronto Press, 1980.

Innis on Russia: The Russian Diary and Other Writings (edited with a preface by William Christian). Toronto: University of Toronto Press, 1981.

Selected Writings about Innis: Biographical, Bibliographical, and Interpretative

Barnes, T.J. “Focus: A Geographical Appreciation of Harold A. Innis.” Canadian Geographer. 37 (1993): 352-364.

Creighton, Donald. Harold Adams Innis: Portrait of a Scholar. Toronto: University of Toronto Press, 1957.

Havelock, E.A. “Harold Innis: A Man of His Times” and “Harold Innis: The Philosophical Historian.” Et cetra 38 (1981): 242-268.

Neill, Robin. A New Theory of Value: The Canadian Economics of Harold Adams Innis. Toronto: University of Toronto Press, 1972.

Neill, Robin. “Rationality and the Information Environment: A Reassessment of the Work of Harold Adams Innis.” Journal of Canadian Studies 22 (1987-88): 78-92.

Patterson, Graeme. History and Communications: Harold Innis, Marshall McLuhan, the Interpretation of History. Toronto: University of Toronto Press, 1990.

Stamps, Judith. Unthinking Modernity: Innis, McLuhan, and the Frankfurt School. Kingston and Montreal: McGill-Queen’s University Press, 1995.

Additional References: Relevant to the Presented Interpretation

Ingram, J.K. A History of Political Economy. New York: Augustus M. Kelly (1888, 1967).

Johnson, E.S. and Johnson, H.G. In the Shadow of Keynes. Oxford: Basil Blackwell, 1978.

Kitch, E.W. “Fire of Truth: A Remembrance of Law and Economics at Chicago, 1932-1970.” Journal of Law and Economics 26 (1983): 163-233.

Morgan, M.S. and Rutherford, M., editors. From Interwar Pluralism to Postwar Neoclassicism. Durham, NC: Duke University, 1998.

Neill, R.F. “Economic Historiography in the 1950s: The Saskatchewan School.” Journal of Canadian Studies 34 (1999): 243-260.

Spengler, J.J. “Sociological Presuppositions in Economic Theory.” Southern Economic Journal 7 (1940): 131-157.

Yonay, Y.P. The Struggle over the Soul of Economics. Princeton University Press, Princeton, 1998.

Citation: Neill, Robin. “Harold Adams Innis”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/harold-adams-innis/

Smoot-Hawley Tariff

Anthony O’Brien, Lehigh University

The Smoot-Hawley Tariff of 1930 was the subject of enormous controversy at the time of its passage and remains one of the most notorious pieces of legislation in the history of the United States. In the popular press and in political discussions the usual assumption is that the Smoot-Hawley Tariff was a policy disaster that significantly worsened the Great Depression. During the controversy over passage of the North American Free Trade Agreement (NAFTA) in the 1990s, Vice President Al Gore and billionaire former presidential candidate Ross Perot met in a debate on the Larry King Live program. To help make his point that Perot’s opposition to NAFTA was wrong-headed, Gore gave Perot a framed portrait of Sen. Smoot and Rep. Hawley. Gore assumed the audience would consider Smoot and Hawley to have been exemplars of a foolish protectionism. Although the popular consensus on Smoot-Hawley is clear, the verdict among scholars is more mixed, particularly with respect to the question of whether the tariff significantly worsened the Great Depression.

Background to Passage of the Tariff

The Smoot-Hawley Tariff grew out of the campaign promises of Herbert Hoover during the 1928 presidential election. Hoover, the Republican candidate, had pledged to help farmers by raising tariffs on imports of farm products. Although the 1920s were generally a period of prosperity in the United States, this was not true of agriculture; average farm incomes actually declined between 1920 and 1929. During the campaign Hoover had focused on plans to raise tariffs on farm products, but the tariff plank in the 1928 Republican Party platform had actually referred to the potential of more far-reaching increases:

[W]e realize that there are certain industries which cannot now successfully compete with foreign producers because of lower foreign wages and a lower cost of living abroad, and we pledge the next Republican Congress to an examination and where necessary a revision of these schedules to the end that American labor in the industries may again command the home market, may maintain its standard of living, and may count upon steady employment in its accustomed field.

In a longer perspective, the Republican Party had been in favor of a protective tariff since its founding in the 1850s. The party drew significant support from manufacturing interests in the Midwest and Northeast that believed they benefited from high tariff barriers against foreign imports. Although the free trade arguments dear to most economists were espoused by few American politicians during the 1920s, the Democratic Party was generally critical of high tariffs. In the 1920s the Democratic members of Congress tended to represent southern agricultural interests — which saw high tariffs as curtailing foreign markets for their exports, particularly cotton — or unskilled urban workers — who saw the tariff as driving up the cost of living.

The Republicans did well in the 1928 election, picking up 30 seats in the House — giving them a 267 to 167 majority — and seven seats in the Senate — giving them a 56 to 39 majority. Hoover easily defeated the Democratic presidential candidate, New York Governor Al Smith, capturing 58 percent of the popular vote and 444 of 531 votes in the Electoral College. Hoover took office on March 4, 1929 and immediately called a special session of Congress to convene on April 15 for the purpose of raising duties on agricultural products. Once the session began it became clear, however, that the Republican Congressional leadership had in mind much more sweeping tariff increases.

The House concluded its work relatively quickly and passed a bill on May 28 by a vote of 264 to 147. The bill faced a considerably more difficult time in the Senate. A block of Progressive Republicans, representing midwestern and western states, held the balance of power in the Senate. Some of these Senators had supported the third-party candidacy of Wisconsin Senator Robert LaFollette during the 1924 presidential election and they were much less protectionist than the Republican Party as a whole. It proved impossible to put together a majority in the Senate to pass the bill and the special session ended in November 1929 without a bill being passed.

By the time Congress reconvened the following spring the Great Depression was well underway. Economists date the onset of the Great Depression to the cyclical peak of August 1929, although the stock market crash of October 1929 is the more traditional beginning. By the spring of 1930 it was already clear that the downturn would be severe. The impact of the Depression helped to secure the final few votes necessary to put together a slim majority in the Senate in favor of passage of the bill. Final passage in the Senate took place on June 13, 1930 by a vote of 44 to 42. Final passage took place in the House the following day by a vote of 245 to 177. The vote was largely on party lines. Republicans in the House voted 230 to 27 in favor of final passage. Ten of the 27 Republicans voting no were Progressives from Wisconsin and Minnesota. Democrats voted 150 to 15 against final passage. Ten of the 15 Democrats voting for final passage were from Louisiana or Florida and represented citrus or sugar interests that received significant new protection under the bill.

President Hoover had expressed reservations about the wide-ranging nature of the bill and had privately expressed fears that the bill might provoke retaliation from America’s trading partners. He received a petition signed by more than 1,000 economists, urging him to veto the bill. Ultimately, he signed the Smoot-Hawley bill into law on June 17, 1930.

Tariff Levels under Smoot-Hawley

Calculating the extent to which Smoot-Hawley raised tariffs is not straightforward. The usual summary measure of tariff protection is the ratio of total tariff duties collected to the value of imports. This measure is misleading when applied to the early 1930s. Most of the tariffs in the Smoot-Hawley bill were specific — such as $1.125 per ton of pig iron — rather than ad valorem — or a percentage of the value of the product. During the early 1930s the prices of many products declined, causing the specific tariff to become an increasing percentage of the value of the product. The chart below shows the ratio of import duties collected to the value of dutiable imports. The increase shown for the early 1930s was partly due to declining prices and, therefore, exaggerates the effects of the Smoot-Hawley rate increases.

Source: U.S. Bureau of the Census, Historical Statistics of the United States, Colonial Times to 1970, Washington, D.C.: USGPO, 1975, Series 212.

A more accurate measure of the increase in tariff rates attributable to Smoot-Hawley can be found in a study carried out by the U.S. Tariff Commission. This study calculated the ad valorem rates that would have prevailed on actual U.S. imports in 1928, if the Smoot-Hawley rates been in effect then. These rates were compared with the rates prevailing under the Tariff Act of 1922, known as the Fordney-McCumber Tariff. The results are reproduced in Table 1 for the broad product categories used in tariff schedules and for total dutiable imports.

Table 1
Tariffs Rates under Fordney-McCumber vs. Smoot-Hawley

Equivalent ad valorem rates
Product Fordney-McCumber Smoot-Hawley
Chemicals 29.72% 36.09%
Earthenware, and Glass 48.71 53.73
Metals 33.95 35.08
Wood 24.78 11.73
Sugar 67.85 77.21
Tobacco 63.09 64.78
Agricultural Products 22.71 35.07
Spirits and Wines 38.83 47.44
Cotton Manufactures 40.27 46.42
Flax, Hemp, and Jute 18.16 19.14
Wool and Manufactures 49.54 59.83
Silk Manufactures 56.56 59.13
Rayon Manufactures 52.33 53.62
Paper and Books 24.74 26.06
Sundries 36.97 28.45
Total 38.48 41.14

Source: U.S. Tariff Commission, The Tariff Review, July 1930, Table II, p. 196.

By this measure, Smoot-Hawley raised average tariff rates by about 2 ½ percentage points from the already high rates prevailing under the Fordney-McCumber Tariff of 1922.

The Basic Macroeconomics of the Tariff

Economists are almost uniformly critical of tariffs. One of the bedrock principles of economics is that voluntary trade makes everyone involved better off. For the U.S. government to interfere with trade between Canadian lumber producers and U.S. lumber importers — as it did under Smoot-Hawley by raising the tariff on lumber imports — makes both parties to the trade worse off. In a larger sense, it also hurts the efficiency of the U.S. economy by making it rely on higher priced U.S. lumber rather than less expensive Canadian lumber.

But what is the effect of a tariff on the overall level of employment and production in an economy? The usual answer is that a tariff will leave the overall level of employment and production in an economy largely unaffected. Although the popular view is very different, most economists do not believe that tariffs either create jobs or destroy jobs in aggregate. Economists believe that the overall level of jobs and production in the economy is determined by such things as the capital stock, the population, the state of technology, and so on. These factors are not generally affected by tariffs. So, for instance, a tariff on imports of lumber might drive up housing prices and cause a reduction in the number of houses built. But economists believe that the unemployment in the housing industry will not be long-lived. Economists are somewhat divided on why this is true. Some believe that the economy automatically adjusts rapidly to reallocate labor and machinery that are displaced from one use — such as making houses — into other uses. Other economists believe that this adjustment does not take place automatically, but can be brought about through active monetary or fiscal policy. In either view, the economy is seen as ordinarily being at its so-called full-employment or potential level and deviating from that level only for brief periods of time. Tariffs have the ability to change the mix of production and the mix of jobs available in an economy, but not to change the overall level of production or the overall level of jobs. The macroeconomic impact of tariffs is therefore very limited.

In the case of the Smoot-Hawley Tariff, however, the U.S. economy was in depression in 1930. No active monetary or fiscal policies were carried out and the economy was not making much progress back to full employment. In fact, the cyclical trough was not reached until March 1933 and the economy did not return to full employment until 1941. Under these circumstances is it possible for Smoot-Hawley to have had a significant impact on the level of employment and production and would that impact have been positive or negative?

A simple view of the determination of equilibrium Gross Domestic Product (Y) holds that it is equal to the sum of aggregate expenditures. Aggregate expenditures are divided into four categories: spending by households on consumption goods (C), spending by households and firms on investment goods — such as houses, and machinery and equipment (I), spending by the government on goods and services (G), and net exports, which are the difference between spending on exports by foreign households and firms (EX) and spending on imports by domestic households and firms (IM). So, in the basic algebra of the principles of economics course, at equilibrium, Y = C + I + G + (EX – IM).

The usual story of the Great Depression is that some combination of falling consumption spending and falling investment spending had resulted in the equilibrium level of GDP being far below its full employment level. By raising tariffs on imports, Smoot-Hawley would have reduced the level of imports, but would not have had any direct effect on exports. This simple analysis seems to lead to a surprising conclusion: by reducing imports, Smoot-Hawley would have raised the level of aggregate expenditures in the economy (by increasing net exports or (EX – IM)) and, therefore, increased the level of GDP relative to what it would otherwise have been.

A potential flaw in this argument is that it assumes that Smoot-Hawley did not have a negative impact on U.S. exports. In fact, it may have had a negative impact on exports if foreign governments were led to retaliate against the passage of Smoot-Hawley by raising tariffs on imports of U.S. goods. If net exports fell as a result of Smoot-Hawley, then the tariff would have had a negative macroeconomic impact; it would have made the Depression worse. In 1934 Joseph Jones wrote a very influential book in which he argued that widespread retaliation against Smoot-Hawley had, in fact, taken place. Jones’s book helped to establish the view among the public and among scholars that the passage of Smoot-Hawley had been a policy blunder that had worsened the Great Depression.

Did Retaliation Take Place?

This is a simplified analysis and there are other ways in which Smoot-Hawley could have had a macroeconomic impact, such as by increasing the price level in the U.S. relative to foreign price levels. But in recent years there has been significant scholarly interest in the question of whether Smoot-Hawley did provoke significant retaliation and, therefore, made the Depression worse. Clearly it is possible to overstate the extent of retaliation and Jones almost certainly did. For instance, the important decision by Britain to abandon a century-long commitment to free trade and raise tariffs in 1931 was not affected to any significant extent by Smoot-Hawley.

On the other hand, the case for retaliation by Canada is fairly clear. Then, as now, Canada was easily the largest trading partner of the United States. In 1929, 18 percent of U.S. merchandise exports went to Canada and 11 percent of U.S. merchandise imports came from Canada. At the time of the passage of Smoot-Hawley the Canadian Prime Minister was William Lyon Mackenzie King of the Liberal Party. King had been in office for most of the period since 1921 and had several times reduced Canadian tariffs. He held the position that tariffs should be used to raise revenue, but should not be used for protection. In early 1929 he was contemplating pushing for further tariff reductions, but this option was foreclosed by Hoover’s call for a special session of Congress to consider tariff increases.

As Smoot-Hawley neared passage King came under intense pressure from the Canadian Conservative Party and its leader, Richard Bedford Bennett, to retaliate. In May 1930 Canada imposed so-called countervailing duties on 16 products imported from the United States. The duties on these products — which represented about 30 percent of the value of all U.S. merchandise exports to Canada — were raised to the levels charged by the United States. In a speech, King made clear the retaliatory nature of these increases:

[T]he countervailing duties ? [are] designed to give a practical illustration to the United States of the desire of Canada to trade at all times on fair and equal terms?. For the present we raise the duties on these selected commodities to the level applied against Canadian exports of the same commodities by other countries, but at the same time we tell our neighbour ? we are ready in the future ? to consider trade on a reciprocal basis?.

In the election campaign the following July, Smoot-Hawley was a key issue. Bennett, the Conservative candidate, was strongly in favor in retaliation. In one campaign speech he declared:

How many thousands of American workmen are living on Canadian money today? They’ve got the jobs and we’ve got the soup kitchens?. I will not beg of any country to buy our goods. I will make [tariffs] fight for you. I will use them to blast a way into markets that have been closed.

Bennett handily won the election and pushed through the Canadian Parliament further tariff increases.

What Was the Impact of the Tariff on the Great Depression?

If there was retaliation for Smoot-Hawley, was this enough to have made the tariff a significant contributor to the severity of the Great Depression? Most economists are skeptical because foreign trade made up a small part of the U.S. economy in 1929 and the magnitude of the decline in GDP between 1929 and 1933 was so large. Table 2 gives values for nominal GDP, for real GDP (in 1929 dollars), for nominal and real net exports, and for nominal and real exports. In real terms, net exports did decline by about $.7 billion between 1929 and 1933, but this amounts to less than one percent of 1929 real GDP and is dwarfed by the total decline in real GDP between 1929 and 1933.

Table 2
GDP and Exports, 1929-1933

Year Nominal GDP Real GDP Nominal Net Exports Real Net Exports Nominal Exports Real Exports
1929 $103.1 $103.1 $0.4 $0.3 $5.9 $5.9
1930 $90.4 $93.3 $0.3 $0.0 $4.4 $4.9
1931 $75.8 $86.1 $0.0 -$0.4 $2.9 $4.1
1932 $58.0 $74.7 $0.0 -$0.3 $2.0 $3.3
1933 $55.6 $73.2 $0.1 -$0.4 $2.0 $3.3

Source: U.S. Department of Commerce, National Income and Product Accounts of the United States, Vol. I, 1929-1958, Washington, D.C.: USGPO, 1993.

If we focus on the decline in exports, we can construct an upper bound for the negative impact of Smoot-Hawley. Between 1929 and 1931, real exports declined by an amount equal to about 1.7% of 1929 real GDP. Declines in aggregate expenditures are usually thought to have a multiplied effect on equilibrium GDP. The best estimates are that the multiplier is roughly two. In that case, real GDP would have declined by about 3.4% between 1929 and 1931 as a result of the decline in real exports. Real GDP actually declined by about 16.5% between 1929 and 1931, so the decline in real exports can account for about 21% of the total decline in real GDP. The decline in real exports, then, may well have played an important, but not crucial, role in the decline in GDP during the first two years of the Depression. Bear in mind, though, that not all — perhaps not even most — of the decline in exports can be attributed to retaliation for Smoot-Hawley. Even if Smoot-Hawley had not been passed, U.S. exports would have fallen as incomes declined in Canada, the United Kingdom, and in other U.S. trading partners and as tariff rates in some of these countries increased for reasons unconnected to Smoot-Hawley.

Hawley-Smoot or Smoot-Hawley: A Note on Usage

Congressional legislation is often referred to by the names of the member of the House of Representatives and the member of the Senate who have introduced the bill. Tariff legislation always originates in the House of Representatives and according to convention the name of its House sponsor, in this case Representative Willis Hawley of Oregon, would precede the name of its Senate sponsor, Senator Reed Smoot of Utah — hence, Hawley-Smoot. In this instance, though, Senator Smoot was far better known than Representative Hawley and so the legislation is usually referred to as the Smoot-Hawley Tariff. The more formal name of the legislation was the U.S. Tariff Act of 1930.)

Further Reading

The Republican Party platform for 1928 is reprinted as: “Republican Platform [of 1928]” in Arthur M. Schlesinger, Jr., Fred L. Israel, and William P. Hansen, editors, History of American Presidential Elections, 1789-1968, New York: Chelsea House, 1971, Vol. 3. Herbert Hoover’s views on the tariff can be found in Herbert Hoover, The Future of Our Foreign Trade, Washington, D.C.: GPO, 1926 and Herbert Hoover, The Memoirs of Herbert Hoover: The Cabinet and the Presidency, 1920-1933, New York: Macmillan, 1952, Chapter 41. Trade statistics for this period can be found in U.S. Department of Commerce, Economic Analysis of Foreign Trade of the United States in Relation to the Tariff. Washington, D.C.: GPO, 1933 and in the annual supplements to the Survey of Current Business.

A classic account of the political process that resulted in the Smoot-Hawley Tariff is given in E. E. Schattschneider, Politics, Pressures and the Tariff, New York: Prentice-Hall, 1935. The best case for the view that there was extensive foreign retaliation against Smoot-Hawley is given in Joseph Jones, Tariff Retaliation: Repercussions of the Hawley-Smoot Bill, Philadelphia: University of Pennsylvania Press, 1934. The Jones book should be used with care; his argument is generally considered to be overstated. The view that party politics was of supreme importance in passage of the tariff is well argued in Robert Pastor, Congress and the Politics of United States Foreign Economic Policy, 1929-1976, Berkeley: University of California Press, 1980.

A discussion of the potential macroeconomic impact of Smoot-Hawley appears in Rudiger Dornbusch and Stanley Fischer, “The Open Economy: Implications for Monetary and Fiscal Policy.” In The American Business Cycle: Continuity and Change, edited by Robert J. Gordon, NBER Studies in Business Cycles, Volume 25, Chicago: University of Chicago Press, 1986, pp. 466-70. See, also, the article by Barry Eichengreen listed below. An argument that Smoot-Hawley is unlikely to have had a significant macroeconomic effect is given in Peter Temin, Lessons from the Great Depression, Cambridge, MA: MIT Press, 1989, p. 46. For an argument emphasizing the importance of Smoot-Hawley in explaining the Great Depression, see Alan Meltzer, “Monetary and Other Explanations of the Start of the Great Depression,” Journal of Monetary Economics, 2 (1976): 455-71.

Recent journal articles that deal with the issues discussed in this entry are:

Callahan, Colleen, Judith A. McDonald and Anthony Patrick O’Brien. “Who Voted for Smoot-Hawley?” Journal of Economic History 54, no. 3 (1994): 683-90.

Crucini, Mario J. and James Kahn. “Tariffs and Aggregate Economic Activity: Lessons from the Great Depression.” Journal of Monetary Economics 38, no. 3 (1996): 427-67.

Eichengreen, Barry. “The Political Economy of the Smoot-Hawley Tariff.” Research in Economic History 12 (1989): 1-43.

Irwin, Douglas. “The Smoot-Hawley Tariff: A Quantitative Assessment.” Review of Economics and Statistics 80, no. 2 (1998): 326-334.

Irwin Douglas and Randall S. Kroszner. “Log-Rolling and Economic Interests in the Passage of the Smoot-Hawley Tariff.” Carnegie-Rochester Series on Public Policy 45 (1996): 173-200.

McDonald Judith, Anthony Patrick O’Brien, and Colleen Callahan. “Trade Wars: Canada’s Reaction to the Smoot-Hawley Tariff.” Journal of Economic History 57, no. 4 (1997): 802-26.

Citation: O’Brien, Anthony. “Smoot-Hawley Tariff”. EH.Net Encyclopedia, edited by Robert Whaples. August 14, 2001. URL http://eh.net/encyclopedia/smoot-hawley-tariff/

An Overview of the Great Depression

Randall Parker, East Carolina University

This article provides an overview of selected events and economic explanations of the interwar era. What follows is not intended to be a detailed and exhaustive review of the literature on the Great Depression, or of any one theory in particular. Rather, it will attempt to describe the “big picture” events and topics of interest. For the reader who wishes more extensive analysis and detail, references to additional materials are also included.

The 1920s

The Great Depression, and the economic catastrophe that it was, is perhaps properly scaled in reference to the decade that preceded it, the 1920s. By conventional macroeconomic measures, this was a decade of brisk economic growth in the United States. Perhaps the moniker “the roaring twenties” summarizes this period most succinctly. The disruptions and shocking nature of World War I had been survived and it was felt the United States was entering a “new era.” In January 1920, the Federal Reserve seasonally adjusted index of industrial production, a standard measure of aggregate economic activity, stood at 81 (1935–39 = 100). When the index peaked in July 1929 it was at 114, for a growth rate of 40.6 percent over this period. Similar rates of growth over the 1920–29 period equal to 47.3 percent and 42.4 percent are computed using annual real gross national product data from Balke and Gordon (1986) and Romer (1988), respectively. Further computations using the Balke and Gordon (1986) data indicate an average annual growth rate of real GNP over the 1920–29 period equal to 4.6 percent. In addition, the relative international economic strength of this country was clearly displayed by the fact that nearly one-half of world industrial output in 1925–29 was produced in the United States (Bernanke, 1983).

Consumer Durables Market

The decade of the 1920s also saw major innovations in the consumption behavior of households. The development of installment credit over this period led to substantial growth in the consumer durables market (Bernanke, 1983). Purchases of automobiles, refrigerators, radios and other such durable goods all experienced explosive growth during the 1920s as small borrowers, particularly households and unincorporated businesses, utilized their access to available credit (Persons, 1930; Bernanke, 1983; Soule, 1947).

Economic Growth in the 1920s

Economic growth during this period was mitigated only somewhat by three recessions. According to the National Bureau of Economic Research (NBER) business cycle chronology, two of these recessions were from May 1923 through July 1924 and October 1926 through November 1927. Both of these recessions were very mild and unremarkable. In contrast, the 1920s began with a recession lasting 18 months from the peak in January 1920 until the trough of July 1921. Original estimates of real GNP from the Commerce Department showed that real GNP fell 8 percent between 1919 and 1920 and another 7 percent between 1920 and 1921 (Romer, 1988). The behavior of prices contributed to the naming of this recession “the Depression of 1921,” as the implicit price deflator for GNP fell 16 percent and the Bureau of Labor Statistics wholesale price index fell 46 percent between 1920 and 1921. Although thought to be severe, Romer (1988) has argued that the so-called “postwar depression” was not as severe as once thought. While the deflation from war-time prices was substantial, revised estimates of real GNP show falls in output of only 1 percent between 1919 and 1920 and 2 percent between 1920 and 1921. Romer (1988) also argues that the behaviors of output and prices are inconsistent with the conventional explanation of the Depression of 1921 being primarily driven by a decline in aggregate demand. Rather, the deflation and the mild recession are better understood as resulting from a decline in aggregate demand together with a series of positive supply shocks, particularly in the production of agricultural goods, and significant decreases in the prices of imported primary commodities. Overall, the upshot is that the growth path of output was hardly impeded by the three minor downturns, so that the decade of the 1920s can properly be viewed economically as a very healthy period.

Fed Policies in the 1920s

Friedman and Schwartz (1963) label the 1920s “the high tide of the Reserve System.” As they explain, the Federal Reserve became increasingly confident in the tools of policy and in its knowledge of how to use them properly. The synchronous movements of economic activity and explicit policy actions by the Federal Reserve did not go unnoticed. Taking the next step and concluding there was cause and effect, the Federal Reserve in the 1920s began to use monetary policy as an implement to stabilize business cycle fluctuations. “In retrospect, we can see that this was a major step toward the assumption by government of explicit continuous responsibility for economic stability. As the decade wore on, the System took – and perhaps even more was given – credit for the generally stable conditions that prevailed, and high hopes were placed in the potency of monetary policy as then administered” (Friedman and Schwartz, 1963).

The giving/taking of credit to/by the Federal Reserve has particular value pertaining to the recession of 1920–21. Although suggesting the Federal Reserve probably tightened too much, too late, Friedman and Schwartz (1963) call this episode “the first real trial of the new system of monetary control introduced by the Federal Reserve Act.” It is clear from the history of the time that the Federal Reserve felt as though it had successfully passed this test. The data showed that the economy had quickly recovered and brisk growth followed the recession of 1920–21 for the remainder of the decade.

Questionable Lessons “Learned” by the Fed

Moreover, Eichengreen (1992) suggests that the episode of 1920–21 led the Federal Reserve System to believe that the economy could be successfully deflated or “liquidated” without paying a severe penalty in terms of reduced output. This conclusion, however, proved to be mistaken at the onset of the Depression. As argued by Eichengreen (1992), the Federal Reserve did not appreciate the extent to which the successful deflation could be attributed to the unique circumstances that prevailed during 1920–21. The European economies were still devastated after World War I, so the demand for United States’ exports remained strong many years after the War. Moreover, the gold standard was not in operation at the time. Therefore, European countries were not forced to match the deflation initiated in the United States by the Federal Reserve (explained below pertaining to the gold standard hypothesis).

The implication is that the Federal Reserve thought that deflation could be generated with little effect on real economic activity. Therefore, the Federal Reserve was not vigorous in fighting the Great Depression in its initial stages. It viewed the early years of the Depression as another opportunity to successfully liquidate the economy, especially after the perceived speculative excesses of the 1920s. However, the state of the economic world in 1929 was not a duplicate of 1920–21. By 1929, the European economies had recovered and the interwar gold standard was a vehicle for the international transmission of deflation. Deflation in 1929 would not operate as it did in 1920–21. The Federal Reserve failed to understand the economic implications of this change in the international standing of the United States’ economy. The result was that the Depression was permitted to spiral out of control and was made much worse than it otherwise would have been had the Federal Reserve not considered it to be a repeat of the 1920–21 recession.

The Beginnings of the Great Depression

In January 1928 the seeds of the Great Depression, whenever they were planted, began to germinate. For it is around this time that two of the most prominent explanations for the depth, length, and worldwide spread of the Depression first came to be manifest. Without any doubt, the economics profession would come to a firm consensus around the idea that the economic events of the Great Depression cannot be properly understood without a solid linkage to both the behavior of the supply of money together with Federal Reserve actions on the one hand and the flawed structure of the interwar gold standard on the other.

It is well documented that many public officials, such as President Herbert Hoover and members of the Federal Reserve System in the latter 1920s, were intent on ending what they perceived to be the speculative excesses that were driving the stock market boom. Moreover, as explained by Hamilton (1987), despite plentiful denials to the contrary, the Federal Reserve assumed the role of “arbiter of security prices.” Although there continues to be debate as to whether or not the stock market was overvalued at the time (White, 1990; DeLong and Schleifer, 1991), the main point is that the Federal Reserve believed there to be a speculative bubble in equity values. Hamilton (1987) describes how the Federal Reserve, intending to “pop” the bubble, embarked on a highly contractionary monetary policy in January 1928. Between December 1927 and July 1928 the Federal Reserve conducted $393 million of open market sales of securities so that only $80 million remained in the Open Market account. Buying rates on bankers’ acceptances1 were raised from 3 percent in January 1928 to 4.5 percent by July, reducing Federal Reserve holdings of such bills by $193 million, leaving a total of only $185 million of these bills on balance. Further, the discount rate was increased from 3.5 percent to 5 percent, the highest level since the recession of 1920–21. “In short, in terms of the magnitudes consciously controlled by the Fed, it would be difficult to design a more contractionary policy than that initiated in January 1928” (Hamilton, 1987).

The pressure did not stop there, however. The death of Federal Reserve Bank President Benjamin Strong and the subsequent control of policy ascribed to Adolph Miller of the Federal Reserve Board insured that the fall in the stock market was going to be made a reality. Miller believed the speculative excesses of the stock market were hurting the economy, and the Federal Reserve continued attempting to put an end to this perceived harm (Cecchetti, 1998). The amount of Federal Reserve credit that was being extended to market participants in the form of broker loans became an issue in 1929. The Federal Reserve adamantly discouraged lending that was collateralized by equities. The intentions of the Board of Governors of the Federal Reserve were made clear in a letter dated February 2, 1929 sent to Federal Reserve banks. In part the letter read:

The board has no disposition to assume authority to interfere with the loan practices of member banks so long as they do not involve the Federal reserve banks. It has, however, a grave responsibility whenever there is evidence that member banks are maintaining speculative security loans with the aid of Federal reserve credit. When such is the case the Federal reserve bank becomes either a contributing or a sustaining factor in the current volume of speculative security credit. This is not in harmony with the intent of the Federal Reserve Act, nor is it conducive to the wholesome operation of the banking and credit system of the country. (Board of Governors of the Federal Reserve 1929: 93–94, quoted from Cecchetti, 1998)

The deflationary pressure to stock prices had been applied. It was now a question of when the market would break. Although the effects were not immediate, the wait was not long.

The Economy Stumbles

The NBER business cycle chronology dates the start of the Great Depression in August 1929. For this reason many have said that the Depression started on Main Street and not Wall Street. Be that as it may, the stock market plummeted in October of 1929. The bursting of the speculative bubble had been achieved and the economy was now headed in an ominous direction. The Federal Reserve’s seasonally adjusted index of industrial production stood at 114 (1935–39 = 100) in August 1929. By October it had fallen to 110 for a decline of 3.5 percent (annualized percentage decline = 14.7 percent). After the crash, the incipient recession intensified, with the industrial production index falling from 110 in October to 100 in December 1929, or 9 percent (annualized percentage decline = 41 percent). In 1930, the index fell further from 100 in January to 79 in December, or an additional 21percent.

Links between the Crash and the Depression?

While popular history treats the crash and the Depression as one and the same event, economists know that they were not. But there is no doubt that the crash was one of the things that got the ball rolling. Several authors have offered explanations for the linkage between the crash and the recession of 1929–30. Mishkin (1978) argues that the crash and an increase in liabilities led to a deterioration in households’ balance sheets. The reduced liquidity2 led consumers to defer consumption of durable goods and housing and thus contributed to a fall in consumption. Temin (1976) suggests that the fall in stock prices had a negative wealth effect on consumption, but attributes only a minor role to this given that stocks were not a large fraction of total wealth; the stock market in 1929, although falling dramatically, remained above the value it had achieved in early 1928, and the propensity to consume from wealth was small during this period. Romer (1990) provides evidence suggesting that if the stock market were thought to be a predictor of future economic activity, then the crash can rightly be viewed as a source of increased consumer uncertainty that depressed spending on consumer durables and accelerated the decline that had begun in August 1929. Flacco and Parker (1992) confirm Romer’s findings using different data and alternative estimation techniques.

Looking back on the behavior of the economy during the year of 1930, industrial production declined 21 percent, the consumer price index fell 2.6 percent, the supply of high-powered money (that is, the liabilities of the Federal Reserve that are usable as money, consisting of currency in circulation and bank reserves; also called the monetary base) fell 2.8 percent, the nominal supply of money as measured by M1 (the product of the monetary base3 multiplied by the money multiplier4) dipped 3.5 percent and the ex post real interest rate turned out to be 11.3 percent, the highest it had been since the recession of 1920–21 (Hamilton, 1987). In spite of this, when put into historical context, there was no reason to view the downturn of 1929–30 as historically unprecedented. Its magnitude was comparable to that of many recessions that had previously occurred. Perhaps there was justifiable optimism in December 1930 that the economy might even shake off the negative movement and embark on the path to recovery, rather like what had occurred after the recession of 1920–21 (Bernanke, 1983). As we know, the bottom would not come for another 27 months.

The Economy Crumbles

Banking Failures

During 1931, there was a “change in the character of the contraction” (Friedman and Schwartz, 1963). Beginning in October 1930 and lasting until December 1930, the first of a series of banking panics now accompanied the downward spasms of the business cycle. Although bank failures had occurred throughout the 1920s, the magnitude of the failures that occurred in the early 1930s was of a different order altogether (Bernanke, 1983). The absence of any type of deposit insurance resulted in the contagion of the panics being spread to sound financial institutions and not just those on the margin.

Traditional Methods of Combating Bank Runs Not Used

Moreover, institutional arrangements that had existed in the private banking system designed to provide liquidity – to convert assets into cash – to fight bank runs before 1913 were not exercised after the creation of the Federal Reserve System. For example, during the panic of 1907, the effects of the financial upheaval had been contained through a combination of lending activities by private banks, called clearinghouses, and the suspension of deposit convertibility into currency. While not preventing bank runs and the financial panic, their economic impact was lessened to a significant extent by these countermeasures enacted by private banks, as the economy quickly recovered in 1908. The aftermath of the panic of 1907 and the desire to have a central authority to combat the contagion of financial disruptions was one of the factors that led to the establishment of the Federal Reserve System. After the creation of the Federal Reserve, clearinghouse lending and suspension of deposit convertibility by private banks were not undertaken. Believing the Federal Reserve to be the “lender of last resort,” it was apparently thought that the responsibility to fight bank runs was the domain of the central bank (Friedman and Schwartz, 1963; Bernanke, 1983). Unfortunately, when the banking panics came in waves and the financial system was collapsing, being the “lender of last resort” was a responsibility that the Federal Reserve either could not or would not assume.

Money Supply Contracts

The economic effects of the banking panics were devastating. Aside from the obvious impact of the closing of failed banks and the subsequent loss of deposits by bank customers, the money supply accelerated its downward spiral. Although the economy had flattened out after the first wave of bank failures in October–December 1930, with the industrial production index steadying from 79 in December 1930 to 80 in April 1931, the remainder of 1931 brought a series of shocks from which the economy was not to recover for some time.

Second Wave of Banking Failure

In May, the failure of Austria’s largest bank, the Kredit-anstalt, touched off financial panics in Europe. In September 1931, having had enough of the distress associated with the international transmission of economic depression, Britain abandoned its participation in the gold standard. Further, just as the United States’ economy appeared to be trying to begin recovery, the second wave of bank failures hit the financial system in June and did not abate until December. In addition, the Hoover administration in December 1931, adhering to its principles of limited government, embarked on a campaign to balance the federal budget. Tax increases resulted the following June, just as the economy was to hit the first low point of its so-called “double bottom” (Hoover, 1952).

The results of these events are now evident. Between January and December 1931 the industrial production index declined from 78 to 66, or 15.4 percent, the consumer price index fell 9.4 percent, the nominal supply of M1 dipped 5.7 percent, the ex post real interest rate5 remained at 11.3 percent, and although the supply of high-powered money6 actually increased 5.5 percent, the currency–deposit and reserve–deposit ratios began their upward ascent, and thus the money multiplier started its downward plunge (Hamilton, 1987). If the economy had flattened out in the spring of 1931, then by December output, the money supply, and the price level were all on negative growth paths that were dragging the economy deeper into depression.

Third Wave of Banking Failure

The economic difficulties were far from over. The economy displayed some evidence of recovery in late summer/early fall of 1932. However, in December 1932 the third, and largest, wave of banking panics hit the financial markets and the collapse of the economy arrived with the business cycle hitting bottom in March 1933. Industrial production between January 1932 and March 1933 fell an additional 15.6 percent. For the combined years of 1932 and 1933, the consumer price index fell a cumulative 16.2 percent, the nominal supply of M1 dropped 21.6 percent, the nominal M2 money supply fell 34.7 percent, and although the supply of high-powered money increased 8.4 percent, the currency–deposit and reserve–deposit ratios accelerated their upward ascent. Thus the money multiplier continued on a downward plunge that was not arrested until March 1933. Similar behaviors for real GDP, prices, money supplies and other key macroeconomic variables occurred in many European economies as well (Snowdon and Vane, 1999; Temin, 1989).

An examination of the macroeconomic data in August 1929 compared to March 1933 provides a stark contrast. The unemployment rate of 3 percent in August 1929 was at 25 percent in March 1933. The industrial production index of 114 in August 1929 was at 54 in March 1933, or a 52.6 percent decrease. The money supply had fallen 35 percent, prices plummeted by about 33 percent, and more than one-third of banks in the United States were either closed or taken over by other banks. The “new era” ushered in by “the roaring twenties” was over. Roosevelt took office in March 1933, a nationwide bank holiday was declared from March 6 until March 13, and the United States abandoned the international gold standard in April 1933. Recovery commenced immediately and the economy began its long path back to the pre-1929 secular growth trend.

Table 1 summarizes the drop in industrial production in the major economies of Western Europe and North America. Table 2 gives gross national product estimates for the United States from 1928 to 1941. The constant price series adjusts for inflation and deflation.

Table 1
Indices of Total Industrial Production, 1927 to 1935 (1929 = 100)

1927 1928 1929 1930 1931 1932 1933 1934 1935
Britain 95 94 100 94 86 89 95 105 114
Canada 85 94 100 91 78 68 69 82 90
France 84 94 100 99 85 74 83 79 77
Germany 95 100 100 86 72 59 68 83 96
Italy 87 99 100 93 84 77 83 85 99
Netherlands 87 94 100 109 101 90 90 93 95
Sweden 85 88 100 102 97 89 93 111 125
U.S. 85 90 100 83 69 55 63 69 79

Source: Industrial Statistics, 1900-57 (Paris, OEEC, 1958), Table 2.

Table 2
U.S. GNP at Constant (1929) and Current Prices, 1928-1941

Year GNP at constant (1929) prices (billions of $) GNP at current prices (billions of $)
1928 98.5 98.7
1929 104.4 104.6
1930 95.1 91.2
1931 89.5 78.5
1932 76.4 58.6
1933 74.2 56.1
1934 80.8 65.5
1935 91.4 76.5
1936 100.9 83.1
1937 109.1 91.2
1938 103.2 85.4
1939 111.0 91.2
1940 121.0 100.5
1941 131.7 124.7

Contemporary Explanations

The economics profession during the 1930s was at a loss to explain the Depression. The most prominent conventional explanations were of two types. First, some observers at the time firmly grounded their explanations on the two pillars of classical macroeconomic thought, Say’s Law and the belief in the self-equilibrating powers of the market. Many argued that it was simply a question of time before wages and prices adjusted fully enough for the economy to return to full employment and achieve the realization of the putative axiom that “supply creates its own demand.” Second, the Austrian school of thought argued that the Depression was the inevitable result of overinvestment during the 1920s. The best remedy for the situation was to let the Depression run its course so that the economy could be purified from the negative effects of the false expansion. Government intervention was viewed by the Austrian school as a mechanism that would simply prolong the agony and make any subsequent depression worse than it would ordinarily be (Hayek, 1966; Hayek, 1967).

Liquidationist Theory

The Hoover administration and the Federal Reserve Board also contained several so-called “liquidationists.” These individuals basically believed that economic agents should be forced to re-arrange their spending proclivities and alter their alleged profligate use of resources. If it took mass bankruptcies to produce this result and wipe the slate clean so that everyone could have a fresh start, then so be it. The liquidationists viewed the events of the Depression as an economic penance for the speculative excesses of the 1920s. Thus, the Depression was the price that was being paid for the misdeeds of the previous decade. This is perhaps best exemplified in the well-known quotation of Treasury Secretary Andrew Mellon, who advised President Hoover to “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” Mellon continued, “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people” (Hoover, 1952). Hoover apparently followed this advice as the Depression wore on. He continued to reassure the public that if the principles of orthodox finance were faithfully followed, recovery would surely be the result.

The business press at the time was not immune from such liquidationist prescriptions either. The Commercial and Financial Chronicle, in an August 3, 1929 editorial entitled “Is Not Group Speculating Conspiracy, Fostering Sham Prosperity?” complained of the economy being replete with profligate spending including:

(a) The luxurious diversification of diet advantageous to dairy men … and fruit growers …; (b) luxurious dressing … more silk and rayon …; (c) free spending for automobiles and their accessories, gasoline, house furnishings and equipment, radios, travel, amusements and sports; (d) the displacement from the farms by tractors and autos of produce-consuming horses and mules to a number aggregating 3,700,000 for the period 1918–1928 … (e) the frills of education to thousands for whom places might better be reserved at bench or counter or on the farm. (Quoted from Nelson, 1991)

Persons, in a paper which appeared in the November 1930 Quarterly Journal of Economics, demonstrates that some academic economists also held similar liquidationist views.

Although certainly not universal, the descriptions above suggest that no small part of the conventional wisdom at the time believed the Depression to be a penitence for past sins. In addition, it was thought that the economy would be restored to full employment equilibrium once wages and prices adjusted sufficiently. Say’s Law will ensure the economy will return to health, and supply will create its own demand sufficient to return to prosperity, if we simply let the system work its way through. In his memoirs published in 1952, 20 years after his election defeat, Herbert Hoover continued to steadfastly maintain that if Roosevelt and the New Dealers would have stuck to the policies his administration put in place, the economy would have made a full recovery within 18 months after the election of 1932. We have to intensify our resolve to “stay the course.” All will be well in time if we just “take our medicine.” In hindsight, it challenges the imagination to think up worse policy prescriptions for the events of 1929–33.

Modern Explanations

There remains considerable debate regarding the economic explanations for the behavior of the business cycle between August 1929 and March 1933. This section describes the main hypotheses that have been presented in the literature attempting to explain the causes for the depth, protracted length, and worldwide propagation of the Great Depression.

The United States’ experience, considering the preponderance of empirical results and historical simulations contained in the economic literature, can largely be accounted for by the monetary hypothesis of Friedman and Schwartz (1963) together with the nonmonetary/financial hypotheses of Bernanke (1983) and Fisher (1933). That is, most, but not all, of the characteristic phases of the business cycle and depth to which output fell from 1929 to 1933 can be accounted for by the monetary and nonmonetary/financial hypotheses. The international experience, well documented in Choudri and Kochin (1980), Hamilton (1988), Temin (1989), Bernanke and James (1991), and Eichengreen (1992), can be properly understood as resulting from a flawed interwar gold standard. Each of these hypotheses is explained in greater detail below.

Nonmonetary/Nonfinancial Theories

It should be noted that I do not include a section covering the nonmonetary/nonfinancial theories of the Great Depression. These theories, including Temin’s (1976) focus on autonomous consumption decline, the collapse of housing construction contained in Anderson and Butkiewicz (1980), the effects of the stock market crash, the uncertainty hypothesis of Romer (1990), and the Smoot–Hawley Tariff Act of 1930, are all worthy of mention and can rightly be apportioned some of the responsibility for initiating the Depression. However, any theory of the Depression must be able to account for the protracted problems associated with the punishing deflation imposed on the United States and the world during that era. While the nonmonetary/nonfinancial theories go a long way accounting for the impetus for, and first year of the Depression, my reading of the empirical results of the economic literature indicates that they do not have the explanatory power of the three other theories mentioned above to account for the depths to which the economy plunged.

Moreover, recent research by Olney (1999) argues convincingly that the decline in consumption was not autonomous at all. Rather, the decline resulted because high consumer indebtedness threatened future consumption spending because default was expensive. Olney shows that households were shouldering an unprecedented burden of installment debt – especially for automobiles. In addition, down payments were large and contracts were short. Missed installment payments triggered repossession, reducing consumer wealth in 1930 because households lost all acquired equity. Cutting consumption was the only viable strategy in 1930 for avoiding default.

The Monetary Hypothesis

In reviewing the economic history of the Depression above, it was mentioned that the supply of money fell by 35 percent, prices dropped by about 33 percent, and one-third of all banks vanished. Milton Friedman and Anna Schwartz, in their 1963 book A Monetary History of the United States, 1867–1960, call this massive drop in the supply of money “The Great Contraction.”

Friedman and Schwartz (1963) discuss and painstakingly document the synchronous movements of the real economy with the disruptions that occurred in the financial sector. They point out that the series of bank failures that occurred beginning in October 1930 worsened economic conditions in two ways. First, bank shareholder wealth was reduced as banks failed. Second, and most importantly, the bank failures were exogenous shocks and led to the drastic decline in the money supply. The persistent deflation of the 1930s follows directly from this “great contraction.”

Criticisms of Fed Policy

However, this raises an important question: Where was the Federal Reserve while the money supply and the financial system were collapsing? If the Federal Reserve was created in 1913 primarily to be the “lender of last resort” for troubled financial institutions, it was failing miserably. Friedman and Schwartz pin the blame squarely on the Federal Reserve and the failure of monetary policy to offset the contractions in the money supply. As the money multiplier continued on its downward path, the monetary base, rather than being aggressively increased, simply progressed slightly upwards on a gently positive sloping time path. As banks were failing in waves, was the Federal Reserve attempting to contain the panics by aggressively lending to banks scrambling for liquidity? The unfortunate answer is “no.” When the panics were occurring, was there discussion of suspending deposit convertibility or suspension of the gold standard, both of which had been successfully employed in the past? Again the unfortunate answer is “no.” Did the Federal Reserve consider the fact that it had an abundant supply of free gold, and therefore that monetary expansion was feasible? Once again the unfortunate answer is “no.” The argument can be summarized by the following quotation:

At all times throughout the 1929–33 contraction, alternative policies were available to the System by which it could have kept the stock of money from falling, and indeed could have increased it at almost any desired rate. Those policies did not involve radical innovations. They involved measures of a kind the System had taken in earlier years, of a kind explicitly contemplated by the founders of the System to meet precisely the kind of banking crisis that developed in late 1930 and persisted thereafter. They involved measures that were actually proposed and very likely would have been adopted under a slightly different bureaucratic structure or distribution of power, or even if the men in power had had somewhat different personalities. Until late 1931 – and we believe not even then – the alternative policies involved no conflict with the maintenance of the gold standard. Until September 1931, the problem that recurrently troubled the System was how to keep the gold inflows under control, not the reverse. (Friedman and Schwartz, 1963)

The inescapable conclusion is that it was a failure of the policies of the Federal Reserve System in responding to the crises of the time that made the Depression as bad as it was. If monetary policy had responded differently, the economic events of 1929–33 need not have been as they occurred. This assertion is supported by the results of Fackler and Parker (1994). Using counterfactual historical simulations, they show that if the Federal Reserve had kept the M1 money supply growing along its pre-October 1929 trend of 3.3 percent annually, most of the Depression would have been averted. McCallum (1990) also reaches similar conclusions employing a monetary base feedback policy in his counterfactual simulations.

Lack of Leadership at the Fed

Friedman and Schwartz trace the seeds of these regrettable events to the death of Federal Reserve Bank of New York President Benjamin Strong in 1928. Strong’s death altered the locus of power in the Federal Reserve System and left it without effective leadership. Friedman and Schwartz maintain that Strong had the personality, confidence and reputation in the financial community to lead monetary policy and sway policy makers to his point of view. Friedman and Schwartz believe that Strong would not have permitted the financial panics and liquidity crises to persist and affect the real economy. Instead, after Governor Strong died, the conduct of open market operations changed from a five-man committee dominated by the New York Federal Reserve to that of a 12-man committee of Federal Reserve Bank governors. Decisiveness in leadership was replaced by inaction and drift. Others (Temin, 1989; Wicker, 1965) reject this point, claiming the policies of the Federal Reserve in the 1930s were not inconsistent with the policies pursued in the decade of the 1920s.

The Fed’s Failure to Distinguish between Nominal and Real Interest Rates

Meltzer (1976) also points out errors made by the Federal Reserve. His argument is that the Federal Reserve failed to distinguish between nominal and real interest rates. That is, while nominal rates were falling, the Federal Reserve did virtually nothing, since it construed this to be a sign of an “easy” credit market. However, in the face of deflation, real rates were rising and there was in fact a “tight” credit market. Failure to make this distinction led money to be a contributing factor to the initial decline of 1929.

Deflation

Cecchetti (1992) and Nelson (1991) bolster the monetary hypothesis by demonstrating that the deflation during the Depression was anticipated at short horizons, once it was under way. The result, using the Fisher equation, is that high ex ante real interest rates were the transmission mechanism that led from falling prices to falling output. In addition, Cecchetti (1998) and Cecchetti and Karras (1994) argue that if the lower bound of the nominal interest rate is reached, then continued deflation renders the opportunity cost of holding money negative. In this instance the nature of money changes. Now the rate of deflation places a floor on the real return nonmoney assets must provide to make them attractive to hold. If they cannot exceed the rate on money holdings, then agents will move their assets into cash and the result will be negative net investment and a decapitalization of the economy.

Critics of the Monetary Hypothesis

The monetary hypothesis, however, is not without its detractors. Paul Samuelson observes that the monetary base did not fall during the Depression. Moreover, expecting the Federal Reserve to have aggressively increased the monetary base by whatever amount was necessary to stop the decline in the money supply is hindsight. A course of action for monetary policy such as this was beyond the scope of discussion prevailing at the time. In addition, others, like Moses Abramovitz, point out that the money supply had endogenous components that were beyond the Federal Reserve’s ability to control. Namely, the money supply may have been falling as a result of declining economic activity, or so-called “reverse causation.” Moreover the gold standard, to which the United States continued to adhere until March 1933, also tied the hands of the Federal Reserve in so far as gold outflows that occurred required the Federal Reserve to contract the supply of money. These views are also contained in Temin (1989) and Eichengreen (1992), as discussed below.

Bernanke (1983) argues that the monetary hypothesis: (i) is not a complete explanation of the link between the financial sector and aggregate output in the 1930s; (ii) does not explain how it was that decreases in the money supply caused output to keep falling over many years, especially since it is widely believed that changes in the money supply only change prices and other nominal economic values in the long run, not real economic values like output ; and (iii) is quantitatively insufficient to explain the depth of the decline in output. Bernanke (1983) not only resurrected and sharpened Fisher’s (1933) debt deflation hypothesis, but also made further contributions to what has come to be known as the nonmonetary/financial hypothesis.

The Nonmonetary/Financial Hypothesis

Bernanke (1983), building on the monetary hypothesis of Friedman and Schwartz (1963), presents an alternative interpretation of the way in which the financial crises may have affected output. The argument involves both the effects of debt deflation and the impact that bank panics had on the ability of financial markets to efficiently allocate funds from lenders to borrowers. These nonmonetary/financial theories hold that events in financial markets other than shocks to the money supply can help to account for the paths of output and prices during the Great Depression.

Fisher (1933) asserted that the dominant forces that account for “great” depressions are (nominal) over-indebtedness and deflation. Specifically, he argued that real debt burdens were substantially increased when there were dramatic declines in the price level and nominal incomes. The combination of deflation, falling nominal income and increasing real debt burdens led to debtor insolvency, lowered aggregate demand, and thereby contributed to a continuing decline in the price level and thus further increases in the real burden of debt.

The “Credit View”

Bernanke (1983), in what is now called the “credit view,” provided additional details to help explain Fisher’s debt deflation hypothesis. He argued that in normal circumstances, an initial decline in prices merely reallocates wealth from debtors to creditors, such as banks. Usually, such wealth redistributions are minor in magnitude and have no first-order impact on the economy. However, in the face of large shocks, deflation in the prices of assets forfeited to banks by debtor bankruptcies leads to a decline in the nominal value of assets on bank balance sheets. For a given value of bank liabilities, also denominated in nominal terms, this deterioration in bank assets threatens insolvency. As banks reallocate away from loans to safer government securities, some borrowers, particularly small ones, are unable to obtain funds, often at any price. Further, if this reallocation is long-lived, the shortage of credit for these borrowers helps to explain the persistence of the downturn. As the disappearance of bank financing forces lower expenditure plans, aggregate demand declines, which again contributes to the downward deflationary spiral. For debt deflation to be operative, it is necessary to demonstrate that there was a substantial build-up of debt prior to the onset of the Depression and that the deflation of the 1930s was at least partially unanticipated at medium- and long-term horizons at the time that the debt was being incurred. Both of these conditions appear to have been in place (Fackler and Parker, 2001; Hamilton, 1992; Evans and Wachtel, 1993).

The Breakdown in Credit Markets

In addition, the financial panics which occurred hindered the credit allocation mechanism. Bernanke (1983) explains that the process of credit intermediation requires substantial information gathering and non-trivial market-making activities. The financial disruptions of 1930–33 are correctly viewed as substantial impediments to the performance of these services and thus impaired the efficient allocation of credit between lenders and borrowers. That is, financial panics and debtor and business bankruptcies resulted in a increase in the real cost of credit intermediation. As the cost of credit intermediation increased, sources of credit for many borrowers (especially households, farmers and small firms) became expensive or even unobtainable at any price. This tightening of credit put downward pressure on aggregate demand and helped turn the recession of 1929–30 into the Great Depression. The empirical support for the validity of the nonmonetary/financial hypothesis during the Depression is substantial (Bernanke, 1983; Fackler and Parker, 1994, 2001; Hamilton, 1987, 1992), although support for the “credit view” for the transmission mechanism of monetary policy in post-World War II economic activity is substantially weaker. In combination, considering the preponderance of empirical results and historical simulations contained in the economic literature, the monetary hypothesis and the nonmonetary/financial hypothesis go a substantial distance toward accounting for the economic experiences of the United States during the Great Depression.

The Role of Pessimistic Expectations

To this combination, the behavior of expectations should also be added. As explained by James Tobin, there was another reason for a “change in the character of the contraction” in 1931. Although Friedman and Schwartz attribute this “change” to the bank panics that occurred, Tobin points out that change also took place because of the emergence of pessimistic expectations. If it was thought that the early stages of the Depression were symptomatic of a recession that was not different in kind from similar episodes in our economic history, and that recovery was a real possibility, the public need not have had pessimistic expectations. Instead the public may have anticipated things would get better. However, after the British left the gold standard, expectations changed in a very pessimistic way. The public may very well have believed that the business cycle downturn was not going to be reversed, but rather was going to get worse than it was. When households and business investors begin to make plans based on the economy getting worse instead of making plans based on anticipations of recovery, the depressing economic effects on consumption and investment of this switch in expectations are common knowledge in the modern macroeconomic literature. For the literature on the Great Depression, the empirical research conducted on the expectations hypothesis focuses almost exclusively on uncertainty (which is not the same thing as pessimistic/optimistic expectations) and its contribution to the onset of the Depression (Romer, 1990; Flacco and Parker, 1992). Although Keynes (1936) writes extensively about the state of expectations and their economic influence, the literature is silent regarding the empirical validity of the expectations hypothesis in 1931–33. Yet, in spite of this, the continued shocks that the United States’ economy received demonstrated that the business cycle downturn of 1931–33 was of a different kind than had previously been known. Once the public believed this to be so and made their plans accordingly, the results had to have been economically devastating. There is no formal empirical confirmation and I have not segregated the expectations hypothesis as a separate hypothesis in the overview. However, the logic of the above argument compels me to be of the opinion that the expectations hypothesis provides an impressive addition to the monetary hypothesis and the nonmonetary/financial hypothesis in accounting for the economic experiences of the United States during the Great Depression.

The Gold Standard Hypothesis

Recent research on the operation of the interwar gold standard has deepened our understanding of the Depression and its international character. The way and manner in which the interwar gold standard was structured and operated provide a convincing explanation of the international transmission of deflation and depression that occurred in the 1930s.

The story has its beginning in the 1870–1914 period. During this time the gold standard functioned as a pegged exchange rate system where certain rules were observed. Namely, it was necessary for countries to permit their money supplies to be altered in response to gold flows in order for the price-specie flow mechanism to function properly. It operated successfully because countries that were gaining gold allowed their money supply to increase and raise the domestic price level to restore equilibrium and maintain the fixed exchange rate of their currency. Countries that were losing gold were obligated to permit their money supply to decrease and generate a decline in their domestic price level to restore equilibrium and maintain the fixed exchange rate of their currency. Eichengreen (1992) discusses and extensively documents that the gold standard of this period functioned as smoothly as it did because of the international commitment countries had to the gold standard and the level of international cooperation exhibited during this time. “What rendered the commitment to the gold standard credible, then, was that the commitment was international, not merely national. That commitment was activated through international cooperation” (Eichengreen, 1992).

The gold standard was suspended when the hostilities of World War I broke out. By the end of 1928, major countries such as the United States, the United Kingdom, France and Germany had re-established ties to a functioning fixed exchange rate gold standard. However, Eichengreen (1992) points out that the world in which the gold standard functioned before World War I was not the same world in which the gold standard was being re-established. A credible commitment to the gold standard, as Hamilton (1988) explains, required that a country maintain fiscal soundness and political objectives that insured the monetary authority could pursue a monetary policy consistent with long-run price stability and continuous convertibility of the currency. Successful operation required these conditions to be in place before re-establishment of the gold standard was operational. However, many governments during the interwar period went back on the gold standard in the opposite set of circumstances. They re-established ties to the gold standard because they were incapable, due to the political chaos generated after World War I, of fiscal soundness and did not have political objectives conducive to reforming monetary policy such that it could insure long-run price stability. “By this criterion, returning to the gold standard could not have come at a worse time or for poorer reasons” (Hamilton, 1988). Kindleberger (1973) stresses the fact that the pre-World War I gold standard functioned as well as it did because of the unquestioned leadership exercised by Great Britain. After World War I and the relative decline of Britain, the United States did not exhibit the same strength of leadership Britain had shown before. The upshot is that it was an unsuitable environment in which to re-establish the gold standard after World War I and the interwar gold standard was destined to drift in a state of malperformance as no one took responsibility for its proper functioning. However, the problems did not end there.

Flaws in the Interwar International Gold Standard

Lack of Symmetry in the Response of Gold-Gaining and Gold-Losing Countries

The interwar gold standard operated with four structural/technical flaws that almost certainly doomed it to failure (Eichengreen, 1986; Temin, 1989; Bernanke and James, 1991). The first, and most damaging, was the lack of symmetry in the response of gold-gaining countries and gold-losing countries that resulted in a deflationary bias that was to drag the world deeper into deflation and depression. If a country was losing gold reserves, it was required to decrease its money supply to maintain its commitment to the gold standard. Given that a minimum gold reserve had to be maintained and that countries became concerned when the gold reserve fell within 10 percent of this minimum, little gold could be lost before the necessity of monetary contraction, and thus deflation, became a reality. Moreover, with a fractional gold reserve ratio of 40 percent, the result was a decline in the domestic money supply equal to 2.5 times the gold outflow. On the other hand, there was no such constraint on countries that experienced gold inflows. Gold reserves were accumulated without the binding requirement that the domestic money supply be expanded. Thus the price–specie flow mechanism ceased to function and the equilibrating forces of the pre-World War I gold standard were absent during the interwar period. If a country attracting gold reserves were to embark on a contractionary path, the result would be the further extraction of gold reserves from other countries on the gold standard and the imposition of deflation on their economies as well, as they were forced to contract their money supplies. “As it happened, both of the two major gold surplus countries – France and the United States, who at the time together held close to 60 percent of the world’s monetary gold – took deflationary paths in 1928–1929” (Bernanke and James, 1991).

Foreign Exchange Reserves

Second, countries that did not have reserve currencies could hold their minimum reserves in the form of both gold and convertible foreign exchange reserves. If the threat of devaluation of a reserve currency appeared likely, a country holding foreign exchange reserves could divest itself of the foreign exchange, as holding it became a more risky proposition. Further, the convertible reserves were usually only fractionally backed by gold. Thus, if countries were to prefer gold holdings as opposed to foreign exchange reserves for whatever reason, the result would be a contraction in the world money supply as reserves were destroyed in the movement to gold. This effect can be thought of as equivalent to the effect on the domestic money supply in a fractional reserve banking system of a shift in the public’s money holdings toward currency and away from bank deposits.

The Bank of France and Open Market Operations

Third, the powers of many European central banks were restricted or excluded outright. In particular, as discussed by Eichengreen (1986), the Bank of France was prohibited from engaging in open market operations, i.e. the purchase or sale of government securities. Given that France was one of the countries amassing gold reserves, this restriction largely prevented them from adhering to the rules of the gold standard. The proper response would have been to expand their supply of money and inflate so as not to continue to attract gold reserves and impose deflation on the rest of the world. This was not done. France continued to accumulate gold until 1932 and did not leave the gold standard until 1936.

Inconsistent Currency Valuations

Lastly, the gold standard was re-established at parities that were unilaterally determined by each individual country. When France returned to the gold standard in 1926, it returned at a parity rate that is believed to have undervalued the franc. When Britain returned to the gold standard in 1925, it returned at a parity rate that is believed to have overvalued the pound. In this situation, the only sustainable equilibrium required the French to inflate their economy in response to the gold inflows. However, given their legacy of inflation during the 1921–26 period, France steadfastly resisted inflation (Eichengreen, 1986). The maintenance of the gold standard and the resistance to inflation were now inconsistent policy objectives. The Bank of France’s inability to conduct open market operations only made matters worse. The accumulation of gold and the exporting of deflation to the world was the result.

The Timing of Recoveries

Taken together, the flaws described above made the interwar gold standard dysfunctional and in the end unsustainable. Looking back, we observe that the record of departure from the gold standard and subsequent recovery was different for many different countries. For some countries recovery came sooner. For some it came later. It is in this timing of departure from the gold standard that recent research has produced a remarkable empirical finding. From the work of Choudri and Kochin (1980), Eichengreen and Sachs (1985), Temin (1989), and Bernanke and James (1991), we now know that the sooner a country abandoned the gold standard, the quicker recovery commenced. Spain, which never restored its participation in the gold standard, missed the ravages of the Depression altogether. Britain left the gold standard in September 1931, and started to recover. Sweden left the gold standard at the same time as Britain, and started to recover. The United States left in March 1933, and recovery commenced. France, Holland, and Poland continued to have their economies struggle after the United States’ recovery began as they continued to adhere to the gold standard until 1936. Only after they left did recovery start; departure from the gold standard freed a country from the ravages of deflation.

The Fed and the Gold Standard: The “Midas Touch”

Temin (1989) and Eichengreen (1992) argue that it was the unbending commitment to the gold standard that generated deflation and depression worldwide. They emphasize that the gold standard required fiscal and monetary authorities around the world to submit their economies to internal adjustment and economic instability in the face of international shocks. Given how the gold standard tied countries together, if the gold parity were to be defended and devaluation was not an option, unilateral monetary actions by any one country were pointless. The end result is that Temin (1989) and Eichengreen (1992) reject Friedman and Schwartz’s (1963) claim that the Depression was caused by a series of policy failures on the part of the Federal Reserve. Actions taken in the United States, according to Temin (1989) and Eichengreen (1992), cannot be properly understood in isolation with respect to the rest of the world. If the commitment to the gold standard was to be maintained, monetary and fiscal authorities worldwide had little choice in responding to the crises of the Depression. Why did the Federal Reserve continue a policy of inaction during the banking panics? Because the commitment to the gold standard, what Temin (1989) has labeled “The Midas Touch,” gave them no choice but to let the banks fail. Monetary expansion and the injection of liquidity would lower interest rates, lead to a gold outflow, and potentially be contrary to the rules of the gold standard. Continued deflation due to gold outflows would begin to call into question the monetary authority’s commitment to the gold standard. “Defending gold parity might require the authorities to sit idly by as the banking system crumbled, as the Federal Reserve did at the end of 1931 and again at the beginning of 1933” (Eichengreen, 1992). Thus, if the adherence to the gold standard were to be maintained, the money supply was endogenous with respect to the balance of payments and beyond the influence of the Federal Reserve.

Eichengreen (1992) concludes further that what made the pre-World War I gold standard so successful was absent during the interwar period: credible commitment to the gold standard activated through international cooperation in its implementation and management. Had these important ingredients of the pre-World War I gold standard been present during the interwar period, twentieth-century economic history may have been very different.

Recovery and the New Deal

March 1933 was the rock bottom of the Depression and the inauguration of Franklin D. Roosevelt represented a sharp break with the status quo. Upon taking office, a bank holiday was declared, the United States left the interwar gold standard the following month, and the government commenced with several measures designed to resurrect the financial system. These measures included: (i) the establishment of the Reconstruction Finance Corporation which set about funneling large sums of liquidity to banks and other intermediaries; (ii) the Securities Exchange Act of 1934 which established margin requirements for bank loans used to purchase stocks and bonds and increased information requirements to potential investors; and (iii) the Glass–Steagal Act which strictly separated commercial banking and investment banking. Although delivering some immediate relief to financial markets, lenders continued to be reluctant to extend credit after the events of 1929–33, and the recovery of financial markets was slow and incomplete. Bernanke (1983) estimates that the United States’ financial system did not begin to shed the inefficiencies under which it was operating until the end of 1935.

The NIRA

Policies designed to promote different economic institutions were enacted as part of the New Deal. The National Industrial Recovery Act (NIRA) was passed on June 6, 1933 and was designed to raise prices and wages. In addition, the Act mandated the formation of planning boards in critical sectors of the economy. The boards were charged with setting output goals for their respective sector and the usual result was a restriction of production. In effect, the NIRA was a license for industries to form cartels and was struck down as unconstitutional in 1935. The Agricultural Adjustment Act of 1933 was similar legislation designed to reduce output and raise prices in the farming sector. It too was ruled unconstitutional in 1936.

Relief and Jobs Programs

Other policies intended to provide relief directly to people who were destitute and out of work were rapidly enacted. The Civilian Conservation Corps (CCC), the Tennessee Valley Authority (TVA), the Public Works Administration (PWA) and the Federal Emergency Relief Administration (FERA) were set up shortly after Roosevelt took office and provided jobs for the unemployed and grants to states for direct relief. The Civil Works Administration (CWA), created in 1933–34, and the Works Progress Administration (WPA), created in 1935, were also designed to provide work relief to the jobless. The Social Security Act was also passed in 1935. There surely are other programs with similar acronyms that have been left out, but the intent was the same. In the words of Roosevelt himself, addressing Congress in 1938:

Government has a final responsibility for the well-being of its citizenship. If private co-operative endeavor fails to provide work for the willing hands and relief for the unfortunate, those suffering hardship from no fault of their own have a right to call upon the Government for aid; and a government worthy of its name must make fitting response. (Quoted from Polenberg, 2000)

The Depression had shown the inaccuracies of classifying the 1920s as a “new era.” Rather, the “new era,” as summarized by Roosevelt’s words above and initiated in government’s involvement in the economy, began in March 1933.

The NBER business cycle chronology shows continuous growth from March 1933 until May 1937, at which time a 13-month recession hit the economy. The business cycle rebounded in June 1938 and continued on its upward march to and through the beginning of the United States’ involvement in World War II. The recovery that started in 1933 was impressive, with real GNP experiencing annual rates of the growth in the 10 percent range between 1933 and December 1941, excluding the recession of 1937–38 (Romer, 1993). However, as reported by Romer (1993), real GNP did not return to its pre-Depression level until 1937 and real GNP did not catch up to its pre-Depression secular trend until 1942. Indeed, the unemployment rate, peaking at 25 percent in March 1933, continued to dwell near or above the double-digit range until 1940. It is in this sense that most economists attribute the ending of the Depression to the onset of World War II. The War brought complete recovery as the unemployment rate quickly plummeted after December 1941 to its nadir during the War of below 2 percent.

Explanations for the Pace of Recovery

The question remains, however, that if the War completed the recovery, what initiated it and sustained it through the end of 1941? Should we point to the relief programs of the New Deal and the leadership of Roosevelt? Certainly, they had psychological/expectational effects on consumers and investors and helped to heal the suffering experienced during that time. However, as shown by Brown (1956), Peppers (1973), and Raynold, McMillin and Beard (1991), fiscal policy contributed little to the recovery, and certainly could have done much more.

Once again we return to the financial system for answers. The abandonment of the gold standard, the impact this had on the money supply, and the deliverance from the economic effects of deflation would have to be singled out as the most important contributor to the recovery. Romer (1993) stresses that Eichengreen and Sachs (1985) have it right; recovery did not come before the decision to abandon the old gold parity was made operational. Once this became reality, devaluation of the currency permitted expansion in the money supply and inflation which, rather than promoting a policy of beggar-thy-neighbor, allowed countries to escape the deflationary vortex of economic decline. As discussed in connection with the gold standard hypothesis, the simultaneity of leaving the gold standard and recovery is a robust empirical result that reflects more than simple temporal coincidence.

Romer (1993) reports an increase in the monetary base in the United States of 52 percent between April 1933 and April 1937. The M1 money supply virtually matched this increase in the monetary base, with 49 percent growth over the same period. The sources of this increase were two-fold. First, aside from the immediate monetary expansion permitted by devaluation, as Romer (1993) explains, monetary expansion continued into 1934 and beyond as gold flowed to the United States from Europe due to the increasing political unrest and heightened probability of hostilities that began the progression to World War II. Second, the increase in the money supply matched the increase in the monetary base and the Treasury chose not to sterilize the gold inflows. This is evidence that the monetary expansion resulted from policy decisions and not endogenous changes in the money multiplier. The new regime was freed from the constraints of the gold standard and the policy makers were intent on taking actions of a different nature than what had been done between 1929 and 1933.

Incompleteness of the Recovery before WWII

The Depression had turned a corner and the economy was emerging from the abyss in 1933. However, it still had a long way to go to reach full recovery. Friedman and Schwartz (1963) comment that “the most notable feature of the revival after 1933 was not its rapidity but its incompleteness.” They claim that monetary policy and the Federal Reserve were passive after 1933. The monetary authorities did nothing to stop the fall from 1929 to 1933 and did little to promote the recovery. The Federal Reserve made no effort to increase the stock of high-powered money through the use of either open market operations or rediscounting; Federal Reserve credit outstanding remained “almost perfectly constant from 1934 to mid-1940” (Friedman and Schwartz, 1963). As we have seen above, it was the Treasury that was generating increases in the monetary base at the time by issuing gold certificates equal to the amount of gold reserve inflow and depositing them at the Federal Reserve. When the government spent the money, the Treasury swapped the gold certificates for Federal Reserve notes and this expanded the monetary base (Romer, 1993). Monetary policy was thought to be powerless to promote recovery, and instead it was fiscal policy that became the implement of choice. The research shows that fiscal policy could have done much more to aid in recovery – ironically fiscal policy was the vehicle that was now the focus of attention. There is an easy explanation for why this is so.

The Emergences of Keynes

The economics profession as a whole was at a loss to provide cogent explanations for the events of 1929–33. In the words of Robert Gordon (1998), “economics had lost its intellectual moorings, and it was time for a new diagnosis.” There were no convincing answers regarding why the earlier theories of macroeconomic behavior failed to explain the events that were occurring, and worse, there was no set of principles that established a guide for proper actions in the future. That changed in 1936 with the publication of Keynes’s book The General Theory of Employment, Interest and Money. Perhaps there has been no other person and no other book in economics about which so much has been written. Many consider the arrival of Keynesian thought to have been a “revolution,” although this too is hotly contested (see, for example, Laidler, 1999). The debates that The General Theory generated have been many and long-lasting. There is little that can be said here to add or subtract from the massive literature devoted to the ideas promoted by Keynes, whether they be viewed right or wrong. But the influence over academic thought and economic policy that was generated by The General Theory is not in doubt.

The time was right for a set of ideas that not only explained the Depression’s course of events, but also provided a prescription for remedies that would create better economic performance in the future. Keynes and The General Theory, at the time the events were unfolding, provided just such a package. When all is said and done, we can look back in hindsight and argue endlessly about what Keynes “really meant” or what the “true” contribution of Keynesianism has been to the world of economics. At the time the Depression happened, Keynes represented a new paradigm for young scholars to latch on to. The stage was set for the nurturing of macroeconomics for the remainder of the twentieth century.

This article is a modified version of the introduction to Randall Parker, editor, Reflections on the Great Depression, Edward Elgar Publishing, 2002.

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1 Bankers’ acceptances are explained at http://www.rich.frb.org/pubs/instruments/ch10.html.

2 Liquidity is the ease of converting an asset into money.

3 The monetary base is measured as the sum of currency in the hands of the public plus reserves in the banking system. It is also called high-powered money since the monetary base is the quantity that gets multiplied into greater amounts of money supply as banks make loans and people spend and thereby create new bank deposits.

4 The money multiplier equals [D/R*(1 + D/C)]/(D/R + D/C + D/E), where

D = deposits, R = reserves, C = currency and E = excess reserves in the

banking system.

5 The real interest rate adjusts the observed (nominal) interest rate for inflation or deflation. Ex post refers to the real interest rate after the actual change in prices has been observed; ex ante refers to the real interest rate that is expected at the time the lending occurs.

6 See note 3.

Citation: Parker, Randall. “An Overview of the Great Depression”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/an-overview-of-the-great-depression/

Gold Standard

Lawrence H. Officer, University of Illinois at Chicago

The gold standard is the most famous monetary system that ever existed. The periods in which the gold standard flourished, the groupings of countries under the gold standard, and the dates during which individual countries adhered to this standard are delineated in the first section. Then characteristics of the gold standard (what elements make for a gold standard), the various types of the standard (domestic versus international, coin versus other, legal versus effective), and implications for the money supply of a country on the standard are outlined. The longest section is devoted to the “classical” gold standard, the predominant monetary system that ended in 1914 (when World War I began), followed by a section on the “interwar” gold standard, which operated between the two World Wars (the 1920s and 1930s).

Countries and Dates on the Gold Standard

Countries on the gold standard and the periods (or beginning and ending dates) during which they were on gold are listed in Tables 1 and 2 for the classical and interwar gold standards. Types of gold standard, ambiguities of dates, and individual-country cases are considered in later sections. The country groupings reflect the importance of countries to establishment and maintenance of the standard. Center countries — Britain in the classical standard, the United Kingdom (Britain’s legal name since 1922) and the United States in the interwar period — were indispensable to the spread and functioning of the gold standard. Along with the other core countries — France and Germany, and the United States in the classical period — they attracted other countries to adopt the gold standard, in particular, British colonies and dominions, Western European countries, and Scandinavia. Other countries — and, for some purposes, also British colonies and dominions — were in the periphery: acted on, rather than actors, in the gold-standard eras, and generally not as committed to the gold standard.

Table 1Countries on Classical Gold Standard
Country Type of Gold Standard Period
Center Country
Britaina Coin 1774-1797b, 1821-1914
Other Core Countries
United Statesc Coin 1879-1917d
Francee Coin 1878-1914
Germany Coin 1871-1914
British Colonies and Dominions
Australia Coin 1852-1915
Canadaf Coin 1854-1914
Ceylon Coin 1901-1914
Indiag Exchange (British pound) 1898-1914
Western Europe
Austria-Hungaryh Coin 1892-1914
Belgiumi Coin 1878-1914
Italy Coin 1884-1894
Liechtenstein Coin 1898-1914
Netherlandsj Coin 1875-1914
Portugalk Coin 1854-1891
Switzerland Coin 1878-1914
Scandinavia
Denmarkl Coin 1872-1914
Finland Coin 1877-1914
Norway Coin 1875-1914
Sweden Coin 1873-1914
Eastern Europe
Bulgaria Coin 1906-1914
Greece Coin 1885, 1910-1914
Montenegro Coin 1911-1914
Romania Coin 1890-1914
Russia Coin 1897-1914
Middle East
Egypt Coin 1885-1914
Turkey (Ottoman Empire) Coin 1881m-1914
Asia
Japann Coin 1897-1917
Philippines Exchange (U.S. dollar) 1903-1914
Siam Exchange (British pound) 1908-1914
Straits Settlementso Exchange (British pound) 1906-1914
Mexico and Central America
Costa Rica Coin 1896-1914
Mexico Coin 1905-1913
South America
Argentina Coin 1867-1876, 1883-1885, 1900-1914
Bolivia Coin 1908-1914
Brazil Coin 1888-1889, 1906-1914
Chile Coin 1895-1898
Ecuador Coin 1898-1914
Peru Coin 1901-1914
Uruguay Coin 1876-1914
Africa
Eritrea Exchange (Italian lira) 1890-1914
German East Africa Exchange (German mark) 1885p-1914
Italian Somaliland Exchange (Italian lira) 1889p-1914

a Including colonies (except British Honduras) and possessions without a national currency: New Zealand and certain other Oceanic colonies, South Africa, Guernsey, Jersey, Malta, Gibraltar, Cyprus, Bermuda, British West Indies, British Guiana, British Somaliland, Falkland Islands, other South and West African colonies.
b Or perhaps 1798.
c Including countries and territories with U.S. dollar as exclusive or predominant currency: British Honduras (from 1894), Cuba (from 1898), Dominican Republic (from 1901), Panama (from 1904), Puerto Rico (from 1900), Alaska, Aleutian Islands, Hawaii, Midway Islands (from 1898), Wake Island, Guam, and American Samoa.
d Except August – October 1914.
e Including Tunisia (from 1891) and all other colonies except Indochina.
f Including Newfoundland (from 1895).
g Including British East Africa, Uganda, Zanzibar, Mauritius, and Ceylon (to 1901).
h Including Montenegro (to 1911).
I Including Belgian Congo.
j Including Netherlands East Indies.
k Including colonies, except Portuguese India.
l Including Greenland and Iceland.
m Or perhaps 1883.
n Including Korea and Taiwan.
o Including Borneo.
p Approximate beginning date.

Sources: Bloomfield (1959, pp. 13, 15; 1963), Bordo and Kydland (1995), Bordo and Schwartz (1996), Brown (1940, pp.15-16), Bureau of the Mint (1929), de Cecco (1984, p. 59), Ding (1967, pp. 6- 7), Director of the Mint (1913, 1917), Ford (1985, p. 153), Gallarotti (1995, pp. 272 75), Gunasekera (1962), Hawtrey (1950, p. 361), Hershlag (1980, p. 62), Ingram (1971, p. 153), Kemmerer (1916; 1940, pp. 9-10; 1944, p. 39), Kindleberger (1984, pp. 59-60), Lampe (1986, p. 34), MacKay (1946, p. 64), MacLeod (1994, p. 13), Norman (1892, pp. 83-84), Officer (1996, chs. 3 4), Pamuk (2000, p. 217), Powell (1999, p. 14), Rifaat (1935, pp. 47, 54), Shinjo (1962, pp. 81-83), Spalding (1928), Wallich (1950, pp. 32-36), Yeager (1976, p. 298), Young (1925).

Table 2Countries on Interwar Gold Standard
Country Type ofGold Standard Ending Date
Exchange-RateStabilization CurrencyConvertibilitya
United Kingdomb 1925 1931
Coin 1922e Other Core Countries
Bullion 1928 Germany 1924 1931
Australiag 1925 1930
Exchange 1925 Canadai 1925 1929
Exchange 1925 Indiaj 1925 1931
Coin 1929k South Africa 1925 1933
Austria 1922 1931
Exchange 1926 Danzig 1925 1935
Coin 1925 Italym 1927 1934
Coin 1925 Portugalo 1929 1931
Coin 1925 Scandinavia
Bullion 1927 Finland 1925 1931
Bullion 1928 Sweden 1922 1931
Albania 1922 1939
Exchange 1927 Czechoslovakia 1923 1931
Exchange 1928 Greece 1927 1932
Exchange 1925 Latvia 1922 1931
Coin 1922 Poland 1926 1936
Exchange 1929 Yugoslavia 1925 1932
Egypt 1925 1931
Exchange 1925 Palestine 1927 1931
Exchange 1928 Asia
Coin 1930 Malayat 1925 1931
Coin 1925 Philippines 1922 1933
Exchange 1928 Mexico and Central America
Exchange 1922 Guatemala 1925 1933
Exchange 1922 Honduras 1923 1933
Coin 1925 Nicaragua 1915 1932
Coin 1920 South America
Coin 1927 Bolivia 1926 1931
Exchange 1928 Chile 1925 1931
Coin 1923 Ecuador 1927 1932
Exchange 1927 Peru 1928 1932
Exchange 1928 Venezuela 1923 1930

a And freedom of gold export and import.
b Including colonies (except British Honduras) and possessions without a national currency: Guernsey, Jersey, Malta, Gibraltar, Cyprus, Bermuda, British West Indies, British Guiana, British Somaliland, Falkland Islands, British West African and certain South African colonies, certain Oceanic colonies.
cIncluding countries and territories with U.S. dollar as exclusive or predominant currency: British Honduras, Cuba, Dominican Republic, Panama, Puerto Rico, Alaska, Aleutian Islands, Hawaii, Midway Islands, Wake Island, Guam, and American Samoa.
dNot applicable; “the United States dollar…constituted the central point of reference in the whole post-war stabilization effort and was throughout the period of stabilization at par with gold.” — Brown (1940, p. 394)
e1919 for freedom of gold export.
f Including colonies and possessions, except Indochina and Syria.
g Including Papua (New Guinea) and adjoining islands.
h Kenya, Uganda, and Tanganyika.
I Including Newfoundland.
j Including Bhutan, Nepal, British Swaziland, Mauritius, Pemba Island, and Zanzibar.
k 1925 for freedom of gold export.
l Including Luxemburg and Belgian Congo.
m Including Italian Somaliland and Tripoli.
n Including Dutch Guiana and Curacao (Netherlands Antilles).
o Including territories, except Portuguese India.
p Including Liechtenstein.
q Including Greenland and Iceland.
r Including Greater Lebanon.
s Including Korea and Taiwan.
t Including Straits Settlements, Sarawak, Labuan, and Borneo.

Sources: Bett (1957, p. 36), Brown (1940), Bureau of the Mint (1929), Ding (1967, pp. 6-7), Director of the Mint (1917), dos Santos (1996, pp. 191-92), Eichengreen (1992, p. 299), Federal Reserve Bulletin (1928, pp. 562, 847; 1929, pp. 201, 265, 549; 1930, pp. 72, 440; 1931, p. 554; 1935, p. 290; 1936, pp. 322, 760), Gunasekera (1962), Jonung (1984, p. 361), Kemmerer (1954, pp. 301 302), League of Nations (1926, pp. 7, 15; 1927, pp. 165-69; 1929, pp. 208-13; 1931, pp. 265-69; 1937/38, p. 107; 1946, p. 2), Moggridge (1989, p. 305), Officer (1996, chs. 3-4), Powell (1999, pp. 23-24), Spalding (1928), Wallich (1950, pp. 32-37), Yeager (1976, pp. 330, 344, 359); Young (1925, p. 76).

Characteristics of Gold Standards

Types of Gold Standards

Pure Coin and Mixed Standards

In theory, “domestic” gold standards — those that do not depend on interaction with other countries — are of two types: “pure coin” standard and “mixed” (meaning coin and paper, but also called simply “coin”) standard. The two systems share several properties. (1) There is a well-defined and fixed gold content of the domestic monetary unit. For example, the dollar is defined as a specified weight of pure gold. (2) Gold coin circulates as money with unlimited legal-tender power (meaning it is a compulsorily acceptable means of payment of any amount in any transaction or obligation). (3) Privately owned bullion (gold in mass, foreign coin considered as mass, or gold in the form of bars) is convertible into gold coin in unlimited amounts at the government mint or at the central bank, and at the “mint price” (of gold, the inverse of the gold content of the monetary unit). (4) Private parties have no restriction on their holding or use of gold (except possibly that privately created coined money may be prohibited); in particular, they may melt coin into bullion. The effect is as if coin were sold to the monetary authority (central bank or Treasury acting as a central bank) for bullion. It would make sense for the authority to sell gold bars directly for coin, even though not legally required, thus saving the cost of coining. Conditions (3) and (4) commit the monetary authority in effect to transact in coin and bullion in each direction such that the mint price, or gold content of the monetary unit, governs in the marketplace.

Under a pure coin standard, gold is the only money. Under a mixed standard, there are also paper currency (notes) — issued by the government, central bank, or commercial banks — and demand-deposit liabilities of banks. Government or central-bank notes (and central-bank deposit liabilities) are directly convertible into gold coin at the fixed established price on demand. Commercial-bank notes and demand deposits might be converted not directly into gold but rather into gold-convertible government or central-bank currency. This indirect convertibility of commercial-bank liabilities would apply certainly if the government or central- bank currency were legal tender but also generally even if it were not. As legal tender, gold coin is always exchangeable for paper currency or deposits at the mint price, and usually the monetary authority would provide gold bars for its coin. Again, two-way transactions in unlimited amounts fix the currency price of gold at the mint price. The credibility of the monetary-authority commitment to a fixed price of gold is the essence of a successful, ongoing gold-standard regime.

A pure coin standard did not exist in any country during the gold-standard periods. Indeed, over time, gold coin declined from about one-fifth of the world money supply in 1800 (2/3 for gold and silver coin together, as silver was then the predominant monetary standard) to 17 percent in 1885 (1/3 for gold and silver, for an eleven-major-country aggregate), 10 percent in 1913 (15 percent for gold and silver, for the major-country aggregate), and essentially zero in 1928 for the major-country aggregate (Triffin, 1964, pp. 15, 56). See Table 3. The zero figure means not that gold coin did not exist, rather that its main use was as reserves for Treasuries, central banks, and (generally to a lesser extent) commercial banks.

Table 3Structure of Money: Major-Countries Aggregatea(end of year)
1885 1928
8 50
33 0d
18 21
33 99

a Core countries: Britain, United States, France, Germany. Western Europe: Belgium, Italy, Netherlands, Switzerland. Other countries: Canada, Japan, Sweden.
b Metallic money, minor coin, paper currency, and demand deposits.
c 1885: Gold and silver coin; overestimate, as includes commercial-bank holdings that could not be isolated from coin held outside banks by the public. 1913: Gold and silver coin. 1928: Gold coin.
d Less than 0.5 percent.
e 1885 and 1913: Gold, silver, and foreign exchange. 1928: Gold and foreign exchange.
f Official gold: Gold in official reserves. Money gold: Gold-coin component of money supply.

Sources: Triffin (1964, p. 62), Sayers (1976, pp. 348, 352) for 1928 Bank of England dollar reserves (dated January 2, 1929).

An “international” gold standard, which naturally requires that more than one country be on gold, requires in addition freedom both of international gold flows (private parties are permitted to import or export gold without restriction) and of foreign-exchange transactions (an absence of exchange control). Then the fixed mint prices of any two countries on the gold standard imply a fixed exchange rate (“mint parity”) between the countries’ currencies. For example, the dollar- sterling mint parity was $4.8665635 per pound sterling (the British pound).

Gold-Bullion and Gold-Exchange Standards

In principle, a country can choose among four kinds of international gold standards — the pure coin and mixed standards, already mentioned, a gold-bullion standard, and a gold- exchange standard. Under a gold-bullion standard, gold coin neither circulates as money nor is it used as commercial-bank reserves, and the government does not coin gold. The monetary authority (Treasury or central bank) stands ready to transact with private parties, buying or selling gold bars (usable only for import or export, not as domestic currency) for its notes, and generally a minimum size of transaction is specified. For example, in 1925 1931 the Bank of England was on the bullion standard and would sell gold bars only in the minimum amount of 400 fine (pure) ounces, approximately £1699 or $8269. Finally, the monetary authority of a country on a gold-exchange standard buys and sells not gold in any form but rather gold- convertible foreign exchange, that is, the currency of a country that itself is on the gold coin or bullion standard.

Gold Points and Gold Export/Import

A fixed exchange rate (the mint parity) for two countries on the gold standard is an oversimplification that is often made but is misleading. There are costs of importing or exporting gold. These costs include freight, insurance, handling (packing and cartage), interest on money committed to the transaction, risk premium (compensation for risk), normal profit, any deviation of purchase or sale price from the mint price, possibly mint charges, and possibly abrasion (wearing out or removal of gold content of coin — should the coin be sold abroad by weight or as bullion). Expressing the exporting costs as the percent of the amount invested (or, equivalently, as percent of parity), the product of 1/100th of these costs and mint parity (the number of units of domestic currency per unit of foreign currency) is added to mint parity to obtain the gold-export point — the exchange rate at which gold is exported. To obtain the gold-import point, the product of 1/100th of the importing costs and mint parity is subtracted from mint parity.

If the exchange rate is greater than the gold-export point, private-sector “gold-point arbitrageurs” export gold, thereby obtaining foreign currency. Conversely, for the exchange rate less than the gold-import point, gold is imported and foreign currency relinquished. Usually the gold is, directly or indirectly, purchased from the monetary authority of the one country and sold to the monetary authority in the other. The domestic-currency cost of the transaction per unit of foreign currency obtained is the gold-export point. That per unit of foreign currency sold is the gold-import point. Also, foreign currency is sold, or purchased, at the exchange rate. Therefore arbitrageurs receive a profit proportional to the exchange-rate/gold-point divergence.

Gold-Point Arbitrage

However, the arbitrageurs’ supply of foreign currency eliminates profit by returning the exchange rate to below the gold-export point. Therefore perfect “gold-point arbitrage” would ensure that the exchange rate has upper limit of the gold-export point. Similarly, the arbitrageurs’ demand for foreign currency returns the exchange rate to above the gold-import point, and perfect arbitrage ensures that the exchange rate has that point as a lower limit. It is important to note what induces the private sector to engage in gold-point arbitrage: (1) the profit motive; and (2) the credibility of the commitment to (a) the fixed gold price and (b) freedom of foreign exchange and gold transactions, on the part of the monetary authorities of both countries.

Gold-Point Spread

The difference between the gold points is called the (gold-point) spread. The gold points and the spread may be expressed as percentages of parity. Estimates of gold points and spreads involving center countries are provided for the classical and interwar gold standards in Tables 4 and 5. Noteworthy is that the spread for a given country pair generally declines over time both over the classical gold standard (evidenced by the dollar-sterling figures) and for the interwar compared to the classical period.

Table 4Gold-Point Estimates: Classical Gold Standard
Countries Period Gold Pointsa(percent) Spreadd(percent) Method of Computation
Exportb Importc
U.S./Britain 1881-1890 0.6585 0.7141 1.3726 PA
U.S./Britain 1891-1900 0.6550 0.6274 1.2824 PA
U.S./Britain 1901-1910 0.4993 0.5999 1.0992 PA
U.S./Britain 1911-1914 0.5025 0.5915 1.0940 PA
France/U.S. 1877-1913 0.6888 0.6290 1.3178 MED
Germany/U.S. 1894-1913 0.4907 0.7123 1.2030 MED
France/Britain 1877-1913 0.4063 0.3964 0.8027 MED
Germany/Britain 1877-1913 0.3671 0.4405 0.8076 MED
Germany/France 1877-1913 0.4321 0.5556 0.9877 MED
Austria/Britain 1912 0.6453 0.6037 1.2490 SE
Netherlands/Britain 1912 0.5534 0.3552 0.9086 SE
Scandinaviae /Britain 1912 0.3294 0.6067 0.9361 SE

a For numerator country.
b Gold-import point for denominator country.
c Gold-export point for denominator country.
d Gold-export point plus gold-import point.
e Denmark, Sweden, and Norway.

Method of Computation: PA = period average. MED = median exchange rate form estimate of various authorities for various dates, converted to percent deviation from parity. SE = single exchange-rate- form estimate, converted to percent deviation from parity.

Sources: U.S./Britain — Officer (1996, p. 174). France/U.S., Germany/U.S., France/Britain, Germany/Britain, Germany/France — Morgenstern (1959, pp. 178-81). Austria/Britain, Netherlands/Britain, Scandinavia/Britain — Easton (1912, pp. 358-63).

Table 5Gold-Point Estimates: Interwar Gold Standard
Countries Period Gold Pointsa(percent) Spreadd(percent) Method of Computation
Exportb Importc
U.S./Britain 1925-1931 0.6287 0.4466 1.0753 PA
U.S./France 1926-1928e 0.4793 0.5067 0.9860 PA
U.S./France 1928-1933f 0.5743 0.3267 0.9010 PA
U.S./Germany 1926-1931 0.8295 0.3402 1.1697 PA
France/Britain 1926 0.2042 0.4302 0.6344 SE
France/Britain 1929-1933 0.2710 0.3216 0.5926 MED
Germany/Britain 1925-1933 0.3505 0.2676 0.6181 MED
Canada/Britain 1929 0.3521 0.3465 0.6986 SE
Netherlands/Britain 1929 0.2858 0.5146 0.8004 SE
Denmark/Britain 1926 0.4432 0.4930 0.9362 SE
Norway/Britain 1926 0.6084 0.3828 0.9912 SE
Sweden/Britain 1926 0.3881 0.3828 0.7709 SE

a For numerator country.
b Gold-import point for denominator country.
c Gold-export point for denominator country.
d Gold-export point plus gold-import point.
e To end of June 1928. French-franc exchange-rate stabilization, but absence of currency convertibility; see Table 2.
f Beginning July 1928. French-franc convertibility; see Table 2.

Method of Computation: PA = period average. MED = median exchange rate form estimate of various authorities for various dates, converted to percent deviation from parity. SE = single exchange-rate- form estimate, converted to percent deviation from parity.

Sources: U.S./Britain — Officer (1996, p. 174). U.S./France, U.S./Germany, France/Britain 1929- 1933, Germany/Britain — Morgenstern (1959, pp. 185-87). Canada/Britain, Netherlands/Britain — Einzig (1929, pp. 98-101) [Netherlands/Britain currencies’ mint parity from Spalding (1928, p. 135). France/Britain 1926, Denmark/Britain, Norway/Britain, Sweden/Britain — Spalding (1926, pp. 429-30, 436).

The effective monetary standard of a country is distinguishable from its legal standard. For example, a country legally on bimetallism usually is effectively on either a gold or silver monometallic standard, depending on whether its “mint-price ratio” (the ratio of its mint price of gold to mint price of silver) is greater or less than the world price ratio. In contrast, a country might be legally on a gold standard but its banks (and government) have “suspended specie (gold) payments” (refusing to convert their notes into gold), so that the country is in fact on a “paper standard.” The criterion adopted here is that a country is deemed on the gold standard if (1) gold is the predominant effective metallic money, or is the monetary bullion, (2) specie payments are in force, and (3) there is a limitation on the coinage and/or the legal-tender status of silver (the only practical and historical competitor to gold), thus providing institutional or legal support for the effective gold standard emanating from (1) and (2).

Implications for Money Supply

Consider first the domestic gold standard. Under a pure coin standard, the gold in circulation, monetary base, and money supply are all one. With a mixed standard, the money supply is the product of the money multiplier (dependent on the commercial-banks’ reserves/deposit and the nonbank-public’s currency/deposit ratios) and the monetary base (the actual and potential reserves of the commercial banking system, with potential reserves held by the nonbank public). The monetary authority alters the monetary base by changing its gold holdings and its loans, discounts, and securities portfolio (non gold assets, called its “domestic assets”). However, the level of its domestic assets is dependent on its gold reserves, because the authority generates demand liabilities (notes and deposits) by increasing its assets, and convertibility of these liabilities must be supported by a gold reserve, if the gold standard is to be maintained. Therefore the gold standard provides a constraint on the level (or growth) of the money supply.

The international gold standard involves balance-of-payments surpluses settled by gold imports at the gold-import point, and deficits financed by gold exports at the gold-export point. (Within the spread, there are no gold flows and the balance of payments is in equilibrium.) The change in the money supply is then the product of the money multiplier and the gold flow, providing the monetary authority does not change its domestic assets. For a country on a gold- exchange standard, holdings of “foreign exchange” (the reserve currency) take the place of gold. In general, the “international assets” of a monetary authority may consist of both gold and foreign exchange.

The Classical Gold Standard

Dates of Countries Joining the Gold Standard

Table 1 (above) lists all countries that were on the classical gold standard, the gold- standard type to which each adhered, and the period(s) on the standard. Discussion here concentrates on the four core countries. For centuries, Britain was on an effective silver standard under legal bimetallism. The country switched to an effective gold standard early in the eighteenth century, solidified by the (mistakenly) gold-overvalued mint-price ratio established by Isaac Newton, Master of the Mint, in 1717. In 1774 the legal-tender property of silver was restricted, and Britain entered the gold standard in the full sense on that date. In 1798 coining of silver was suspended, and in 1816 the gold standard was formally adopted, ironically during a paper-standard regime (the “Bank Restriction Period,” of 1797-1821), with the gold standard effectively resuming in 1821.

The United States was on an effective silver standard dating back to colonial times, legally bimetallic from 1786, and on an effective gold standard from 1834. The legal gold standard began in 1873-1874, when Acts ended silver-dollar coinage and limited legal tender of existing silver coins. Ironically, again the move from formal bimetallism to a legal gold standard occurred during a paper standard (the “greenback period,” of 1861-1878), with a dual legal and effective gold standard from 1879.

International Shift to the Gold Standard

The rush to the gold standard occurred in the 1870s, with the adherence of Germany, the Scandinavian countries, France, and other European countries. Legal bimetallism shifted from effective silver to effective gold monometallism around 1850, as gold discoveries in the United States and Australia resulted in overvalued gold at the mints. The gold/silver market situation subsequently reversed itself, and, to avoid a huge inflow of silver, many European countries suspended the coinage of silver and limited its legal-tender property. Some countries (France, Belgium, Switzerland) adopted a “limping” gold standard, in which existing former-standard silver coin retained full legal tender, permitting the monetary authority to redeem its notes in silver as well as gold.

As Table 1 shows, most countries were on a gold-coin (always meaning mixed) standard. The gold-bullion standard did not exist in the classical period (although in Britain that standard was embedded in legislation of 1819 that established a transition to restoration of the gold standard). A number of countries in the periphery were on a gold-exchange standard, usually because they were colonies or territories of a country on a gold-coin standard. In situations in which the periphery country lacked its own (even-coined) currency, the gold-exchange standard existed almost by default. Some countries — China, Persia, parts of Latin America — never joined the classical gold standard, instead retaining their silver or bimetallic standards.

Sources of Instability of the Classical Gold Standard

There were three elements making for instability of the classical gold standard. First, the use of foreign exchange as reserves increased as the gold standard progressed. Available end-of- year data indicate that, worldwide, foreign exchange in official reserves (the international assets of the monetary authority) increased by 36 percent from 1880 to 1899 and by 356 percent from 1899 to 1913. In comparison, gold in official reserves increased by 160 percent from 1880 to 1903 but only by 88 percent from 1903 to 1913. (Lindert, 1969, pp. 22, 25) While in 1913 only Germany among the center countries held any measurable amount of foreign exchange — 15 percent of total reserves excluding silver (which was of limited use) — the percentage for the rest of the world was double that for Germany (Table 6). If there were a rush to cash in foreign exchange for gold, reduction or depletion of the gold of reserve-currency countries could place the gold standard in jeopardy.

Table 6Share of Foreign Exchange in Official Reserves(end of year, percent)
Country 1928b
Excluding Silverb
0 10
0 0c
0d 51
13 16
27 32

a Official reserves: gold, silver, and foreign exchange.
b Official reserves: gold and foreign exchange.
c Less than 0.05 percent.
d Less than 0.5 percent.

Sources: 1913 — Lindert (1969, pp. 10-11). 1928 — Britain: Board of Governors of the Federal Reserve System [cited as BG] (1943, p. 551), Sayers (1976, pp. 348, 352) for Bank of England dollar reserves (dated January 2, 1929). United States: BG (1943, pp. 331, 544), foreign exchange consisting of Federal Reserve Banks holdings of foreign-currency bills. France and Germany: Nurkse (1944, p. 234). Rest of world [computed as residual]: gold, BG (1943, pp. 544-51); foreign exchange, from “total” (Triffin, 1964, p. 66), France, and Germany.

Second, Britain — the predominant reserve-currency country — was in a particularly sensitive situation. Again considering end-of 1913 data, almost half of world foreign-exchange reserves were in sterling, but the Bank of England had only three percent of world gold reserves (Tables 7-8). Defining the “reserve ratio” of the reserve-currency-country monetary authority as the ratio of (i) official reserves to (ii) liabilities to foreign monetary authorities held in financial institutions in the country, in 1913 this ratio was only 31 percent for the Bank of England, far lower than those of the monetary authorities of the other core countries (Table 9). An official run on sterling could easily force Britain off the gold standard. Because sterling was an international currency, private foreigners also held considerable liquid assets in London, and could themselves initiate a run on sterling.

Table 7Composition of World Official Foreign-Exchange Reserves(end of year, percent)
1913a British pounds 77
2 French francs }2}

}

16
5b

a Excluding holdings for which currency unspecified.
b Primarily Dutch guilders and Scandinavian kroner.

Sources: 1913 — Lindert (1969, pp. 18-19). 1928 — Components of world total: Triffin (1964, pp. 22, 66), Sayers (1976, pp. 348, 352) for Bank of England dollar reserves (dated January 2, 1929), Board of Governors of the Federal Reserve System [cited as BG] (1943, p. 331) for Federal Reserve Banks holdings of foreign-currency bills.

Table 8Official-Reserves Components: Percent of World Total(end of year)
Country 1928
Gold Foreign Exchange
0 7 United States 27 0a
0b 13 Germany 6 4
95 36 Table 9Reserve Ratiosa of Reserve-Currency Countries

(end of year)

Country 1928c
Excluding Silverc
0.31 0.33
90.55 5.45
2.38 not available
2.11 not available

a Ratio of official reserves to official liquid liabilities (that is, liabilities to foreign governments and central banks).
b Official reserves: gold, silver, and foreign exchange.
c Official reserves: gold and foreign exchange.

Sources : 1913 — Lindert (1969, pp. 10-11, 19). Foreign-currency holdings for which currency unspecified allocated proportionately to the four currencies based on known distribution. 1928 — Gold reserves: Board of Governors of the Federal Reserve System [cited as BG] (1943, pp. 544, 551). Foreign- exchange reserves: Sayers (1976, pp. 348, 352) for Bank of England dollar reserves (dated January 2, 1929); BG (1943, p. 331) for Federal Reserve Banks holdings of foreign-currency bills. Official liquid liabilities: Triffin (1964, p. 22), Sayers (1976, pp. 348, 352).

Third, the United States, though a center country, was a great source of instability to the gold standard. Its Treasury held a high percentage of world gold reserves (more than that of the three other core countries combined in 1913), resulting in an absurdly high reserve ratio — Tables 7-9). With no central bank and a decentralized banking system, financial crises were frequent. Far from the United States assisting Britain, gold often flowed from the Bank of England to the United States to satisfy increases in U.S. demand for money. Though in economic size the United States was the largest of the core countries, in many years it was a net importer rather than exporter of capital to the rest of the world — the opposite of the other core countries. The political power of silver interests and recurrent financial panics led to imperfect credibility in the U.S. commitment to the gold standard. Runs on banks and runs on the Treasury gold reserve placed the U.S. gold standard near collapse in the early and mid-1890s. During that period, the credibility of the Treasury’s commitment to the gold standard was shaken. Indeed, the gold standard was saved in 1895 (and again in 1896) only by cooperative action of the Treasury and a bankers’ syndicate that stemmed gold exports.

Rules of the Game

According to the “rules of the [gold-standard] game,” central banks were supposed to reinforce, rather than “sterilize” (moderate or eliminate) or ignore, the effect of gold flows on the monetary supply. A gold outflow typically decreases the international assets of the central bank and thence the monetary base and money supply. The central-bank’s proper response is: (1) raise its “discount rate,” the central-bank interest rate for rediscounting securities (cashing, at a further deduction from face value, a short-term security from a financial institution that previously discounted the security), thereby inducing commercial banks to adopt a higher reserves/deposit ratio and therefore decreasing the money multiplier; and (2) decrease lending and sell securities, thereby decreasing domestic assets and thence the monetary base. On both counts the money supply is further decreased. Should the central bank rather increase its domestic assets when it loses gold, it engages in “sterilization” of the gold flow and is decidedly not following the “rules of the game.” The converse argument (involving gold inflow and increases in the money supply) also holds, with sterilization involving the central bank decreasing its domestic assets when it gains gold.

Price Specie-Flow Mechanism

A country experiencing a balance-of-payments deficit loses gold and its money supply decreases, both automatically and by policy in accordance with the “rules of the game.” Money income contracts and the price level falls, thereby increasing exports and decreasing imports. Similarly, a surplus country gains gold, the money supply increases, money income expands, the price level rises, exports decrease and imports increase. In each case, balance-of-payments equilibrium is restored via the current account. This is called the “price specie-flow mechanism.” To the extent that wages and prices are inflexible, movements of real income in the same direction as money income occur; in particular, the deficit country suffers unemployment but the payments imbalance is nevertheless corrected.

The capital account also acts to restore balance, via interest-rate increases in the deficit country inducing a net inflow of capital. The interest-rate increases also reduce real investment and thence real income and imports. Similarly, interest-rate decreases in the surplus country elicit capital outflow and increase real investment, income, and imports. This process enhances the current-account correction of the imbalance.

One problem with the “rules of the game” is that, on “global-monetarist” theoretical grounds, they were inconsequential. Under fixed exchange rates, gold flows simply adjust money supply to money demand; the money supply is not determined by policy. Also, prices, interest rates, and incomes are determined worldwide. Even core countries can influence these variables domestically only to the extent that they help determine them in the global marketplace. Therefore the price-specie-flow and like mechanisms cannot occur. Historical data support this conclusion: gold flows were too small to be suggestive of these mechanisms; and prices, incomes, and interest rates moved closely in correspondence (rather than in the opposite directions predicted by the adjustment mechanisms induced by the “rules of the game”) — at least among non-periphery countries, especially the core group.

Discount Rate Rule and the Bank of England

However, the Bank of England did, in effect, manage its discount rate (“Bank Rate”) in accordance with rule (1). The Bank’s primary objective was to maintain convertibility of its notes into gold, that is, to preserve the gold standard, and its principal policy tool was Bank Rate. When its “liquidity ratio” of gold reserves to outstanding note liabilities decreased, it would usually increase Bank Rate. The increase in Bank Rate carried with it market short-term increase rates, inducing a short-term capital inflow and thereby moving the exchange rate away from the gold-export point by increasing the exchange value of the pound. The converse also held, with a rise in the liquidity ratio involving a Bank Rate decrease, capital outflow, and movement of the exchange rate away from the gold import point. The Bank was constantly monitoring its liquidity ratio, and in response altered Bank Rate almost 200 times over 1880- 1913.

While the Reichsbank (the German central bank), like the Bank of England, generally moved its discount rate inversely to its liquidity ratio, most other central banks often violated the rule, with changes in their discount rates of inappropriate direction, or of insufficient amount or frequency. The Bank of France, in particular, kept its discount rate stable. Unlike the Bank of England, it chose to have large gold reserves (see Table 8), with payments imbalances accommodated by fluctuations in its gold rather than financed by short-term capital flows. The United States, lacking a central bank, had no discount rate to use as a policy instrument.

Sterilization Was Dominant

As for rule (2), that the central-bank’s domestic and international assets move in the same direction; in fact the opposite behavior, sterilization, was dominant, as shown in Table 10. The Bank of England followed the rule more than any other central bank, but even so violated it more often than not! How then did the classical gold standard cope with payments imbalances? Why was it a stable system?

Table 10Annual Changes in Internationala and Domesticb Assets of Central BankPercent of Changes in the Same Directionc
1880-1913d Britain 33
__ France 33
31 British Dominionse 13
32 Scandinaviag 25
33 South Americai 23

a 1880-1913: Gold, silver and foreign exchange. 1922-1936: Gold and foreign exchange.
b Domestic income-earning assets: discounts, loans, securities.
c Implying country is following “rules of the game.” Observations with zero or negligible changes in either class of assets excluded.
d Years when country is off gold standard excluded. See Tables 1 and 2.
e Australia and South Africa.
f1880-1913: Austria-Hungary, Belgium, and Netherlands. 1922-1936: Austria, Italy, Netherlands, and Switzerland.
g Denmark, Finland, Norway, and Sweden.
h1880-1913: Russia. 1922-1936: Bulgaria, Czechoslovakia, Greece, Hungary, Poland, Romania, and Yugoslavia.
I Chile, Colombia, Peru, and Uruguay.

Sources: Bloomfield (1959, p. 49), Nurkse (1944, p. 69).

The Stability of the Classical Gold Standard

The fundamental reason for the stability of the classical gold standard is that there was always absolute private-sector credibility in the commitment to the fixed domestic-currency price of gold on the part of the center country (Britain), two (France and Germany) of the three remaining core countries, and certain other European countries (Belgium, Netherlands, Switzerland, and Scandinavia). Certainly, that was true from the late-1870s onward. (For the United States, this absolute credibility applied from about 1900.) In earlier periods, that commitment had a contingency aspect: it was recognized that convertibility could be suspended in the event of dire emergency (such as war); but, after normal conditions were restored, convertibility would be re-established at the pre-existing mint price and gold contracts would again be honored. The Bank Restriction Period is an example of the proper application of the contingency, as is the greenback period (even though the United States, effectively on the gold standard, was legally on bimetallism).

Absolute Credibility Meant Zero Convertibility and Exchange Risk

The absolute credibility in countries’ commitment to convertiblity at the existing mint price implied that there was extremely low, essentially zero, convertibility risk (the probability that Treasury or central-bank notes would not be redeemed in gold at the established mint price) and exchange risk (the probability that the mint parity between two currencies would be altered, or that exchange control or prohibition of gold export would be instituted).

Reasons Why Commitment to Convertibility Was So Credible

There were many reasons why the commitment to convertibility was so credible. (1) Contracts were expressed in gold; if convertibility were abandoned, contracts would inevitably be violated — an undesirable outcome for the monetary authority. (2) Shocks to the domestic and world economies were infrequent and generally mild. There was basically international peace and domestic calm.

(3) The London capital market was the largest, most open, most diversified in the world, and its gold market was also dominant. A high proportion of world trade was financed in sterling, London was the most important reserve-currency center, and balances of payments were often settled by transferring sterling assets rather than gold. Therefore sterling was an international currency — not merely supplemental to gold but perhaps better: a boon to non- center countries, because sterling involved positive, not zero, interest return and its transfer costs were much less than those of gold. Advantages to Britain were the charges for services as an international banker, differential interest returns on its financial intermediation, and the practice of countries on a sterling (gold-exchange) standard of financing payments surpluses with Britain by piling up short-term sterling assets rather than demanding Bank of England gold.

(4) There was widespread ideology — and practice — of “orthodox metallism,” involving authorities’ commitment to an anti-inflation, balanced-budget, stable-money policy. In particular, the ideology implied low government spending and taxes and limited monetization of government debt (financing of budget deficits by printing money). Therefore it was not expected that a country’s price level or inflation would get out of line with that of other countries, with resulting pressure on the country’s adherence to the gold standard. (5) This ideology was mirrored in, and supported by, domestic politics. Gold had won over silver and paper, and stable-money interests (bankers, industrialists, manufacturers, merchants, professionals, creditors, urban groups) over inflationary interests (farmers, landowners, miners, debtors, rural groups).

(6) There was freedom from government regulation and a competitive environment, domestically and internationally. Therefore prices and wages were more flexible than in other periods of human history (before and after). The core countries had virtually no capital controls; the center country (Britain) had adopted free trade, and the other core countries had moderate tariffs. Balance-of-payments financing and adjustment could proceed without serious impediments.

(7) Internal balance (domestic macroeconomic stability, at a high level of real income and employment) was an unimportant goal of policy. Preservation of convertibility of paper currency into gold would not be superseded as the primary policy objective. While sterilization of gold flows was frequent (see above), the purpose was more “meeting the needs of trade” (passive monetary policy) than fighting unemployment (active monetary policy).

(8) The gradual establishment of mint prices over time ensured that the implied mint parities (exchange rates) were in line with relative price levels; so countries joined the gold standard with exchange rates in equilibrium. (9) Current-account and capital-account imbalances tended to be offsetting for the core countries, especially for Britain. A trade deficit induced a gold loss and a higher interest rate, attracting a capital inflow and reducing capital outflow. Indeed, the capital- exporting core countries — Britain, France, and Germany — could eliminate a gold loss simply by reducing lending abroad.

Rareness of Violations of Gold Points

Many of the above reasons not only enhanced credibility in existing mint prices and parities but also kept international-payments imbalances, and hence necessary adjustment, of small magnitude. Responding to the essentially zero convertibility and exchange risks implied by the credible commitment, private agents further reduced the need for balance-of-payments adjustment via gold-point arbitrage (discussed above) and also via a specific kind of speculation. When the exchange rate moved beyond a gold point, arbitrage acted to return it to the spread. So it is not surprising that “violations of the gold points” were rare on a monthly average basis, as demonstrated in Table 11 for the dollar, franc, and mark exchange rate versus sterling. Certainly, gold-point violations did occur; but they rarely persisted sufficiently to be counted on monthly average data. Such measured violations were generally associated with financial crises. (The number of dollar-sterling violations for 1890-1906 exceeding that for 1889-1908 is due to the results emanating from different researchers using different data. Nevertheless, the important common finding is the low percent of months encompassed by violations.)

Table 11Violations of Gold Points
Exchange Rate Time Period Number of Months Number dollar-sterling 240 0.4
1890-1906 3 dollar-sterling 76 0
1889-1908 12b mark-sterling 240 7.5

a May 1925 – August 1931: full months during which both United States and Britain on gold standard.
b Approximate number, deciphered from graph.

Sources: Dollar-sterling, 1890-1906 and 1925-1931 — Officer (1996, p. 235). All other — Giovannini (1993, pp. 130-31).

Stabilizing Speculation

The perceived extremely low convertibility and exchange risks gave private agents profitable opportunities not only outside the spread (gold-point arbitrage) but also within the spread (exchange-rate speculation). As the exchange value of a country’s currency weakened, the exchange rate approaching the gold-export point, speculators had an ever greater incentive to purchase domestic currency with foreign currency (a capital inflow); for they had good reason to believe that the exchange rate would move in the opposite direction, whereupon they would reverse their transaction at a profit. Similarly, a strengthened currency, with the exchange rate approaching the gold-import point, involved speculators selling the domestic currency for foreign currency (a capital outflow). Clearly, the exchange rate would either not go beyond the gold point (via the actions of other speculators of the same ilk) or would quickly return to the spread (via gold-point arbitrage). Also, the further the exchange rate moved toward the gold point, the greater the potential profit opportunity; for there was a decreased distance to that gold point and an increased distance from the other point.

This “stabilizing speculation” enhanced the exchange value of depreciating currencies that were about to lose gold; and thus the gold loss could be prevented. The speculation was all the more powerful, because the absence of controls on capital movements meant private capital flows were highly responsive to exchange-rate changes. Dollar-sterling data, in Table 12, show that this speculation was extremely efficient in keeping the exchange rate away from the gold points — and increasingly effective over time. Interestingly, these statements hold even for the 1890s, during which at times U.S. maintenance of currency convertibility was precarious. The average deviation of the exchange rate from the midpoint of the spread fell decade-by-decade from about 1/3 of one percent of parity in 1881-1890 (23 percent of the gold-point spread) to only 12/100th of one percent of parity in 1911-1914 (11 percent of the spread).

Table 12Average Deviation of Dollar-Sterling Exchange Rate from Gold-Point-Spread Midpoint
Percent of Parity Quarterly observations
0.32 1891-1900 19
0.15 1911-1914a 11
0.28 Monthly observations
0.24 1925-1931c 26

a Ending with second quarter of 1914.
b Third quarter 1925 – second quarter 1931: full quarters during which both United States and Britain on gold standard.
c May 1925 – August 1931: full months during which both United States and Britain on gold standard.

Source: Officer (1996, pp. 182, 191, 272).

Government Policies That Enhanced Gold-Standard Stability

Government policies also enhanced gold-standard stability. First, by the turn of the century South Africa — the main world gold producer — sold all its gold in London, either to private parties or actively to the Bank of England, with the Bank serving also as residual purchaser of the gold. Thus the Bank had the means to replenish its gold reserves. Second, the orthodox- metallism ideology and the leadership of the Bank of England — other central banks would often gear their monetary policy to that of the Bank — kept monetary policies harmonized. Monetary discipline was maintained.

Third, countries used “gold devices,” primarily the manipulation of gold points, to affect gold flows. For example, the Bank of England would foster gold imports by lowering the foreign gold-export point (number of units of foreign currency per pound, the British gold-import point) through interest-free loans to gold importers or raising its purchase price for bars and foreign coin. The Bank would discourage gold exports by lowering the foreign gold-import point (the British gold-export point) via increasing its selling prices for gold bars and foreign coin, refusing to sell bars, or redeeming its notes in underweight domestic gold coin. These policies were alternative to increasing Bank Rate.

The Bank of France and Reichsbank employed gold devices relative to discount-rate changes more than Britain did. Some additional policies included converting notes into gold only in Paris or Berlin rather than at branches elsewhere in the country, the Bank of France converting its notes in silver rather than gold (permitted under its “limping” gold standard), and the Reichsbank using moral suasion to discourage the export of gold. The U.S. Treasury followed similar policies at times. In addition to providing interest-free loans to gold importers and changing the premium at which it would sell bars (or refusing to sell bars outright), the Treasury condoned banking syndicates to put pressure on gold arbitrageurs to desist from gold export in 1895 and 1896, a time when the U.S. adherence to the gold standard was under stress.

Fourth, the monetary system was adept at conserving gold, as evidenced in Table 3. This was important, because the increased gold required for a growing world economy could be obtained only from mining or from nonmonetary hoards. While the money supply for the eleven- major-country aggregate more than tripled from 1885 to 1913, the percent of the money supply in the form of metallic money (gold and silver) more than halved. This process did not make the gold standard unstable, because gold moved into commercial-bank and central-bank (or Treasury) reserves: the ratio of gold in official reserves to official plus money gold increased from 33 to 54 percent. The relative influence of the public versus private sector in reducing the proportion of metallic money in the money supply is an issue warranting exploration by monetary historians.

Fifth, while not regular, central-bank cooperation was not generally required in the stable environment in which the gold standard operated. Yet this cooperation was forthcoming when needed, that is, during financial crises. Although Britain was the center country, the precarious liquidity position of the Bank of England meant that it was more often the recipient than the provider of financial assistance. In crises, it would obtain loans from the Bank of France (also on occasion from other central banks), and the Bank of France would sometimes purchase sterling to push up that currency’s exchange value. Assistance also went from the Bank of England to other central banks, as needed. Further, the credible commitment was so strong that private bankers did not hesitate to make loans to central banks in difficulty.

In sum, “virtuous” two-way interactions were responsible for the stability of the gold standard. The credible commitment to convertibility of paper money at the established mint price, and therefore the fixed mint parities, were both a cause and a result of (1) the stable environment in which the gold standard operated, (2) the stabilizing behavior of arbitrageurs and speculators, and (3) the responsible policies of the authorities — and (1), (2), and (3), and their individual elements, also interacted positively among themselves.

Experience of Periphery

An important reason for periphery countries to join and maintain the gold standard was the access to the capital markets of the core countries thereby fostered. Adherence to the gold standard connoted that the peripheral country would follow responsible monetary, fiscal, and debt-management policies — and, in particular, faithfully repay the interest on and principal of debt. This “good housekeeping seal of approval” (the term coined by Bordo and Rockoff, 1996), by reducing the risk premium, involved a lower interest rate on the country’s bonds sold abroad, and very likely a higher volume of borrowing. The favorable terms and greater borrowing enhanced the country’s economic development.

However, periphery countries bore the brunt of the burden of adjustment of payments imbalances with the core (and other Western European) countries, for three reasons. First, some of the periphery countries were on a gold-exchange standard. When they ran a surplus, they typically increased — and with a deficit, decreased — their liquid balances in London (or other reserve-currency country) rather than withdraw gold from the reserve-currency country. The monetary base of the periphery country would increase, or decrease, but that of the reserve-currency country would remain unchanged. This meant that such changes in domestic variables — prices, incomes, interest rates, portfolios, etc.–that occurred to correct the surplus or deficit, were primarily in the periphery country. The periphery, rather than the core, “bore the burden of adjustment.”

Second, when Bank Rate increased, London drew funds from France and Germany, that attracted funds from other Western European and Scandinavian countries, that drew capital from the periphery. Also, it was easy for a core country to correct a deficit by reducing lending to, or bringing capital home from, the periphery. Third, the periphery countries were underdeveloped; their exports were largely primary products (agriculture and mining), which inherently were extremely sensitive to world market conditions. This feature made adjustment in the periphery compared to the core take the form more of real than financial correction. This conclusion also follows from the fact that capital obtained from core countries for the purpose of economic development was subject to interruption and even reversal. While the periphery was probably better off with access to the capital than in isolation, its welfare gain was reduced by the instability of capital import.

The experience on adherence to the gold standard differed among periphery groups. The important British dominions and colonies — Australia, New Zealand, Canada, and India — successfully maintained the gold standard. They were politically stable and, of course, heavily influenced by Britain. They paid the price of serving as an economic cushion to the Bank of England’s financial situation; but, compared to the rest of the periphery, gained a relatively stable long-term capital inflow. In undeveloped Latin American and Asia, adherence to the gold standard was fragile, with lack of complete credibility in the commitment to convertibility. Many of the reasons for credible commitment that applied to the core countries were absent — for example, there were powerful inflationary interests, strong balance-of-payments shocks, and rudimentary banking sectors. For Latin America and Asia, the cost of adhering to the gold standard was very apparent: loss of the ability to depreciate the currency to counter reductions in exports. Yet the gain, in terms of a steady capital inflow from the core countries, was not as stable or reliable as for the British dominions and colonies.

The Breakdown of the Classical Gold Standard

The classical gold standard was at its height at the end of 1913, ironically just before it came to an end. The proximate cause of the breakdown of the classical gold standard was political: the advent of World War I in August 1914. However, it was the Bank of England’s precarious liquidity position and the gold-exchange standard that were the underlying cause. With the outbreak of war, a run on sterling led Britain to impose extreme exchange control — a postponement of both domestic and international payments — that made the international gold standard non-operational. Convertibility was not legally suspended; but moral suasion, legalistic action, and regulation had the same effect. Gold exports were restricted by extralegal means (and by Trading with the Enemy legislation), with the Bank of England commandeering all gold imports and applying moral suasion to bankers and bullion brokers.

Almost all other gold-standard countries undertook similar policies in 1914 and 1915. The United States entered the war and ended its gold standard late, adopting extralegal restrictions on convertibility in 1917 (although in 1914 New York banks had temporarily imposed an informal embargo on gold exports). An effect of the universal removal of currency convertibility was the ineffectiveness of mint parities and inapplicability of gold points: floating exchange rates resulted.

Interwar Gold Standard

Return to the Gold Standard

In spite of the tremendous disruption to domestic economies and the worldwide economy caused by World War I, a general return to gold took place. However, the resulting interwar gold standard differed institutionally from the classical gold standard in several respects. First, the new gold standard was led not by Britain but rather by the United States. The U.S. embargo on gold exports (imposed in 1917) was removed in 1919, and currency convertibility at the prewar mint price was restored in 1922. The gold value of the dollar rather than of the pound sterling would typically serve as the reference point around which other currencies would be aligned and stabilized. Second, it follows that the core would now have two center countries, the United Kingdom and the United States.

Third, for many countries there was a time lag between stabilizing a country’s currency in the foreign-exchange market (fixing the exchange rate or mint parity) and resuming currency convertibility. Given a lag, the former typically occurred first, currency stabilization operating via central-bank intervention in the foreign-exchange market (transacting in the domestic currency and a reserve currency, generally sterling or the dollar). Table 2 presents the dates of exchange- rate stabilization and currency convertibility resumption for the countries on the interwar gold standard. It is fair to say that the interwar gold standard was at its height at the end of 1928, after all core countries were fully on the standard and before the Great Depression began.

Fourth, the contingency aspect of convertibility conversion, that required restoration of convertibility at the mint price that existed prior to the emergency (World War I), was broken by various countries — even core countries. Some countries (including the United States, United Kingdom, Denmark, Norway, Netherlands, Sweden, Switzerland, Australia, Canada, Japan, Argentina) stabilized their currencies at the prewar mint price. However, other countries (France, Belgium, Italy, Portugal, Finland, Bulgaria, Romania, Greece, Chile) established a gold content of their currency that was a fraction of the prewar level: the currency was devalued in terms of gold, the mint price was higher than prewar. A third group of countries (Germany, Austria, Hungary) stabilized new currencies adopted after hyperinflation. A fourth group (Czechoslovakia, Danzig, Poland, Estonia, Latvia, Lithuania) consisted of countries that became independent or were created following the war and that joined the interwar gold standard. A fifth group (some Latin American countries) had been on silver or paper standards during the classical period but went on the interwar gold standard. A sixth country group (Russia) had been on the classical gold standard, but did not join the interwar gold standard. A seventh group (Spain, China, Iran) joined neither gold standard.

The fifth way in which the interwar gold standard diverged from the classical experience was the mix of gold-standard types. As Table 2 shows, the gold coin standard, dominant in the classical period, was far less prevalent in the interwar period. In particular, all four core countries had been on coin in the classical gold standard; but, of them, only the United States was on coin interwar. The gold-bullion standard, nonexistent prewar, was adopted by two core countries (United Kingdom and France) as well as by two Scandinavian countries (Denmark and Norway). Most countries were on a gold-exchange standard. The central banks of countries on the gold-exchange standard would convert their currencies not into gold but rather into “gold-exchange” currencies (currencies themselves convertible into gold), in practice often sterling, sometimes the dollar (the reserve currencies).

Instability of the Interwar Gold Standard

The features that fostered stability of the classical gold standard did not apply to the interwar standard; instead, many forces made for instability. (1) The process of establishing fixed exchange rates was piecemeal and haphazard, resulting in disequilibrium exchange rates. The United Kingdom restored convertibility at the prewar mint price without sufficient deflation, resulting in an overvalued currency of about ten percent. (Expressed in a common currency at mint parity, the British price level was ten percent higher than that of its trading partners and competitors). A depressed export sector and chronic balance-of-payments difficulties were to result. Other overvalued currencies (in terms of mint parity) were those of Denmark, Italy, and Norway. In contrast, France, Germany, and Belgium had undervalued currencies. (2) Wages and prices were less flexible than in the prewar period. In particular, powerful unions kept wages and unemployment high in British export industries, hindering balance-of-payments correction.

(3) Higher trade barriers than prewar also restrained adjustment.

(4) The gold-exchange standard economized on total world gold via the gold of reserve- currency countries backing their currencies in their reserves role for countries on that standard and also for countries on a coin or bullion standard that elected to hold part of their reserves in London or New York. (Another economizing element was continuation of the move of gold out of the money supply and into banking and official reserves that began in the classical period: for the eleven-major-country aggregate, gold declined to less than œ of one percent of the money supply in 1928, and the ratio of official gold to official-plus-money gold reached 99 percent — Table 3). The gold-exchange standard was inherently unstable, because of the conflict between (a) the expansion of sterling and dollar liabilities to foreign central banks to expand world liquidity, and (b) the resulting deterioration in the reserve ratio of the Bank of England, and U.S. Treasury and Federal Reserve Banks.

This instability was particularly severe in the interwar period, for several reasons. First, France was now a large official holder of sterling, with over half the official reserves of the Bank of France in foreign exchange in 1928, versus essentially none in 1913 (Table 6); and France was resentful that the United Kingdom had used its influence in the League of Nations to induce financially reconstructed countries in Europe to adopt the gold-exchange (sterling) standard. Second, many more countries were on the gold-exchange standard than prewar. Cooperation in restraining a run on sterling or the dollar would be difficult to achieve. Third, the gold-exchange standard, associated with colonies in the classical period, was viewed as a system inferior to a coin standard.

(5) In the classical period, London was the one dominant financial center; in the interwar period it was joined by New York and, in the late 1920s, Paris. Both private and official holdings of foreign currency could shift among the two or three centers, as interest-rate differentials and confidence levels changed.

(6) The problem with gold was not overall scarcity but rather maldistribution. In 1928, official reserve-currency liabilities were much more concentrated than in 1913: the United Kingdom accounted for 77 percent of world foreign-exchange reserves and France less than two percent (versus 47 and 30 percent in 1913 — Table 7). Yet the United Kingdom held only seven percent of world official gold and France 13 percent (Table 8). Reflecting its undervalued currency, France also possessed 39 percent of world official foreign exchange. Incredibly, the United States held 37 percent of world official gold — more than all the non-core countries together.

(7) Britain’s financial position was even more precarious than in the classical period. In 1928, the gold and dollar reserves of the Bank of England covered only one third of London’s liquid liabilities to official foreigners, a ratio hardly greater than in 1913 (and compared to a U.S. ratio of almost 5œ — Table 9). Various elements made the financial position difficult compared to prewar. First, U.K. liquid liabilities were concentrated on stronger countries (France, United States), whereas its liquid assets were predominantly in weaker countries (such as Germany). Second, there was ongoing tension with France, that resented the sterling-dominated gold- exchange standard and desired to cash in its sterling holding for gold to aid its objective of achieving first-class financial status for Paris.

(8) Internal balance was an important goal of policy, which hindered balance-of-payments adjustment, and monetary policy was affected greatly by domestic politics rather than geared to preservation of currency convertibility. (9) Especially because of (8), the credibility in authorities’ commitment to the gold standard was not absolute. Convertibility risk and exchange risk could be well above zero, and currency speculation could be destabilizing rather than stabilizing; so that when a country’s currency approached or reached its gold-export point, speculators might anticipate that currency convertibility would not be maintained and the currency devalued. Hence they would sell rather than buy the currency, which, of course, would help bring about the very outcome anticipated.

(10) The “rules of the game” were infrequently followed and, for most countries, violated even more often than in the classical gold standard — Table 10. Sterilization of gold inflows by the Bank of England can be viewed as an attempt to correct the overvalued pound by means of deflation. However, the U.S. and French sterilization of their persistent gold inflows reflected exclusive concern for the domestic economy and placed the burden of adjustment on other countries in the form of deflation.

(11) The Bank of England did not provide a leadership role in any important way, and central-bank cooperation was insufficient to establish credibility in the commitment to currency convertibility.

Breakdown of the Interwar Gold Standard

Although Canada effectively abandoned the gold standard early in 1929, this was a special case in two respects. First, the action was an early drastic reaction to high U.S. interest rates established to fight the stock-market boom but that carried the threat of unsustainable capital outflow and gold loss for other countries. Second, use of gold devices was the technique used to restrict gold exports and informally terminate the Canadian gold standard.

The beginning of the end of the interwar gold standard occurred with the Great Depression. The depression began in the periphery, with low prices for exports and debt-service requirements leading to insurmountable balance-of-payments difficulties while on the gold standard. However, U.S. monetary policy was an important catalyst. In the second half of 1927 the Federal Reserve pursued an easy-money policy, which supported foreign currencies but also fed the boom in the New York stock market. Reversing policy to fight the Wall Street boom, higher interest rates attracted monies to New York, which weakened sterling in particular. The stock market crash in October 1929, while helpful to sterling, was followed by a passive monetary policy that did not prevent the U.S. depression that started shortly thereafter and that spread to the rest of the world via declines in U.S. trade and lending. In 1929 and 1930 a number of periphery countries either formally suspended currency convertibility or restricted it so that their currencies went beyond the gold-export point.

It was destabilizing speculation, emanating from lack of confidence in authorities’ commitment to currency convertibility that ended the interwar gold standard. In May 1931 there was a run on Austria’s largest commercial bank, and the bank failed. The run spread to Germany, where an important bank also collapsed. The countries’ central banks lost substantial reserves; international financial assistance was too late; and in July 1931 Germany adopted exchange control, followed by Austria in October. These countries were definitively off the gold standard.

The Austrian and German experiences, as well as British budgetary and political difficulties, were among the factors that destroyed confidence in sterling, which occurred in mid-July 1931. Runs on sterling ensued, and the Bank of England lost much of its reserves. Loans from abroad were insufficient, and in any event taken as a sign of weakness. The gold standard was abandoned in September, and the pound quickly and sharply depreciated on the foreign- exchange market, as overvaluation of the pound would imply.

Amazingly, there were no violations of the dollar-sterling gold points on a monthly average basis to the very end of August 1931 (Table 11). In contrast, the average deviation of the dollar-sterling exchange rate from the midpoint of the gold-point spread in 1925-1931 was more than double that in 1911-1914, by either of two measures (Table 12), suggesting less- dominant stabilizing speculation compared to the prewar period. Yet the 1925-1931 average deviation was not much more (in one case, even less) than in earlier decades of the classical gold standard. The trust in the Bank of England had a long tradition, and the shock to confidence in sterling that occurred in July 1931 was unexpected by the British authorities.

Following the U.K. abandonment of the gold standard, many countries followed, some to maintain their competitiveness via currency devaluation, others in response to destabilizing capital flows. The United States held on until 1933, when both domestic and foreign demands for gold, manifested in runs on U.S. commercial banks, became intolerable. The “gold bloc” countries (France, Belgium, Netherlands, Switzerland, Italy, Poland) and Danzig lasted even longer; but, with their currencies now overvalued and susceptible to destabilizing speculation, these countries succumbed to the inevitable by the end of 1936. Albania stayed on gold until occupied by Italy in 1939. As much as a cause, the Great Depression was a consequence of the gold standard; for gold-standard countries hesitated to inflate their economies for fear of weakening the balance of payments, suffering loss of gold and foreign-exchange reserves, and being forced to abandon convertibility or the gold parity. So the gold standard involved “golden fetters” (the title of the classic work of Eichengreen, 1992) that inhibited monetary and fiscal policy to fight the depression. Therefore, some have argued, these fetters seriously exacerbated the severity of the Great Depression within countries (because expansionary policy to fight unemployment was not adopted) and fostered the international transmission of the Depression (because as a country’s output decreased, its imports fell, thus reducing exports and income of other countries).

The “international gold standard,” defined as the period of time during which all four core countries were on the gold standard, existed from 1879 to 1914 (36 years) in the classical period and from 1926 or 1928 to 1931 (four or six years) in the interwar period. The interwar gold standard was a dismal failure in longevity, as well as in its association with the greatest depression the world has known.

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Citation: Officer, Lawrence. “Gold Standard”. EH.Net Encyclopedia, edited by Robert Whaples. March 26, 2008. URL http://eh.net/encyclopedia/gold-standard/

Manufactured and Natural Gas Industry

Christopher Castaneda, California State University – Sacramento

The historical gas industry includes two chemically distinct flammable gasses. These are natural gas and several variations of manufactured coal gas. Natural gas is composed primarily of methane, a hydrocarbon composed of one carbon atom and four hydrogen atoms, or CH4. As a “fossil fuel,” natural gas flowing from the earth is rarely pure. It is commonly associated with petroleum and may contain other hydrocarbons including butane, ethane, and propane. In the United States, substantial commercial natural gas utilization did not begin until after the discovery of large quantities of both crude oil and natural gas in western Pennsylvania during 1859.

Manufactured Gas

Manufactured coal gas (sometimes referred to as “town gas”), and its several variants, was used for lighting throughout most of the nineteenth century. Consumers also used this gas as a fuel for heating and cooking from the late nineteenth through the mid-twentieth century in many locations where natural gas was unavailable. Generally, a rather simple process of heating coal, or other organic substance, produces a flammable gas. The resulting gas (a combination of carbon monoxide, hydrogen and other gasses depending upon the exact process) was stored in a “holder” or “gasometer” for later distribution. Coal based “gas works” produced manufactured gas from the early nineteenth century through the mid-twentieth century. Commercial utilization of manufactured coal gas occurred prior to that of natural gas due to the comparative ease of producing coal gas. The first manufactured coal gas light demonstration in the United States apparently took place in 1802. Benjamin Henfrey of Northumberland, Pennsylvania, used a “thermo-lamp,” reportedly based on European design, with which he produced a “beautiful and brilliant light,” Despite Henfrey’s successful demonstration in this case and others, he was unable to attract financial support to develop further his gas light endeavors.

Other experimenters followed, but the most successful were several members of the Peale family. Charles Willson Peale, the family patriarch, Revolutionary War colonel, and George Washington’s portraitist, opened a museum in Independence Hall in Philadelphia and subsequently transferred control of it to his son Rubens. Seeking ways to attract paying visitors, Rubens decided to use gaslights in the museum. With technical assistance from chemist Benjamin Kugler in 1814, Rubens installed gaslights. He operated and maintained the museum’s gas works for the next several years until his fear that a fire, or explosion, might destroy the building caused him to disassemble the equipment.

Rembrandt Peale in Baltimore

In the meantime, Rembrandt Peale, another of Charles’ sons, opened a new Peale Museum in Baltimore. The Baltimore museum was similar to his father’s Philadelphia museum in that it contained both works of art and specimens of nature. Rembrandt understood that his museum’s success depended upon its ability to attract paying visitors, and he installed gaslights in the Baltimore museum.

The first advertisement for the museum’s new gas light attraction appeared in the “American and Commercial Daily Advertiser” on June 13, 1816. The ad stated:

Gas Lights – Without Oil, Tallow, Wicks or Smoke. It is not necessary to invite attention to the gas lights by which my salon of paintings is now illuminated; those who have seen the ring beset with gems of light are sufficiently disposed to spread their reputation; the purpose of this notice is merely to say that the Museum will be illuminated every evening until the public curiosity be gratified.

Controlled by a valve attached to the wall in a side room on the second floor next to the lecture hall, Rembrandt Peale dazzled onlookers with his “magic ring” of one hundred burners. The valve allowed Rembrandt to vary the luminosity from dim to very bright. The successful demonstration of gas lighting at the museum underscored to Rembrandt the immense potential for the widespread application of gas lighting.

In his successful gas light demonstration, Rembrandt recognized an opportunity to develop a commercial gasworks for Baltimore. Rembrandt had purchased the patent for Dr. Kugler’s gas light method, and he organized a group of men to join him in a commercial gas lighting venture. These men established the Gas Light Company of Baltimore (GLCB) on June 17, 1816. On February 7, 1817, the GLCB lit its first street lamp at Market and Lemon Streets. The Belvidere Theater located directly across the street from the gas works became the first building illuminated by GLCB, and J. T. Cohen who lived on North Charles Street owned the first private home lit by gas. Rembrandt’s role at GLCB soon diminished, in large part because he lacked understanding of both business and relevant technological issues. Rembrandt was ultimately forced out of the company, and he continued his career as an artist.

The Gas Light Company of Baltimore was the first commercial gas light company in the United States. Other entrepreneurs soon thereafter formed gas light firms for their cities and towns. By 1850, about 50 urban areas in the United States had a manufactured gas works. Generally, gas lighting was available only in medium sized or larger cities, and it was used for lighting streets, commercial establishments, and some residences. Despite the rapid spread of gas lighting, it was expensive and beyond the means of most Americans. Other than gas, whale oil and tallow candles continued to be the most popular fuels for lighting.

1840s-50s: Use of Manufactured Gas Spreads Rapidly

Manufactured gas utilization for lighting and heating spread rapidly throughout the nation during the 1840s and 1850s. By the mid-nineteenth century, New York City ranked first in manufactured gas utilization by consuming approximately 600 million cubic feet (MMcf) per year, compared to Philadelphia’s consumption of approximately 300 MMcf per year.

Developments in portable gas lighting allowed for gas lamp installations in some passenger railroad cars. In the 1850s, the New Jersey Railroad’s service between New York City and Philadelphia offered gas lighting. Coal gas was stored in a wrought-iron cylinder attached to the undercarriage of the passenger cars. Each cylinder contained enough gas to light the two burners per car for fifteen hours. The New Haven Railroad also used gas lighting in the smoking cars of its night express. Each car had two burners that together consumed 7 cubic feet (cf) of gas per hour.

Challenge from Electric Lighting and Consolidation

Although kerosene and tallow candles competed with coal gas for the nineteenth century lighting market, it was electricity that forced permanent restructuring on the manufactured gas industry. In the early 1880s, Thomas Edison promoted electricity as both a safer and cleaner energy source than coal gas which had a strong odor and left soot around the burners. However, the superior quality of electric light and its rapid accessibility after 1882 forced gas light companies to begin promoting manufactured gas for cooking instead of lighting.

By the late nineteenth century, independent gas distribution firms began to merge. Competitive pressures from electric power, in particular, forced gas firms located in the same urban area to consider consolidating operations. By the early twentieth century many coal gas companies also began merging with electric power firms. These business combinations resulted in the formation of large public utility holding companies, many of which were referred to collectively as the “Power Trust.” These large utility firms controlled urban manufactured and natural gas production, transmission, and distribution as well as the same for electric power.

Manufactured gas continued to be used well into the twentieth century in many urban areas that did not have access to natural gas. Between 1930 and the mid-1950s, however, utility companies began converting their manufactured gas plants to natural gas, as the natural fuel became available through newly built long-distance gas pipelines.

Natural Gas

While the manufactured gas business expanded rapidly in the United States during the nineteenth century, natural gas was then neither widely available nor easy to utilize. During the Colonial era, it was the subject more of curiosity than utility. Both George Washington and Thomas Jefferson observed natural gas “springs” in present-day West Virginia. However, the first sustained commercial use of natural gas, albeit relatively minimal, occurred in Fredonia, New York in 1825.

After discovery of large quantities of both oil and natural gas at Titusville, Pennsylvania in 1859, natural gas found a growing market. The large iron and steel works in Pittsburgh contracted for natural gas supply as this fuel offered a stable temperature for industrial heat. Residents and commercial establishments in Pittsburgh also used natural gas for heating purposes. In 1884, the New York Times proclaimed that natural gas would help reduce Pittsburgh’s unpleasant coal smoke pollution.

1920s: Development of Southwestern Fields

The discovery of massive southwestern natural gas fields and technological advancements in long distance pipeline construction dramatically altered the twentieth century gas industry market structure. In 1918, drillers discovered huge natural gas fields in the Panhandle area of North Texas. In 1922, a crew located a large gas well in Kansas that became the first one in the Hugoton field, located in the common Kansas, Oklahoma, and Texas border area (generally referred to as the mid-continent area). The combined Panhandle/Hugoton Field became the nation’s largest gas producing area comprising more than 1.6 million acres. It contained as much as 117 trillion cubic feet (Tcf) of natural gas and accounted for approximately 16 percent of total U.S. reserves in the twentieth century.

As oil drillers had done earlier in Appalachia, they initially exploited the Panhandle Field for petroleum only while allowing an estimated 1 billion cubic feet per day (Bcf/d) of natural gas to escape into the atmosphere. As new markets emerged for the burgeoning natural gas supply, the commercial value of southwestern natural gas attracted entrepreneurial interest and bolstered the fortunes of existing firms. These discoveries led to the establishment of many new companies including the Lone Star Gas Company, Arkansas Louisiana Gas Company, Kansas Natural Gas Company, United Gas Company, and others, some of which evolved into large firms.

Pipeline Advances

The sheer volume of the southwestern fields emphasized the need for advancements in pipeline technology to transport the natural gas to distant urban markets. In particular, new welding technologies allowed pipeline builders in the 1920s to construct longer lines. In the early years of the decade, oxy-acetylene torches were used for welding, and in 1923 electric arc welding was successfully used on thin-walled, high tensile strength, large-diameter pipelines necessary for long-distance compressed gas transmission. Improved welding techniques made pipe joints stronger than the pipe itself; seamless pipe became available for gas pipelines beginning in 1925. Along with enhancements in pipeline construction materials and techniques, gas compressor and ditching machine technology improved as well. Long-distance pipelines became a significant segment of the gas industry beginning in the 1920s.

These new technologies made possible the transportation of southwestern natural gas to distant markets. Until the late 1920s, most interstate natural gas transportation took place in the Northeast, and it was based upon Appalachian production. In 1921, natural gas produced in West Virginia accounted for approximately 65% of interstate gas transportation while only 2% of interstate gas originated in Texas. The discovery of southwestern gas fields occurred as Appalachian gas reserves and production began to diminish. The southwestern gas fields quickly overshadowed those of the historically important Appalachian area.

Between the mid-1920s and the mid-1930s, the combination of abundant and relatively inexpensive southwestern natural gas production, improved pipeline technology, and increasing nation-wide natural gas demand stimulated the creation of a new interstate gas pipeline industry. Metropolitan manufactured gas distribution companies, typically part of large holding companies, financed most of the pipelines built during this first era of rapid pipeline construction. Long distance lines built during this era included the Northern Natural Gas Company, Panhandle Eastern Pipe Line Company, and the Natural Gas Pipeline Company.

Midwestern urban utilities that began receiving natural gas typically mixed it with existing manufactured gas production. This mixed gas had a higher Btu content than straight manufactured gas. Eventually, with access to reliable supplies of natural gas, all U.S. gas utilities converted their distribution systems to straight natural gas.

Samuel Insull

In the late 1920s and early 1930s, the most well-known public utility figure was Samuel Insull, a former personal secretary of Thomas Edison. Insull’s public utility empire headquartered in Chicago did not fare well in the economic climate that followed the 1929 Wall Street stock market crash. His gas and electric power empire crumbled, and he fled the country. The collapse of the Insull empire symbolized the end of a long period of unrestrained and rapid growth in the U.S. public utility industry.

Federal Regulation

In the meantime, the Federal Trade Commission (FTC) launched a massive investigation of the nation’s public utilities, and its work culminated in New Deal legislation that imposed federal regulation on the gas and electric industries. The Public Utility Holding Company Act (1935) broke apart the multi-tiered gas and electric power companies while the Federal Power Act (1935) and the Natural Gas Act (1938), respectively authorized the Federal Power Commission (FPC) to regulate the interstate transmission and sale of electric power and natural gas.

During the Depression the gas industry also suffered its worst tragedy in the twentieth century. In 1937 at New London, Texas, an undetected natural gas leak at the Consolidated High School resulted in a tremendous explosion that virtually destroyed the Consolidated High School, 15 minutes before the end of the school day. Initial estimates of 500 dead were later revised to 294. Texas Governor Allred appointed a military court of inquiry that determined an accumulation of odorless gas in the school’s basement, possibly ignited by the spark of an electric light switch, created the explosion. This terrible tragedy was marked in irony. On top of the wreckage, a broken blackboard contained these words apparently written before the explosion:

Oil and natural gas are East Texas’ greatest mineral blessings. Without them this school would not be here, and none of us would be here learning our lessons.

Although many gas firms used odorants, the New London explosion resulted in the implementation of new natural gas odorization regulations in Texas.

The New Deal era regulatory regime did not appear to constrain gas industry growth during the post-World War II era, as entrepreneurs organized several long-distance gas pipeline firms to connect southwestern gas supply with northeastern markets. Both during and immediately after World War II, a second era of rapid gas industry growth occurred. Pipeline firms targeted northeastern markets such as Philadelphia, New York and Boston, very large urban areas previously without natural gas supply. These cities subsequently converted their distribution systems from manufactured coal gas to the more efficient natural gas.

In the 1950s, the beginnings of a national market for natural gas had emerged. During the last half of the twentieth century, natural gas consumption in the U.S. ranged from about 20-30% of total national energy utilization. However, the era of natural gas abundance ended in the late 1960s.

1960s to 1980s: Price Controls, Shortages, and Decontrol

The first overt sign of serious industry trouble emerged in the late 1960s when natural gas shortages first appeared. Economists almost uniformly blamed the shortages on gas pricing regulations instituted by the so-called Phillips Decision of 1954. This law extended the FPC’s price setting authority over the natural gas producers that sold gas to interstate pipelines for resale. The FPC’s consumerist orientation meant that it had held gas prices low and producers lost their incentive to develop new gas supply for the interstate market.

The 1973 OPEC oil embargo exacerbated the growing shortage problem as factories switched boiler fuels from petroleum to natural gas. Cold winters further strained the nation’s gas industry. The resulting energy crisis compelled consumer groups and politicians to call for changes in the regulatory system that had constricted gas production. In 1978, a new comprehensive federal gas policy dictated by the Natural Gas Policy Act (NGPA) created a new federal agency, the Federal Energy Regulatory Commission (FERC) to assume regulatory authority for the interstate gas industry.

The NGPA also included a complex system of natural gas price decontrols that sought to stimulate domestic natural gas production. These measures soon resulted in the creation of a nationwide gas supply “bubble” and lower prices. The lower prices wreaked additional havoc on the gas pipeline industry since most interstate lines were purchasing gas at high prices under long-term contracts. Large gas purchasers, particularly utilities, subsequently sought to circumvent their high-priced gas contracts with pipelines and purchase natural gas on the emerging spot market.

Once again, dysfunction of the regulated market forced government to act in order to try and bring market balance to the gas industry. Beginning in the mid-1980s, a number of FERC Orders culminating in Order 636 (and amendments) transformed interstate pipelines into virtual common carriers. This industry structural change allowed gas utilities and end-users to contract directly with producers for gas purchases. FERC continued to regulate the gas pipelines’ transportation function.

The Future

Natural gas is a limited resource. While it is the most clean burning of all fossil fuels, it exists in limited supply. Estimates of natural gas availability vary widely from hundreds to thousands of years. Such estimates are dependent upon the technology that must be developed in order to drill for gas in more difficult geographical conditions, find gas where it is expected to be located, and transport it to the consumer. Methane can also be extracted from coal, peat, and oil shale, and if these sources can be successfully utilized for methane production the world’s methane supply will be extended another 500 or more years.

For the foreseeable future, natural gas will continue to be used primarily for residential and commercial heating, electric power generation, and industrial heat processes. The market for methane as a transportation fuel will undoubtedly grow, but improvements in electric vehicles may well dampen any dramatic increase in natural gas powered engines. The environmental characteristics of natural gas will certainly retain this fuel’s position at the forefront of all fossil fuels. In a broadly historical and environmental perspective, we should recognize that in a period of a few hundred years, human society will have burned as fuel for lighting, cooking and heating a very large percentage of the earth’s natural gas supply.

References:

Castaneda, Christopher J. Invisible Fuel: Manufactured and Natural Gas in America, 1800-2000. New York: Twayne Publishers, 1999.

Herbert, John H. Clean Cheap Heat: The Development of Residential Markets for Natural Gas in the United States. New York: Praeger, 1992.

MacAvoy, Paul W. The Natural Gas Market: Sixty Years of Regulation and Deregulation. New Haven: Yale University Press, 2000.

Rose, Mark H. Cities of Light and Heat: Domesticating Gas and Electricity in Urban America. University Park: Pennsylvania State University Press, 1995.

Tussing, Arlon R. and Bob Tippee. The Natural Gas Industry: Evolution, Structure, and Economics, second edition. Cambridge, MA: Ballinger Publishing, 1984.

Citation: Castaneda, Christopher. “Manufactured and Natural Gas Industry”. EH.Net Encyclopedia, edited by Robert Whaples. September 3, 2001. URL http://eh.net/encyclopedia/manufactured-and-natural-gas-industry/

The U.S. Economy in the 1920s

Gene Smiley, Marquette University

Introduction

The interwar period in the United States, and in the rest of the world, is a most interesting era. The decade of the 1930s marks the most severe depression in our history and ushered in sweeping changes in the role of government. Economists and historians have rightly given much attention to that decade. However, with all of this concern about the growing and developing role of government in economic activity in the 1930s, the decade of the 1920s often tends to get overlooked. This is unfortunate because the 1920s are a period of vigorous, vital economic growth. It marks the first truly modern decade and dramatic economic developments are found in those years. There is a rapid adoption of the automobile to the detriment of passenger rail travel. Though suburbs had been growing since the late nineteenth century their growth had been tied to rail or trolley access and this was limited to the largest cities. The flexibility of car access changed this and the growth of suburbs began to accelerate. The demands of trucks and cars led to a rapid growth in the construction of all-weather surfaced roads to facilitate their movement. The rapidly expanding electric utility networks led to new consumer appliances and new types of lighting and heating for homes and businesses. The introduction of the radio, radio stations, and commercial radio networks began to break up rural isolation, as did the expansion of local and long-distance telephone communications. Recreational activities such as traveling, going to movies, and professional sports became major businesses. The period saw major innovations in business organization and manufacturing technology. The Federal Reserve System first tested its powers and the United States moved to a dominant position in international trade and global business. These things make the 1920s a period of considerable importance independent of what happened in the 1930s.

National Product and Income and Prices

We begin the survey of the 1920s with an examination of the overall production in the economy, GNP, the most comprehensive measure of aggregate economic activity. Real GNP growth during the 1920s was relatively rapid, 4.2 percent a year from 1920 to 1929 according to the most widely used estimates. (Historical Statistics of the United States, or HSUS, 1976) Real GNP per capita grew 2.7 percent per year between 1920 and 1929. By both nineteenth and twentieth century standards these were relatively rapid rates of real economic growth and they would be considered rapid even today.

There were several interruptions to this growth. In mid-1920 the American economy began to contract and the 1920-1921 depression lasted about a year, but a rapid recovery reestablished full-employment by 1923. As will be discussed below, the Federal Reserve System’s monetary policy was a major factor in initiating the 1920-1921 depression. From 1923 through 1929 growth was much smoother. There was a very mild recession in 1924 and another mild recession in 1927 both of which may be related to oil price shocks (McMillin and Parker, 1994). The 1927 recession was also associated with Henry Ford’s shut-down of all his factories for six months in order to changeover from the Model T to the new Model A automobile. Though the Model T’s market share was declining after 1924, in 1926 Ford’s Model T still made up nearly 40 percent of all the new cars produced and sold in the United States. The Great Depression began in the summer of 1929, possibly as early as June. The initial downturn was relatively mild but the contraction accelerated after the crash of the stock market at the end of October. Real total GNP fell 10.2 percent from 1929 to 1930 while real GNP per capita fell 11.5 percent from 1929 to 1930.

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Price changes during the 1920s are shown in Figure 2. The Consumer Price Index, CPI, is a better measure of changes in the prices of commodities and services that a typical consumer would purchase, while the Wholesale Price Index, WPI, is a better measure in the changes in the cost of inputs for businesses. As the figure shows the 1920-1921 depression was marked by extraordinarily large price decreases. Consumer prices fell 11.3 percent from 1920 to 1921 and fell another 6.6 percent from 1921 to 1922. After that consumer prices were relatively constant and actually fell slightly from 1926 to 1927 and from 1927 to 1928. Wholesale prices show greater variation. The 1920-1921 depression hit farmers very hard. Prices had been bid up with the increasing foreign demand during the First World War. As European production began to recover after the war prices began to fall. Though the prices of agricultural products fell from 1919 to 1920, the depression brought on dramatic declines in the prices of raw agricultural produce as well as many other inputs that firms employ. In the scramble to beat price increases during 1919 firms had built up large inventories of raw materials and purchased inputs and this temporary increase in demand led to even larger price increases. With the depression firms began to draw down those inventories. The result was that the prices of raw materials and manufactured inputs fell rapidly along with the prices of agricultural produce—the WPI dropped 45.9 percent between 1920 and 1921. The price changes probably tend to overstate the severity of the 1920-1921 depression. Romer’s recent work (1988) suggests that prices changed much more easily in that depression reducing the drop in production and employment. Wholesale prices in the rest of the 1920s were relatively stable though they were more likely to fall than to rise.

Economic Growth in the 1920s

Despite the 1920-1921 depression and the minor interruptions in 1924 and 1927, the American economy exhibited impressive economic growth during the 1920s. Though some commentators in later years thought that the existence of some slow growing or declining sectors in the twenties suggested weaknesses that might have helped bring on the Great Depression, few now argue this. Economic growth never occurs in all sectors at the same time and at the same rate. Growth reallocates resources from declining or slower growing sectors to the more rapidly expanding sectors in accordance with new technologies, new products and services, and changing consumer tastes.

Economic growth in the 1920s was impressive. Ownership of cars, new household appliances, and housing was spread widely through the population. New products and processes of producing those products drove this growth. The combination of the widening use of electricity in production and the growing adoption of the moving assembly line in manufacturing combined to bring on a continuing rise in the productivity of labor and capital. Though the average workweek in most manufacturing remained essentially constant throughout the 1920s, in a few industries, such as railroads and coal production, it declined. (Whaples 2001) New products and services created new markets such as the markets for radios, electric iceboxes, electric irons, fans, electric lighting, vacuum cleaners, and other laborsaving household appliances. This electricity was distributed by the growing electric utilities. The stocks of those companies helped create the stock market boom of the late twenties. RCA, one of the glamour stocks of the era, paid no dividends but its value appreciated because of expectations for the new company. Like the Internet boom of the late 1990s, the electricity boom of the 1920s fed a rapid expansion in the stock market.

Fed by continuing productivity advances and new products and services and facilitated by an environment of stable prices that encouraged production and risk taking, the American economy embarked on a sustained expansion in the 1920s.

Population and Labor in the 1920s

At the same time that overall production was growing, population growth was declining. As can be seen in Figure 3, from an annual rate of increase of 1.85 and 1.93 percent in 1920 and 1921, respectively, population growth rates fell to 1.23 percent in 1928 and 1.04 percent in 1929.

These changes in the overall growth rate were linked to the birth and death rates of the resident population and a decrease in foreign immigration. Though the crude death rate changed little during the period, the crude birth rate fell sharply into the early 1930s. (Figure 4) There are several explanations for the decline in the birth rate during this period. First, there was an accelerated rural-to-urban migration. Urban families have tended to have fewer children than rural families because urban children do not augment family incomes through their work as unpaid workers as rural children do. Second, the period also saw continued improvement in women’s job opportunities and a rise in their labor force participation rates.

Immigration also fell sharply. In 1917 the federal government began to limit immigration and in 1921 an immigration act limited the number of prospective citizens of any nationality entering the United States each year to no more than 3 percent of that nationality’s resident population as of the 1910 census. A new act in 1924 lowered this to 2 percent of the resident population at the 1890 census and more firmly blocked entry for people from central, southern, and eastern European nations. The limits were relaxed slightly in 1929.

The American population also continued to move during the interwar period. Two regions experienced the largest losses in population shares, New England and the Plains. For New England this was a continuation of a long-term trend. The population share for the Plains region had been rising through the nineteenth century. In the interwar period its agricultural base, combined with the continuing shift from agriculture to industry, led to a sharp decline in its share. The regions gaining population were the Southwest and, particularly, the far West.— California began its rapid growth at this time.

 Real Average Weekly or Daily Earnings for Selected=During the 1920s the labor force grew at a more rapid rate than population. This somewhat more rapid growth came from the declining share of the population less than 14 years old and therefore not in the labor force. In contrast, the labor force participation rates, or fraction of the population aged 14 and over that was in the labor force, declined during the twenties from 57.7 percent to 56.3 percent. This was entirely due to a fall in the male labor force participation rate from 89.6 percent to 86.8 percent as the female labor force participation rate rose from 24.3 percent to 25.1 percent. The primary source of the fall in male labor force participation rates was a rising retirement rate. Employment rates for males who were 65 or older fell from 60.1 percent in 1920 to 58.0 percent in 1930.

With the depression of 1920-1921 the unemployment rate rose rapidly from 5.2 to 8.7 percent. The recovery reduced unemployment to an average rate of 4.8 percent in 1923. The unemployment rate rose to 5.8 percent in the recession of 1924 and to 5.0 percent with the slowdown in 1927. Otherwise unemployment remained relatively low. The onset of the Great Depression from the summer of 1929 on brought the unemployment rate from 4.6 percent in 1929 to 8.9 percent in 1930. (Figure 5)

Earnings for laborers varied during the twenties. Table 1 presents average weekly earnings for 25 manufacturing industries. For these industries male skilled and semi-skilled laborers generally commanded a premium of 35 percent over the earnings of unskilled male laborers in the twenties. Unskilled males received on average 35 percent more than females during the twenties. Real average weekly earnings for these 25 manufacturing industries rose somewhat during the 1920s. For skilled and semi-skilled male workers real average weekly earnings rose 5.3 percent between 1923 and 1929, while real average weekly earnings for unskilled males rose 8.7 percent between 1923 and 1929. Real average weekly earnings for females rose on 1.7 percent between 1923 and 1929. Real weekly earnings for bituminous and lignite coal miners fell as the coal industry encountered difficult times in the late twenties and the real daily wage rate for farmworkers in the twenties, reflecting the ongoing difficulties in agriculture, fell after the recovery from the 1920-1921 depression.

The 1920s were not kind to labor unions even though the First World War had solidified the dominance of the American Federation of Labor among labor unions in the United States. The rapid growth in union membership fostered by federal government policies during the war ended in 1919. A committee of AFL craft unions undertook a successful membership drive in the steel industry in that year. When U.S. Steel refused to bargain, the committee called a strike, the failure of which was a sharp blow to the unionization drive. (Brody, 1965) In the same year, the United Mine Workers undertook a large strike and also lost. These two lost strikes and the 1920-21 depression took the impetus out of the union movement and led to severe membership losses that continued through the twenties. (Figure 6)

Under Samuel Gompers’s leadership, the AFL’s “business unionism” had attempted to promote the union and collective bargaining as the primary answer to the workers’ concerns with wages, hours, and working conditions. The AFL officially opposed any government actions that would have diminished worker attachment to unions by providing competing benefits, such as government sponsored unemployment insurance, minimum wage proposals, maximum hours proposals and social security programs. As Lloyd Ulman (1961) points out, the AFL, under Gompers’ direction, differentiated on the basis of whether the statute would or would not aid collective bargaining. After Gompers’ death, William Green led the AFL in a policy change as the AFL promoted the idea of union-management cooperation to improve output and promote greater employer acceptance of unions. But Irving Bernstein (1965) concludes that, on the whole, union-management cooperation in the twenties was a failure.

To combat the appeal of unions in the twenties, firms used the “yellow-dog” contract requiring employees to swear they were not union members and would not join one; the “American Plan” promoting the open shop and contending that the closed shop was un-American; and welfare capitalism. The most common aspects of welfare capitalism included personnel management to handle employment issues and problems, the doctrine of “high wages,” company group life insurance, old-age pension plans, stock-purchase plans, and more. Some firms formed company unions to thwart independent unionization and the number of company-controlled unions grew from 145 to 432 between 1919 and 1926.

Until the late thirties the AFL was a voluntary association of independent national craft unions. Craft unions relied upon the particular skills the workers had acquired (their craft) to distinguish the workers and provide barriers to the entry of other workers. Most craft unions required a period of apprenticeship before a worker was fully accepted as a journeyman worker. The skills, and often lengthy apprenticeship, constituted the entry barrier that gave the union its bargaining power. There were only a few unions that were closer to today’s industrial unions where the required skills were much less (or nonexistent) making the entry of new workers much easier. The most important of these industrial unions was the United Mine Workers, UMW.

The AFL had been created on two principles: the autonomy of the national unions and the exclusive jurisdiction of the national union.—Individual union members were not, in fact, members of the AFL; rather, they were members of the local and national union, and the national was a member of the AFL. Representation in the AFL gave dominance to the national unions, and, as a result, the AFL had little effective power over them. The craft lines, however, had never been distinct and increasingly became blurred. The AFL was constantly mediating jurisdictional disputes between member national unions. Because the AFL and its individual unions were not set up to appeal to and work for the relatively less skilled industrial workers, union organizing and growth lagged in the twenties.

Agriculture

The onset of the First World War in Europe brought unprecedented prosperity to American farmers. As agricultural production in Europe declined, the demand for American agricultural exports rose, leading to rising farm product prices and incomes. In response to this, American farmers expanded production by moving onto marginal farmland, such as Wisconsin cutover property on the edge of the woods and hilly terrain in the Ozark and Appalachian regions. They also increased output by purchasing more machinery, such as tractors, plows, mowers, and threshers. The price of farmland, particularly marginal farmland, rose in response to the increased demand, and the debt of American farmers increased substantially.

This expansion of American agriculture continued past the end of the First World War as farm exports to Europe and farm prices initially remained high. However, agricultural production in Europe recovered much faster than most observers had anticipated. Even before the onset of the short depression in 1920, farm exports and farm product prices had begun to fall. During the depression, farm prices virtually collapsed. From 1920 to 1921, the consumer price index fell 11.3 percent, the wholesale price index fell 45.9 percent, and the farm products price index fell 53.3 percent. (HSUS, Series E40, E42, and E135)

Real average net income per farm fell over 72.6 percent between 1920 and 1921 and, though rising in the twenties, never recovered the relative levels of 1918 and 1919. (Figure 7) Farm mortgage foreclosures rose and stayed at historically high levels for the entire decade of the 1920s. (Figure 8) The value of farmland and buildings fell throughout the twenties and, for the first time in American history, the number of cultivated acres actually declined as farmers pulled back from the marginal farmland brought into production during the war. Rather than indicators of a general depression in agriculture in the twenties, these were the results of the financial commitments made by overoptimistic American farmers during and directly after the war. The foreclosures were generally on second mortgages rather than on first mortgages as they were in the early 1930s. (Johnson, 1973; Alston, 1983)

A Declining Sector

A major difficulty in analyzing the interwar agricultural sector lies in separating the effects of the 1920-21 and 1929-33 depressions from those that arose because agriculture was declining relative to the other sectors. A relatively very slow growing demand for basic agricultural products and significant increases in the productivity of labor, land, and machinery in agricultural production combined with a much more rapid extensive economic growth in the nonagricultural sectors of the economy required a shift of resources, particularly labor, out of agriculture. (Figure 9) The market induces labor to voluntarily move from one sector to another through income differentials, suggesting that even in the absence of the effects of the depressions, farm incomes would have been lower than nonfarm incomes so as to bring about this migration.

The continuous substitution of tractor power for horse and mule power released hay and oats acreage to grow crops for human consumption. Though cotton and tobacco continued as the primary crops in the south, the relative production of cotton continued to shift to the west as production in Arkansas, Missouri, Oklahoma, Texas, New Mexico, Arizona, and California increased. As quotas reduced immigration and incomes rose, the demand for cereal grains grew slowly—more slowly than the supply—and the demand for fruits, vegetables, and dairy products grew. Refrigeration and faster freight shipments expanded the milk sheds further from metropolitan areas. Wisconsin and other North Central states began to ship cream and cheeses to the Atlantic Coast. Due to transportation improvements, specialized truck farms and the citrus industry became more important in California and Florida. (Parker, 1972; Soule, 1947)

The relative decline of the agricultural sector in this period was closely related to the highly inelastic income elasticity of demand for many farm products, particularly cereal grains, pork, and cotton. As incomes grew, the demand for these staples grew much more slowly. At the same time, rising land and labor productivity were increasing the supplies of staples, causing real prices to fall.

Table 3 presents selected agricultural productivity statistics for these years. Those data indicate that there were greater gains in labor productivity than in land productivity (or per acre yields). Per acre yields in wheat and hay actually decreased between 1915-19 and 1935-39. These productivity increases, which released resources from the agricultural sector, were the result of technological improvements in agriculture.

Technological Improvements In Agricultural Production

In many ways the adoption of the tractor in the interwar period symbolizes the technological changes that occurred in the agricultural sector. This changeover in the power source that farmers used had far-reaching consequences and altered the organization of the farm and the farmers’ lifestyle. The adoption of the tractor was land saving (by releasing acreage previously used to produce crops for workstock) and labor saving. At the same time it increased the risks of farming because farmers were now much more exposed to the marketplace. They could not produce their own fuel for tractors as they had for the workstock. Rather, this had to be purchased from other suppliers. Repair and replacement parts also had to be purchased, and sometimes the repairs had to be undertaken by specialized mechanics. The purchase of a tractor also commonly required the purchase of new complementary machines; therefore, the decision to purchase a tractor was not an isolated one. (White, 2001; Ankli, 1980; Ankli and Olmstead, 1981; Musoke, 1981; Whatley, 1987). These changes resulted in more and more farmers purchasing and using tractors, but the rate of adoption varied sharply across the United States.

Technological innovations in plants and animals also raised productivity. Hybrid seed corn increased yields from an average of 40 bushels per acre to 100 to 120 bushels per acre. New varieties of wheat were developed from the hardy Russian and Turkish wheat varieties which had been imported. The U.S. Department of Agriculture’s Experiment Stations took the lead in developing wheat varieties for different regions. For example, in the Columbia River Basin new varieties raised yields from an average of 19.1 bushels per acre in 1913-22 to 23.1 bushels per acre in 1933-42. (Shepherd, 1980) New hog breeds produced more meat and new methods of swine sanitation sharply increased the survival rate of piglets. An effective serum for hog cholera was developed, and the federal government led the way in the testing and eradication of bovine tuberculosis and brucellosis. Prior to the Second World War, a number of pesticides to control animal disease were developed, including cattle dips and disinfectants. By the mid-1920s a vaccine for “blackleg,” an infectious, usually fatal disease that particularly struck young cattle, was completed. The cattle tick, which carried Texas Fever, was largely controlled through inspections. (Schlebecker, 1975; Bogue, 1983; Wood, 1980)

Federal Agricultural Programs in the 1920s

Though there was substantial agricultural discontent in the period from the Civil War to late 1890s, the period from then to the onset of the First World War was relatively free from overt farmers’ complaints. In later years farmers dubbed the 1910-14 period as agriculture’s “golden years” and used the prices of farm crops and farm inputs in that period as a standard by which to judge crop and input prices in later years. The problems that arose in the agricultural sector during the twenties once again led to insistent demands by farmers for government to alleviate their distress.

Though there were increasing calls for direct federal government intervention to limit production and raise farm prices, this was not used until Roosevelt took office. Rather, there was a reliance upon the traditional method to aid injured groups—tariffs, and upon the “sanctioning and promotion of cooperative marketing associations.” In 1921 Congress attempted to control the grain exchanges and compel merchants and stockyards to charge “reasonable rates,” with the Packers and Stockyards Act and the Grain Futures Act. In 1922 Congress passed the Capper-Volstead Act to promote agricultural cooperatives and the Fordney-McCumber Tariff to impose high duties on most agricultural imports.—The Cooperative Marketing Act of 1924 did not bolster failing cooperatives as it was supposed to do. (Hoffman and Liebcap, 1991)

Twice between 1924 and 1928 Congress passed “McNary-Haugan” bills, but President Calvin Coolidge vetoed both. The McNary-Haugan bills proposed to establish “fair” exchange values (based on the 1910-14 period) for each product and to maintain them through tariffs and a private corporation that would be chartered by the government and could buy enough of each commodity to keep its price up to the computed fair level. The revenues were to come from taxes imposed on farmers. The Hoover administration passed the Hawley-Smoot tariff in 1930 and an Agricultural Marketing Act in 1929. This act committed the federal government to a policy of stabilizing farm prices through several nongovernment institutions but these failed during the depression. Federal intervention in the agricultural sector really came of age during the New Deal era of the 1930s.

Manufacturing

Agriculture was not the only sector experiencing difficulties in the twenties. Other industries, such as textiles, boots and shoes, and coal mining, also experienced trying times. However, at the same time that these industries were declining, other industries, such as electrical appliances, automobiles, and construction, were growing rapidly. The simultaneous existence of growing and declining industries has been common to all eras because economic growth and technological progress never affect all sectors in the same way. In general, in manufacturing there was a rapid rate of growth of productivity during the twenties. The rise of real wages due to immigration restrictions and the slower growth of the resident population spurred this. Transportation improvements and communications advances were also responsible. These developments brought about differential growth in the various manufacturing sectors in the United States in the 1920s.

Because of the historic pattern of economic development in the United States, the northeast was the first area to really develop a manufacturing base. By the mid-nineteenth century the East North Central region was creating a manufacturing base and the other regions began to create manufacturing bases in the last half of the nineteenth century resulting in a relative westward and southern shift of manufacturing activity. This trend continued in the 1920s as the New England and Middle Atlantic regions’ shares of manufacturing employment fell while all of the other regions—excluding the West North Central region—gained. There was considerable variation in the growth of the industries and shifts in their ranking during the decade. The largest broadly defined industries were, not surprisingly, food and kindred products; textile mill products; those producing and fabricating primary metals; machinery production; and chemicals. When industries are more narrowly defined, the automobile industry, which ranked third in manufacturing value added in 1919, ranked first by the mid-1920s.

Productivity Developments

Gavin Wright (1990) has argued that one of the underappreciated characteristics of American industrial history has been its reliance on mineral resources. Wright argues that the growing American strength in industrial exports and industrialization in general relied on an increasing intensity in nonreproducible natural resources. The large American market was knit together as one large market without internal barriers through the development of widespread low-cost transportation. Many distinctively American developments, such as continuous-process, mass-production methods were associated with the “high throughput” of fuel and raw materials relative to labor and capital inputs. As a result the United States became the dominant industrial force in the world 1920s and 1930s. According to Wright, after World War II “the process by which the United States became a unified ‘economy’ in the nineteenth century has been extended to the world as a whole. To a degree, natural resources have become commodities rather than part of the ‘factor endowment’ of individual countries.” (Wright, 1990)

In addition to this growing intensity in the use of nonreproducible natural resources as a source of productivity gains in American manufacturing, other technological changes during the twenties and thirties tended to raise the productivity of the existing capital through the replacement of critical types of capital equipment with superior equipment and through changes in management methods. (Soule, 1947; Lorant, 1967; Devine, 1983; Oshima, 1984) Some changes, such as the standardization of parts and processes and the reduction of the number of styles and designs, raised the productivity of both capital and labor. Modern management techniques, first introduced by Frederick W. Taylor, were introduced on a wider scale.

One of the important forces contributing to mass production and increased productivity was the transfer to electric power. (Devine, 1983) By 1929 about 70 percent of manufacturing activity relied on electricity, compared to roughly 30 percent in 1914. Steam provided 80 percent of the mechanical drive capacity in manufacturing in 1900, but electricity provided over 50 percent by 1920 and 78 percent by 1929. An increasing number of factories were buying their power from electric utilities. In 1909, 64 percent of the electric motor capacity in manufacturing establishments used electricity generated on the factory site; by 1919, 57 percent of the electricity used in manufacturing was purchased from independent electric utilities.

The shift from coal to oil and natural gas and from raw unprocessed energy in the forms of coal and waterpower to processed energy in the form of internal combustion fuel and electricity increased thermal efficiency. After the First World War energy consumption relative to GNP fell, there was a sharp increase in the growth rate of output per labor-hour, and the output per unit of capital input once again began rising. These trends can be seen in the data in Table 3. Labor productivity grew much more rapidly during the 1920s than in the previous or following decade. Capital productivity had declined in the decade previous to the 1920s while it also increased sharply during the twenties and continued to rise in the following decade. Alexander Field (2003) has argued that the 1930s were the most technologically progressive decade of the twentieth century basing his argument on the growth of multi-factor productivity as well as the impressive array of technological developments during the thirties. However, the twenties also saw impressive increases in labor and capital productivity as, particularly, developments in energy and transportation accelerated.

 Average Annual Rates of Labor Productivity and Capital Productivity Growth.

Warren Devine, Jr. (1983) reports that in the twenties the most important result of the adoption of electricity was that it would be an indirect “lever to increase production.” There were a number of ways in which this occurred. Electricity brought about an increased flow of production by allowing new flexibility in the design of buildings and the arrangement of machines. In this way it maximized throughput. Electric cranes were an “inestimable boon” to production because with adequate headroom they could operate anywhere in a plant, something that mechanical power transmission to overhead cranes did not allow. Electricity made possible the use of portable power tools that could be taken anywhere in the factory. Electricity brought about improved illumination, ventilation, and cleanliness in the plants, dramatically improving working conditions. It improved the control of machines since there was no longer belt slippage with overhead line shafts and belt transmission, and there were less limitations on the operating speeds of machines. Finally, it made plant expansion much easier than when overhead shafts and belts had been relied upon for operating power.

The mechanization of American manufacturing accelerated in the 1920s, and this led to a much more rapid growth of productivity in manufacturing compared to earlier decades and to other sectors at that time. There were several forces that promoted mechanization. One was the rapidly expanding aggregate demand during the prosperous twenties. Another was the technological developments in new machines and processes, of which electrification played an important part. Finally, Harry Jerome (1934) and, later, Harry Oshima (1984) both suggest that the price of unskilled labor began to rise as immigration sharply declined with new immigration laws and falling population growth. This accelerated the mechanization of the nation’s factories.

Technological changes during this period can be documented for a number of individual industries. In bituminous coal mining, labor productivity rose when mechanical loading devices reduced the labor required from 24 to 50 percent. The burst of paved road construction in the twenties led to the development of a finishing machine to smooth the surface of cement highways, and this reduced the labor requirement from 40 to 60 percent. Mechanical pavers that spread centrally mixed materials further increased productivity in road construction. These replaced the roadside dump and wheelbarrow methods of spreading the cement. Jerome (1934) reports that the glass in electric light bulbs was made by new machines that cut the number of labor-hours required for their manufacture by nearly half. New machines to produce cigarettes and cigars, for warp-tying in textile production, and for pressing clothes in clothing shops also cut labor-hours. The Banbury mixer reduced the labor input in the production of automobile tires by half, and output per worker of inner tubes increased about four times with a new production method. However, as Daniel Nelson (1987) points out, the continuing advances were the “cumulative process resulting from a vast number of successive small changes.” Because of these continuing advances in the quality of the tires and in the manufacturing of tires, between 1910 and 1930 “tire costs per thousand miles of driving fell from $9.39 to $0.65.”

John Lorant (1967) has documented other technological advances that occurred in American manufacturing during the twenties. For example, the organic chemical industry developed rapidly due to the introduction of the Weizman fermentation process. In a similar fashion, nearly half of the productivity advances in the paper industry were due to the “increasingly sophisticated applications of electric power and paper manufacturing processes,” especially the fourdrinier paper-making machines. As Avi Cohen (1984) has shown, the continuing advances in these machines were the result of evolutionary changes to the basic machine. Mechanization in many types of mass-production industries raised the productivity of labor and capital. In the glass industry, automatic feeding and other types of fully automatic production raised the efficiency of the production of glass containers, window glass, and pressed glass. Giedion (1948) reported that the production of bread was “automatized” in all stages during the 1920s.

Though not directly bringing about productivity increases in manufacturing processes, developments in the management of manufacturing firms, particularly the largest ones, also significantly affected their structure and operation. Alfred D. Chandler, Jr. (1962) has argued that the structure of a firm must follow its strategy. Until the First World War most industrial firms were centralized, single-division firms even when becoming vertically integrated. When this began to change the management of the large industrial firms had to change accordingly.

Because of these changes in the size and structure of the firm during the First World War, E. I. du Pont de Nemours and Company was led to adopt a strategy of diversifying into the production of largely unrelated product lines. The firm found that the centralized, divisional structure that had served it so well was not suited to this strategy, and its poor business performance led its executives to develop between 1919 and 1921 a decentralized, multidivisional structure that boosted it to the first rank among American industrial firms.

General Motors had a somewhat different problem. By 1920 it was already decentralized into separate divisions. In fact, there was so much decentralization that those divisions essentially remained separate companies and there was little coordination between the operating divisions. A financial crisis at the end of 1920 ousted W. C. Durant and brought in the du Ponts and Alfred Sloan. Sloan, who had seen the problems at GM but had been unable to convince Durant to make changes, began reorganizing the management of the company. Over the next several years Sloan and other GM executives developed the general office for a decentralized, multidivisional firm.

Though facing related problems at nearly the same time, GM and du Pont developed their decentralized, multidivisional organizations separately. As other manufacturing firms began to diversify, GM and du Pont became the models for reorganizing the management of the firms. In many industrial firms these reorganizations were not completed until well after the Second World War.

Competition, Monopoly, and the Government

The rise of big businesses, which accelerated in the postbellum period and particularly during the first great turn-of-the-century merger wave, continued in the interwar period. Between 1925 and 1939 the share of manufacturing assets held by the 100 largest corporations rose from 34.5 to 41.9 percent. (Niemi, 1980) As a public policy, the concern with monopolies diminished in the 1920s even though firms were growing larger. But the growing size of businesses was one of the convenient scapegoats upon which to blame the Great Depression.

However, the rise of large manufacturing firms in the interwar period is not so easily interpreted as an attempt to monopolize their industries. Some of the growth came about through vertical integration by the more successful manufacturing firms. Backward integration was generally an attempt to ensure a smooth supply of raw materials where that supply was not plentiful and was dispersed and firms “feared that raw materials might become controlled by competitors or independent suppliers.” (Livesay and Porter, 1969) Forward integration was an offensive tactic employed when manufacturers found that the existing distribution network proved inadequate. Livesay and Porter suggested a number of reasons why firms chose to integrate forward. In some cases they had to provide the mass distribution facilities to handle their much larger outputs; especially when the product was a new one. The complexity of some new products required technical expertise that the existing distribution system could not provide. In other cases “the high unit costs of products required consumer credit which exceeded financial capabilities of independent distributors.” Forward integration into wholesaling was more common than forward integration into retailing. The producers of automobiles, petroleum, typewriters, sewing machines, and harvesters were typical of those manufacturers that integrated all the way into retailing.

In some cases, increases in industry concentration arose as a natural process of industrial maturation. In the automobile industry, Henry Ford’s invention in 1913 of the moving assembly line—a technological innovation that changed most manufacturing—lent itself to larger factories and firms. Of the several thousand companies that had produced cars prior to 1920, 120 were still doing so then, but Ford and General Motors were the clear leaders, together producing nearly 70 percent of the cars. During the twenties, several other companies, such as Durant, Willys, and Studebaker, missed their opportunity to become more important producers, and Chrysler, formed in early 1925, became the third most important producer by 1930. Many went out of business and by 1929 only 44 companies were still producing cars. The Great Depression decimated the industry. Dozens of minor firms went out of business. Ford struggled through by relying on its huge stockpile of cash accumulated prior to the mid-1920s, while Chrysler actually grew. By 1940, only eight companies still produced cars—GM, Ford, and Chrysler had about 85 percent of the market, while Willys, Studebaker, Nash, Hudson, and Packard shared the remainder. The rising concentration in this industry was not due to attempts to monopolize. As the industry matured, growing economies of scale in factory production and vertical integration, as well as the advantages of a widespread dealer network, led to a dramatic decrease in the number of viable firms. (Chandler, 1962 and 1964; Rae, 1984; Bernstein, 1987)

It was a similar story in the tire industry. The increasing concentration and growth of firms was driven by scale economies in production and retailing and by the devastating effects of the depression in the thirties. Although there were 190 firms in 1919, 5 firms dominated the industry—Goodyear, B. F. Goodrich, Firestone, U.S. Rubber, and Fisk, followed by Miller Rubber, General Tire and Rubber, and Kelly-Springfield. During the twenties, 166 firms left the industry while 66 entered. The share of the 5 largest firms rose from 50 percent in 1921 to 75 percent in 1937. During the depressed thirties, there was fierce price competition, and many firms exited the industry. By 1937 there were 30 firms, but the average employment per factory was 4.41 times as large as in 1921, and the average factory produced 6.87 times as many tires as in 1921. (French, 1986 and 1991; Nelson, 1987; Fricke, 1982)

The steel industry was already highly concentrated by 1920 as U.S. Steel had around 50 percent of the market. But U. S. Steel’s market share declined through the twenties and thirties as several smaller firms competed and grew to become known as Little Steel, the next six largest integrated producers after U. S. Steel. Jonathan Baker (1989) has argued that the evidence is consistent with “the assumption that competition was a dominant strategy for steel manufacturers” until the depression. However, the initiation of the National Recovery Administration (NRA) codes in 1933 required the firms to cooperate rather than compete, and Baker argues that this constituted a training period leading firms to cooperate in price and output policies after 1935. (McCraw and Reinhardt, 1989; Weiss, 1980; Adams, 1977)

Mergers

A number of the larger firms grew by merger during this period, and the second great merger wave in American industry occurred during the last half of the 1920s. Figure 10 shows two series on mergers during the interwar period. The FTC series included many of the smaller mergers. The series constructed by Carl Eis (1969) only includes the larger mergers and ends in 1930.

This second great merger wave coincided with the stock market boom of the twenties and has been called “merger for oligopoly” rather than merger for monopoly. (Stigler, 1950) This merger wave created many larger firms that ranked below the industry leaders. Much of the activity in occurred in the banking and public utilities industries. (Markham, 1955) In manufacturing and mining, the effects on industrial structure were less striking. Eis (1969) found that while mergers took place in almost all industries, they were concentrated in a smaller number of them, particularly petroleum, primary metals, and food products.

The federal government’s antitrust policies toward business varied sharply during the interwar period. In the 1920s there was relatively little activity by the Justice Department, but after the Great Depression the New Dealers tried to take advantage of big business to make business exempt from the antitrust laws and cartelize industries under government supervision.

With the passage of the FTC and Clayton Acts in 1914 to supplement the 1890 Sherman Act, the cornerstones of American antitrust law were complete. Though minor amendments were later enacted, the primary changes after that came in the enforcement of the laws and in swings in judicial decisions. Their two primary areas of application were in the areas of overt behavior, such as horizontal and vertical price-fixing, and in market structure, such as mergers and dominant firms. Horizontal price-fixing involves firms that would normally be competitors getting together to agree on stable and higher prices for their products. As long as most of the important competitors agree on the new, higher prices, substitution between products is eliminated and the demand becomes much less elastic. Thus, increasing the price increases the revenues and the profits of the firms who are fixing prices. Vertical price-fixing involves firms setting the prices of intermediate products purchased at different stages of production. It also tends to eliminate substitutes and makes the demand less elastic.

Price-fixing continued to be considered illegal throughout the period, but there was no major judicial activity regarding it in the 1920s other than the Trenton Potteries decision in 1927. In that decision 20 individuals and 23 corporations were found guilty of conspiring to fix the prices of bathroom bowls. The evidence in the case suggested that the firms were not very successful at doing so, but the court found that they were guilty nevertheless; their success, or lack thereof, was not held to be a factor in the decision. (Scherer and Ross, 1990) Though criticized by some, the decision was precedent setting in that it prohibited explicit pricing conspiracies per se.

The Justice Department had achieved success in dismantling Standard Oil and American Tobacco in 1911 through decisions that the firms had unreasonably restrained trade. These were essentially the same points used in court decisions against the Powder Trust in 1911, the thread trust in 1913, Eastman Kodak in 1915, the glucose and cornstarch trust in 1916, and the anthracite railroads in 1920. The criterion of an unreasonable restraint of trade was used in the 1916 and 1918 decisions that found the American Can Company and the United Shoe Machinery Company innocent of violating the Sherman Act; it was also clearly enunciated in the 1920 U. S. Steel decision. This became known as the rule of reason standard in antitrust policy.

Merger policy had been defined in the 1914 Clayton Act to prohibit only the acquisition of one corporation’s stock by another corporation. Firms then shifted to the outright purchase of a competitor’s assets. A series of court decisions in the twenties and thirties further reduced the possibilities of Justice Department actions against mergers. “Only fifteen mergers were ordered dissolved through antitrust actions between 1914 and 1950, and ten of the orders were accomplished under the Sherman Act rather than Clayton Act proceedings.”

Energy

The search for energy and new ways to translate it into heat, light, and motion has been one of the unending themes in history. From whale oil to coal oil to kerosene to electricity, the search for better and less costly ways to light our lives, heat our homes, and move our machines has consumed much time and effort. The energy industries responded to those demands and the consumption of energy materials (coal, oil, gas, and fuel wood) as a percent of GNP rose from about 2 percent in the latter part of the nineteenth century to about 3 percent in the twentieth.

Changes in the energy markets that had begun in the nineteenth century continued. Processed energy in the forms of petroleum derivatives and electricity continued to become more important than “raw” energy, such as that available from coal and water. The evolution of energy sources for lighting continued; at the end of the nineteenth century, natural gas and electricity, rather than liquid fuels began to provide more lighting for streets, businesses, and homes.

In the twentieth century the continuing shift to electricity and internal combustion fuels increased the efficiency with which the American economy used energy. These processed forms of energy resulted in a more rapid increase in the productivity of labor and capital in American manufacturing. From 1899 to 1919, output per labor-hour increased at an average annual rate of 1.2 percent, whereas from 1919 to 1937 the increase was 3.5 percent per year. The productivity of capital had fallen at an average annual rate of 1.8 percent per year in the 20 years prior to 1919, but it rose 3.1 percent a year in the 18 years after 1919. As discussed above, the adoption of electricity in American manufacturing initiated a rapid evolution in the organization of plants and rapid increases in productivity in all types of manufacturing.

The change in transportation was even more remarkable. Internal combustion engines running on gasoline or diesel fuel revolutionized transportation. Cars quickly grabbed the lion’s share of local and regional travel and began to eat into long distance passenger travel, just as the railroads had done to passenger traffic by water in the 1830s. Even before the First World War cities had begun passing laws to regulate and limit “jitney” services and to protect the investments in urban rail mass transit. Trucking began eating into the freight carried by the railroads.

These developments brought about changes in the energy industries. Coal mining became a declining industry. As Figure 11 shows, in 1925 the share of petroleum in the value of coal, gas, and petroleum output exceeded bituminous coal, and it continued to rise. Anthracite coal’s share was much smaller and it declined while natural gas and LP (or liquefied petroleum) gas were relatively unimportant. These changes, especially the declining coal industry, were the source of considerable worry in the twenties.

Coal

One of the industries considered to be “sick” in the twenties was coal, particularly bituminous, or soft, coal. Income in the industry declined, and bankruptcies were frequent. Strikes frequently interrupted production. The majority of the miners “lived in squalid and unsanitary houses, and the incidence of accidents and diseases was high.” (Soule, 1947) The number of operating bituminous coal mines declined sharply from 1923 through 1932. Anthracite (or hard) coal output was much smaller during the twenties. Real coal prices rose from 1919 to 1922, and bituminous coal prices fell sharply from then to 1925. (Figure 12) Coal mining employment plummeted during the twenties. Annual earnings, especially in bituminous coal mining, also fell because of dwindling hourly earnings and, from 1929 on, a shrinking workweek. (Figure 13)

The sources of these changes are to be found in the increasing supply due to productivity advances in coal production and in the decreasing demand for coal. The demand fell as industries began turning from coal to electricity and because of productivity advances in the use of coal to create energy in steel, railroads, and electric utilities. (Keller, 1973) In the generation of electricity, larger steam plants employing higher temperatures and steam pressures continued to reduce coal consumption per kilowatt hour. Similar reductions were found in the production of coke from coal for iron and steel production and in the use of coal by the steam railroad engines. (Rezneck, 1951) All of these factors reduced the demand for coal.

Productivity advances in coal mining tended to be labor saving. Mechanical cutting accounted for 60.7 percent of the coal mined in 1920 and 78.4 percent in 1929. By the middle of the twenties, the mechanical loading of coal began to be introduced. Between 1929 and 1939, output per labor-hour rose nearly one third in bituminous coal mining and nearly four fifths in anthracite as more mines adopted machine mining and mechanical loading and strip mining expanded.

The increasing supply and falling demand for coal led to the closure of mines that were too costly to operate. A mine could simply cease operations, let the equipment stand idle, and lay off employees. When bankruptcies occurred, the mines generally just turned up under new ownership with lower capital charges. When demand increased or strikes reduced the supply of coal, idle mines simply resumed production. As a result, the easily expanded supply largely eliminated economic profits.

The average daily employment in coal mining dropped by over 208,000 from its peak in 1923, but the sharply falling real wages suggests that the supply of labor did not fall as rapidly as the demand for labor. Soule (1947) notes that when employment fell in coal mining, it meant fewer days of work for the same number of men. Social and cultural characteristics tended to tie many to their home region. The local alternatives were few, and ignorance of alternatives outside the Appalachian rural areas, where most bituminous coal was mined, made it very costly to transfer out.

Petroleum

In contrast to the coal industry, the petroleum industry was growing throughout the interwar period. By the thirties, crude petroleum dominated the real value of the production of energy materials. As Figure 14 shows, the production of crude petroleum increased sharply between 1920 and 1930, while real petroleum prices, though highly variable, tended to decline.

The growing demand for petroleum was driven by the growth in demand for gasoline as America became a motorized society. The production of gasoline surpassed kerosene production in 1915. Kerosene’s market continued to contract as electric lighting replaced kerosene lighting. The development of oil burners in the twenties began a switch from coal toward fuel oil for home heating, and this further increased the growing demand for petroleum. The growth in the demand for fuel oil and diesel fuel for ship engines also increased petroleum demand. But it was the growth in the demand for gasoline that drove the petroleum market.

The decline in real prices in the latter part of the twenties shows that supply was growing even faster than demand. The discovery of new fields in the early twenties increased the supply of petroleum and led to falling prices as production capacity grew. The Santa Fe Springs, California strike in 1919 initiated a supply shock as did the discovery of the Long Beach, California field in 1921. New discoveries in Powell, Texas and Smackover Arkansas further increased the supply of petroleum in 1921. New supply increases occurred in 1926 to 1928 with petroleum strikes in Seminole, Oklahoma and Hendricks, Texas. The supply of oil increased sharply in 1930 to 1931 with new discoveries in Oklahoma City and East Texas. Each new discovery pushed down real oil prices, and the prices of petroleum derivatives, and the growing production capacity led to a general declining trend in petroleum prices. McMillin and Parker (1994) argue that supply shocks generated by these new discoveries were a factor in the business cycles during the 1920s.

The supply of gasoline increased more than the supply of crude petroleum. In 1913 a chemist at Standard Oil of Indiana introduced the cracking process to refine crude petroleum; until that time it had been refined by distillation or unpressurized heating. In the heating process, various refined products such as kerosene, gasoline, naphtha, and lubricating oils were produced at different temperatures. It was difficult to vary the amount of the different refined products produced from a barrel of crude. The cracking process used pressurized heating to break heavier components down into lighter crude derivatives; with cracking, it was possible to increase the amount of gasoline obtained from a barrel of crude from 15 to 45 percent. In the early twenties, chemists at Standard Oil of New Jersey improved the cracking process, and by 1927 it was possible to obtain twice as much gasoline from a barrel of crude petroleum as in 1917.

The petroleum companies also developed new ways to distribute gasoline to motorists that made it more convenient to purchase gasoline. Prior to the First World War, gasoline was commonly purchased in one- or five-gallon cans and the purchaser used a funnel to pour the gasoline from the can into the car. Then “filling stations” appeared, which specialized in filling cars’ tanks with gasoline. These spread rapidly, and by 1919 gasoline companies werebeginning to introduce their own filling stations or contract with independent stations to exclusively distribute their gasoline. Increasing competition and falling profits led filling station operators to expand into other activities such as oil changes and other mechanical repairs. The general name attached to such stations gradually changed to “service stations” to reflect these new functions.

Though the petroleum firms tended to be large, they were highly competitive, trying to pump as much petroleum as possible to increase their share of the fields. This, combined with the development of new fields, led to an industry with highly volatile prices and output. Firms desperately wanted to stabilize and reduce the production of crude petroleum so as to stabilize and raise the prices of crude petroleum and refined products. Unable to obtain voluntary agreement on output limitations by the firms and producers, governments began stepping in. Led by Texas, which created the Texas Railroad Commission in 1891, oil-producing states began to intervene to regulate production. Such laws were usually termed prorationing laws and were quotas designed to limit each well’s output to some fraction of its potential. The purpose was as much to stabilize and reduce production and raise prices as anything else, although generally such laws were passed under the guise of conservation. Although the federal government supported such attempts, not until the New Deal were federal laws passed to assist this.

Electricity

By the mid 1890s the debate over the method by which electricity was to be transmitted had been won by those who advocated alternating current. The reduced power losses and greater distance over which electricity could be transmitted more than offset the necessity for transforming the current back to direct current for general use. Widespread adoption of machines and appliances by industry and consumers then rested on an increase in the array of products using electricity as the source of power, heat, or light and the development of an efficient, lower cost method of generating electricity.

General Electric, Westinghouse, and other firms began producing the electrical appliances for homes and an increasing number of machines based on electricity began to appear in industry. The problem of lower cost production was solved by the introduction of centralized generating facilities that distributed the electric power through lines to many consumers and business firms.

Though initially several firms competed in generating and selling electricity to consumers and firms in a city or area, by the First World War many states and communities were awarding exclusive franchises to one firm to generate and distribute electricity to the customers in the franchise area. (Bright, 1947; Passer, 1953) The electric utility industry became an important growth industry and, as Figure 15 shows, electricity production and use grew rapidly.

The electric utilities increasingly were regulated by state commissions that were charged with setting rates so that the utilities could receive a “fair return” on their investments. Disagreements over what constituted a “fair return” and the calculation of the rate base led to a steady stream of cases before the commissions and a continuing series of court appeals. Generally these court decisions favored the reproduction cost basis. Because of the difficulty and cost in making these calculations, rates tended to be in the hands of the electric utilities that, it has been suggested, did not lower rates adequately to reflect the rising productivity and lowered costs of production. The utilities argued that a more rapid lowering of rates would have jeopardized their profits. Whether or not this increased their monopoly power is still an open question, but it should be noted, that electric utilities were hardly price-taking industries prior to regulation. (Mercer, 1973) In fact, as Figure 16 shows, the electric utilities began to systematically practice market segmentation charging users with less elastic demands, higher prices per kilowatt-hour.

Energy in the American Economy of the 1920s

The changes in the energy industries had far-reaching consequences. The coal industry faced a continuing decline in demand. Even in the growing petroleum industry, the periodic surges in the supply of petroleum caused great instability. In manufacturing, as described above, electrification contributed to a remarkable rise in productivity. The transportation revolution brought about by the rise of gasoline-powered trucks and cars changed the way businesses received their supplies and distributed their production as well as where they were located. The suburbanization of America and the beginnings of urban sprawl were largely brought about by the introduction of low-priced gasoline for cars.

Transportation

The American economy was forever altered by the dramatic changes in transportation after 1900. Following Henry Ford’s introduction of the moving assembly production line in 1914, automobile prices plummeted, and by the end of the 1920s about 60 percent of American families owned an automobile. The advent of low-cost personal transportation led to an accelerating movement of population out of the crowded cities to more spacious homes in the suburbs and the automobile set off a decline in intracity public passenger transportation that has yet to end. Massive road-building programs facilitated the intercity movement of people and goods. Trucks increasingly took over the movement of freight in competition with the railroads. New industries, such as gasoline service stations, motor hotels, and the rubber tire industry, arose to service the automobile and truck traffic. These developments were complicated by the turmoil caused by changes in the federal government’s policies toward transportation in the United States.

With the end of the First World War, a debate began as to whether the railroads, which had been taken over by the government, should be returned to private ownership or nationalized. The voices calling for a return to private ownership were much stronger, but doing so fomented great controversy. Many in Congress believed that careful planning and consolidation could restore the railroads and make them more efficient. There was continued concern about the near monopoly that the railroads had on the nation’s intercity freight and passenger transportation. The result of these deliberations was the Transportation Act of 1920, which was premised on the continued domination of the nation’s transportation by the railroads—an erroneous presumption.

The Transportation Act of 1920 presented a marked change in the Interstate Commerce Commission’s ability to control railroads. The ICC was allowed to prescribe exact rates that were to be set so as to allow the railroads to earn a fair return, defined as 5.5 percent, on the fair value of their property. The ICC was authorized to make an accounting of the fair value of each regulated railroad’s property; however, this was not completed until well into the 1930s, by which time the accounting and rate rules were out of date. To maintain fair competition between railroads in a region, all roads were to have the same rates for the same goods over the same distance. With the same rates, low-cost roads should have been able to earn higher rates of return than high-cost roads. To handle this, a recapture clause was inserted: any railroad earning a return of more than 6 percent on the fair value of its property was to turn the excess over to the ICC, which would place half of the money in a contingency fund for the railroad when it encountered financial problems and the other half in a contingency fund to provide loans to other railroads in need of assistance.

In order to address the problem of weak and strong railroads and to bring better coordination to the movement of rail traffic in the United States, the act was directed to encourage railroad consolidation, but little came of this in the 1920s. In order to facilitate its control of the railroads, the ICC was given two additional powers. The first was the control over the issuance or purchase of securities by railroads, and the second was the power to control changes in railroad service through the control of car supply and the extension and abandonment of track. The control of the supply of rail cars was turned over to the Association of American Railroads. Few extensions of track were proposed, but as time passed, abandonment requests grew. The ICC, however, trying to mediate between the conflicting demands of shippers, communities and railroads, generally refused to grant abandonments, and this became an extremely sensitive issue in the 1930s.

As indicated above, the premises of the Transportation Act of 1920 were wrong. Railroads experienced increasing competition during the 1920s, and both freight and passenger traffic were drawn off to competing transport forms. Passenger traffic exited from the railroads much more quickly. As the network of all weather surfaced roads increased, people quickly turned from the train to the car. Harmed even more by the move to automobile traffic were the electric interurban railways that had grown rapidly just prior to the First World War. (Hilton-Due, 1960) Not surprisingly, during the 1920s few railroads earned profits in excess of the fair rate of return.

The use of trucks to deliver freight began shortly after the turn of the century. Before the outbreak of war in Europe, White and Mack were producing trucks with as much as 7.5 tons of carrying capacity. Most of the truck freight was carried on a local basis, and it largely supplemented the longer distance freight transportation provided by the railroads. However, truck size was growing. In 1915 Trailmobile introduced the first four-wheel trailer designed to be pulled by a truck tractor unit. During the First World War, thousands of trucks were constructed for military purposes, and truck convoys showed that long distance truck travel was feasible and economical. The use of trucks to haul freight had been growing by over 18 percent per year since 1925, so that by 1929 intercity trucking accounted for more than one percent of the ton-miles of freight hauled.

The railroads argued that the trucks and buses provided “unfair” competition and believed that if they were also regulated, then the regulation could equalize the conditions under which they competed. As early as 1925, the National Association of Railroad and Utilities Commissioners issued a call for the regulation of motor carriers in general. In 1928 the ICC called for federal regulation of buses and in 1932 extended this call to federal regulation of trucks.

Most states had began regulating buses at the beginning of the 1920s in an attempt to reduce the diversion of urban passenger traffic from the electric trolley and railway systems. However, most of the regulation did not aim to control intercity passenger traffic by buses. As the network of surfaced roads expanded during the twenties, so did the routes of the intercity buses. In 1929 a number of smaller bus companies were incorporated in the Greyhound Buslines, the carrier that has since dominated intercity bus transportation. (Walsh, 2000)

A complaint of the railroads was that interstate trucking competition was unfair because it was subsidized while railroads were not. All railroad property was privately owned and subject to property taxes, whereas truckers used the existing road system and therefore neither had to bear the costs of creating the road system nor pay taxes upon it. Beginning with the Federal Road-Aid Act of 1916, small amounts of money were provided as an incentive for states to construct rural post roads. (Dearing-Owen, 1949) However, through the First World War most of the funds for highway construction came from a combination of levies on the adjacent property owners and county and state taxes. The monies raised by the counties were commonly 60 percent of the total funds allocated, and these primarily came from property taxes. In 1919 Oregon pioneered the state gasoline tax, which then began to be adopted by more and more states. A highway system financed by property taxes and other levies can be construed as a subsidization of motor vehicles, and one study for the period up to 1920 found evidence of substantial subsidization of trucking. (Herbst-Wu, 1973) However, the use of gasoline taxes moved closer to the goal of users paying the costs of the highways. Neither did the trucks have to pay for all of the highway construction because automobiles jointly used the highways. Highways had to be constructed in more costly ways in order to accommodate the larger and heavier trucks. Ideally the gasoline taxes collected from trucks should have covered the extra (or marginal) costs of highway construction incurred because of the truck traffic. Gasoline taxes tended to do this.

The American economy occupies a vast geographic region. Because economic activity occurs over most of the country, falling transportation costs have been crucial to knitting American firms and consumers into a unified market. Throughout the nineteenth century the railroads played this crucial role. Because of the size of the railroad companies and their importance in the economic life of Americans, the federal government began to regulate them. But, by 1917 it appeared that the railroad system had achieved some stability, and it was generally assumed that the post-First World War era would be an extension of the era from 1900 to 1917. Nothing could have been further from the truth. Spurred by public investments in highways, cars and trucks voraciously ate into the railroad’s market, and, though the regulators failed to understand this at the time, the railroad’s monopoly on transportation quickly disappeared.

Communications

Communications had joined with transportation developments in the nineteenth century to tie the American economy together more completely. The telegraph had benefited by using the railroads’ right-of-ways, and the railroads used the telegraph to coordinate and organize their far-flung activities. As the cost of communications fell and information transfers sped, the development of firms with multiple plants at distant locations was facilitated. The interwar era saw a continuation of these developments as the telephone continued to supplant the telegraph and the new medium of radio arose to transmit news and provide a new entertainment source.

Telegraph domination of business and personal communications had given way to the telephone as long distance telephone calls between the east and west coasts with the new electronic amplifiers became possible in 1915. The number of telegraph messages handled grew 60.4 percent in the twenties. The number of local telephone conversations grew 46.8 percent between 1920 and 1930, while the number of long distance conversations grew 71.8 percent over the same period. There were 5 times as many long distance telephone calls as telegraph messages handled in 1920, and 5.7 times as many in 1930.

The twenties were a prosperous period for AT&T and its 18 major operating companies. (Brooks, 1975; Temin, 1987; Garnet, 1985; Lipartito, 1989) Telephone usage rose and, as Figure 19 shows, the share of all households with a telephone rose from 35 percent to nearly 42 percent. In cities across the nation, AT&T consolidated its system, gained control of many operating companies, and virtually eliminated its competitors. It was able to do this because in 1921 Congress passed the Graham Act exempting AT&T from the Sherman Act in consolidating competing telephone companies. By 1940, the non-Bell operating companies were all small relative to the Bell operating companies.

Surprisingly there was a decline in telephone use on the farms during the twenties. (Hadwiger-Cochran, 1984; Fischer 1987) Rising telephone rates explain part of the decline in rural use. The imposition of connection fees during the First World War made it more costly for new farmers to hook up. As AT&T gained control of more and more operating systems, telephone rates were increased. AT&T also began requiring, as a condition of interconnection, that independent companies upgrade their systems to meet AT&T standards. Most of the small mutual companies that had provided service to farmers had operated on a shoestring—wires were often strung along fenceposts, and phones were inexpensive “whoop and holler” magneto units. Upgrading to AT&T’s standards raised costs, forcing these companies to raise rates.

However, it also seems likely that during the 1920s there was a general decline in the rural demand for telephone services. One important factor in this was the dramatic decline in farm incomes in the early twenties. The second reason was a change in the farmers’ environment. Prior to the First World War, the telephone eased farm isolation and provided news and weather information that was otherwise hard to obtain. After 1920 automobiles, surfaced roads, movies, and the radio loosened the isolation and the telephone was no longer as crucial.

Othmar Merganthaler’s development of the linotype machine in the late nineteenth century had irrevocably altered printing and publishing. This machine, which quickly created a line of soft, lead-based metal type that could be printed, melted down and then recast as a new line of type, dramatically lowered the costs of printing. Previously, all type had to be painstakingly set by hand, with individual cast letter matrices picked out from compartments in drawers to construct words, lines, and paragraphs. After printing, each line of type on the page had to be broken down and each individual letter matrix placed back into its compartment in its drawer for use in the next printing job. Newspapers often were not published every day and did not contain many pages, resulting in many newspapers in most cities. In contrast to this laborious process, the linotype used a keyboard upon which the operator typed the words in one of the lines in a news column. Matrices for each letter dropped down from a magazine of matrices as the operator typed each letter and were assembled into a line of type with automatic spacers to justify the line (fill out the column width). When the line was completed the machine mechanically cast the line of matrices into a line of lead type. The line of lead type was ejected into a tray and the letter matrices mechanically returned to the magazine while the operator continued typing the next line in the news story. The first Merganthaler linotype machine was installed in the New York Tribune in 1886. The linotype machine dramatically lowered the costs of printing newspapers (as well as books and magazines). Prior to the linotype a typical newspaper averaged no more than 11 pages and many were published only a few times a week. The linotype machine allowed newspapers to grow in size and they began to be published more regularly. A process of consolidation of daily and Sunday newspapers began that continues to this day. Many have termed the Merganthaler linotype machine the most significant printing invention since the introduction of movable type 400 years earlier.

For city families as well as farm families, radio became the new source of news and entertainment. (Barnouw, 1966; Rosen, 1980 and 1987; Chester-Garrison, 1950) It soon took over as the prime advertising medium and in the process revolutionized advertising. By 1930 more homes had radio sets than had telephones. The radio networks sent news and entertainment broadcasts all over the country. The isolation of rural life, particularly in many areas of the plains, was forever broken by the intrusion of the “black box,” as radio receivers were often called. The radio began a process of breaking down regionalism and creating a common culture in the United States.

The potential demand for radio became clear with the first regular broadcast of Westinghouse’s KDKA in Pittsburgh in the fall of 1920. Because the Department of Commerce could not deny a license application there was an explosion of stations all broadcasting at the same frequency and signal jamming and interference became a serious problem. By 1923 the Department of Commerce had gained control of radio from the Post Office and the Navy and began to arbitrarily disperse stations on the radio dial and deny licenses creating the first market in commercial broadcast licenses. In 1926 a U.S. District Court decided that under the Radio Law of 1912 Herbert Hoover, the secretary of commerce, did not have this power. New stations appeared and the logjam and interference of signals worsened. A Radio Act was passed in January of 1927 creating the Federal Radio Commission (FRC) as a temporary licensing authority. Licenses were to be issued in the public interest, convenience, and necessity. A number of broadcasting licenses were revoked; stations were assigned frequencies, dial locations, and power levels. The FRC created 24 clear-channel stations with as much as 50,000 watts of broadcasting power, of which 21 ended up being affiliated with the new national radio networks. The Communications Act of 1934 essentially repeated the 1927 act except that it created a permanent, seven-person Federal Communications Commission (FCC).

Local stations initially created and broadcast the radio programs. The expenses were modest, and stores and companies operating radio stations wrote this off as indirect, goodwill advertising. Several forces changed all this. In 1922, AT&T opened up a radio station in New York City, WEAF (later to become WNBC). AT&T envisioned this station as the center of a radio toll system where individuals could purchase time to broadcast a message transmitted to other stations in the toll network using AT&T’s long distance lines and an August 1922 broadcast by a Long Island realty company became the first conscious use of direct advertising.

Though advertising continued to be condemned, the fiscal pressures on radio stations to accept advertising began rising. In 1923 the American Society of Composers and Publishers (ASCAP), began demanding a performance fee anytime ASCAP-copyrighted music was performed on the radio, either live or on record. By 1924 the issue was settled, and most stations began paying performance fees to ASCAP. AT&T decided that all stations broadcasting with non AT&T transmitters were violating their patent rights and began asking for annual fees from such stations based on the station’s power. By the end of 1924, most stations were paying the fees. All of this drained the coffers of the radio stations, and more and more of them began discreetly accepting advertising.

RCA became upset at AT&T’s creation of a chain of radio stations and set up its own toll network using the inferior lines of Western Union and Postal Telegraph, because AT&T, not surprisingly, did not allow any toll (or network) broadcasting on its lines except by its own stations. AT&T began to worry that its actions might threaten its federal monopoly in long distance telephone communications. In 1926 a new firm was created, the National Broadcasting Company (NBC), which took over all broadcasting activities from AT&T and RCA as AT&T left broadcasting. When NBC debuted in November of 1926, it had two networks: the Red, which was the old AT&T network, and the Blue, which was the old RCA network. Radio networks allowed advertisers to direct advertising at a national audience at a lower cost. Network programs allowed local stations to broadcast superior programs that captured a larger listening audience and in return received a share of the fees the national advertiser paid to the network. In 1927 a new network, the Columbia Broadcasting System (CBS) financed by the Paley family began operation and other new networks entered or tried to enter the industry in the 1930s.

Communications developments in the interwar era present something of a mixed picture. By 1920 long distance telephone service was in place, but rising rates slowed the rate of adoption in the period, and telephone use in rural areas declined sharply. Though direct dialing was first tried in the twenties, its general implementation would not come until the postwar era, when other changes, such as microwave transmission of signals and touch-tone dialing, would also appear. Though the number of newspapers declined, newspaper circulation generally held up. The number of competing newspapers in larger cities began declining, a trend that also would accelerate in the postwar American economy.

Banking and Securities Markets

In the twenties commercial banks became “department stores of finance.”— Banks opened up installment (or personal) loan departments, expanded their mortgage lending, opened up trust departments, undertook securities underwriting activities, and offered safe deposit boxes. These changes were a response to growing competition from other financial intermediaries. Businesses, stung by bankers’ control and reduced lending during the 1920-21 depression, began relying more on retained earnings and stock and bond issues to raise investment and, sometimes, working capital. This reduced loan demand. The thrift institutions also experienced good growth in the twenties as they helped fuel the housing construction boom of the decade. The securities markets boomed in the twenties only to see a dramatic crash of the stock market in late 1929.

There were two broad classes of commercial banks; those that were nationally chartered and those that were chartered by the states. Only the national banks were required to be members of the Federal Reserve System. (Figure 21) Most banks were unit banks because national regulators and most state regulators prohibited branching. However, in the twenties a few states began to permit limited branching; California even allowed statewide branching.—The Federal Reserve member banks held the bulk of the assets of all commercial banks, even though most banks were not members. A high bank failure rate in the 1920s has usually been explained by “overbanking” or too many banks located in an area, but H. Thomas Johnson (1973-74) makes a strong argument against this. (Figure 22)— If there were overbanking, on average each bank would have been underutilized resulting in intense competition for deposits and higher costs and lower earnings. One common reason would have been the free entry of banks as long as they achieved the minimum requirements then in force. However, the twenties saw changes that led to the demise of many smaller rural banks that would likely have been profitable if these changes had not occurred. Improved transportation led to a movement of business activities, including banking, into the larger towns and cities. Rural banks that relied on loans to farmers suffered just as farmers did during the twenties, especially in the first half of the twenties. The number of bank suspensions and the suspension rate fell after 1926. The sharp rise in bank suspensions in 1930 occurred because of the first banking crisis during the Great Depression.

Prior to the twenties, the main assets of commercial banks were short-term business loans, made by creating a demand deposit or increasing an existing one for a borrowing firm. As business lending declined in the 1920s commercial banks vigorously moved into new types of financial activities. As banks purchased more securities for their earning asset portfolios and gained expertise in the securities markets, larger ones established investment departments and by the late twenties were an important force in the underwriting of new securities issued by nonfinancial corporations.

The securities market exhibited perhaps the most dramatic growth of the noncommercial bank financial intermediaries during the twenties, but others also grew rapidly. (Figure 23) The assets of life insurance companies increased by 10 percent a year from 1921 to 1929; by the late twenties they were a very important source of funds for construction investment. Mutual savings banks and savings and loan associations (thrifts) operated in essentially the same types of markets. The Mutual savings banks were concentrated in the northeastern United States. As incomes rose, personal savings increased, and housing construction expanded in the twenties, there was an increasing demand for the thrifts’ interest earning time deposits and mortgage lending.

But the dramatic expansion in the financial sector came in new corporate securities issues in the twenties—especially common and preferred stock—and in the trading of existing shares of those securities. (Figure 24) The late twenties boom in the American economy was rapid, highly visible, and dramatic. Skyscrapers were being erected in most major cities, the automobile manufacturers produced over four and a half million new cars in 1929; and the stock market, like a barometer of this prosperity, was on a dizzying ride to higher and higher prices. “Playing the market” seemed to become a national pastime.

The Dow-Jones index hit its peak of 381 on September 3 and then slid to 320 on October 21. In the following week the stock market “crashed,” with a record number of shares being traded on several days. At the end of Tuesday, October, 29th, the index stood at 230, 96 points less than one week before. On November 13, 1929, the Dow-Jones index reached its lowest point for the year at 198—183 points less than the September 3 peak.

The path of the stock market boom of the twenties can be seen in Figure 25. Sharp price breaks occurred several times during the boom, and each of these gave rise to dark predictions of the end of the bull market and speculation. Until late October of 1929, these predictions turned out to be wrong. Between those price breaks and prior to the October crash, stock prices continued to surge upward. In March of 1928, 3,875,910 shares were traded in one day, establishing a record. By late 1928, five million shares being traded in a day was a common occurrence.

New securities, from rising merger activity and the formation of holding companies, were issued to take advantage of the rising stock prices.—Stock pools, which were not illegal until the 1934 Securities and Exchange Act, took advantage of the boom to temporarily drive up the price of selected stocks and reap large gains for the members of the pool. In stock pools a group of speculators would pool large amounts of their funds and then begin purchasing large amounts of shares of a stock. This increased demand led to rising prices for that stock. Frequently pool insiders would “churn” the stock by repeatedly buying and selling the same shares among themselves, but at rising prices. Outsiders, seeing the price rising, would decide to purchase the stock whose price was rising. At a predetermined higher price the pool members would, within a short period, sell their shares and pull out of the market for that stock. Without the additional demand from the pool, the stock’s price usually fell quickly bringing large losses for the unsuspecting outside investors while reaping large gains for the pool insiders.

Another factor commonly used to explain both the speculative boom and the October crash was the purchase of stocks on small margins. However, contrary to popular perception, margin requirements through most of the twenties were essentially the same as in previous decades. Brokers, recognizing the problems with margin lending in the rapidly changing market, began raising margin requirements in late 1928, and by the fall of 1929, margin requirements were the highest in the history of the New York Stock Exchange. In the 1920s, as was the case for decades prior to that, the usual margin requirements were 10 to 15 percent of the purchase price, and, apparently, more often around 10 percent. There were increases in this percentage by 1928 and by the fall of 1928, well before the crash and at the urging of a special New York Clearinghouse committee, margin requirements had been raised to some of the highest levels in New York Stock Exchange history. One brokerage house required the following of its clients. Securities with a selling price below $10 could only be purchased for cash. Securities with a selling price of $10 to $20 had to have a 50 percent margin; for securities of $20 to $30 a margin requirement of 40 percent; and, for securities with a price above $30 the margin was 30 percent of the purchase price. In the first half of 1929 margin requirements on customers’ accounts averaged a 40 percent margin, and some houses raised their margins to 50 percent a few months before the crash. These were, historically, very high margin requirements. (Smiley and Keehn, 1988)—Even so, during the crash when additional margin calls were issued, those investors who could not provide additional margin saw the brokers’ sell their stock at whatever the market price was at the time and these forced sales helped drive prices even lower.

The crash began on Monday, October 21, as the index of stock prices fell 3 points on the third-largest volume in the history of the New York Stock Exchange. After a slight rally on Tuesday, prices began declining on Wednesday and fell 21 points by the end of the day bringing on the third call for more margin in that week. On Black Thursday, October 24, prices initially fell sharply, but rallied somewhat in the afternoon so that the net loss was only 7 points, but the volume of thirteen million shares set a NYSE record. Friday brought a small gain that was wiped out on Saturday. On Monday, October 28, the Dow Jones index fell 38 points on a volume of nine million shares—three million in the final hour of trading. Black Tuesday, October 29, brought declines in virtually every stock price. Manufacturing firms, which had been lending large sums to brokers for margin loans, had been calling in these loans and this accelerated on Monday and Tuesday. The big Wall Street banks increased their lending on call loans to offset some of this loss of loanable funds. The Dow Jones Index fell 30 points on a record volume of nearly sixteen and a half million shares exchanged. Black Thursday and Black Tuesday wiped out entire fortunes.

Though the worst was over, prices continued to decline until November 13, 1929, as brokers cleaned up their accounts and sold off the stocks of clients who could not supply additional margin. After that, prices began to slowly rise and by April of 1930 had increased 96 points from the low of November 13,— “only” 87 points less than the peak of September 3, 1929. From that point, stock prices resumed their depressing decline until the low point was reached in the summer of 1932.

 

—There is a long tradition that insists that the Great Bull Market of the late twenties was an orgy of speculation that bid the prices of stocks far above any sustainable or economically justifiable level creating a bubble in the stock market. John Kenneth Galbraith (1954) observed, “The collapse in the stock market in the autumn of 1929 was implicit in the speculation that went before.”—But not everyone has agreed with this.

In 1930 Irving Fisher argued that the stock prices of 1928 and 1929 were based on fundamental expectations that future corporate earnings would be high.— More recently, Murray Rothbard (1963), Gerald Gunderson (1976), and Jude Wanniski (1978) have argued that stock prices were not too high prior to the crash.—Gunderson suggested that prior to 1929, stock prices were where they should have been and that when corporate profits in the summer and fall of 1929 failed to meet expectations, stock prices were written down.— Wanniski argued that political events brought on the crash. The market broke each time news arrived of advances in congressional consideration of the Hawley-Smoot tariff. However, the virtually perfect foresight that Wanniski’s explanation requires is unrealistic.— Charles Kindleberger (1973) and Peter Temin (1976) examined common stock yields and price-earnings ratios and found that the relative constancy did not suggest that stock prices were bid up unrealistically high in the late twenties.—Gary Santoni and Gerald Dwyer (1990) also failed to find evidence of a bubble in stock prices in 1928 and 1929.—Gerald Sirkin (1975) found that the implied growth rates of dividends required to justify stock prices in 1928 and 1929 were quite conservative and lower than post-Second World War dividend growth rates.

However, examination of after-the-fact common stock yields and price-earning ratios can do no more than provide some ex post justification for suggesting that there was not excessive speculation during the Great Bull Market.— Each individual investor was motivated by that person’s subjective expectations of each firm’s future earnings and dividends and the future prices of shares of each firm’s stock. Because of this element of subjectivity, not only can we never accurately know those values, but also we can never know how they varied among individuals. The market price we observe will be the end result of all of the actions of the market participants, and the observed price may be different from the price almost all of the participants expected.

In fact, there are some indications that there were differences in 1928 and 1929. Yields on common stocks were somewhat lower in 1928 and 1929. In October of 1928, brokers generally began raising margin requirements, and by the beginning of the fall of 1929, margin requirements were, on average, the highest in the history of the New York Stock Exchange. Though the discount and commercial paper rates had moved closely with the call and time rates on brokers’ loans through 1927, the rates on brokers’ loans increased much more sharply in 1928 and 1929.— This pulled in funds from corporations, private investors, and foreign banks as New York City banks sharply reduced their lending. These facts suggest that brokers and New York City bankers may have come to believe that stock prices had been bid above a sustainable level by late 1928 and early 1929. White (1990) created a quarterly index of dividends for firms in the Dow-Jones index and related this to the DJI. Through 1927 the two track closely, but in 1928 and 1929 the index of stock prices grows much more rapidly than the index of dividends.

The qualitative evidence for a bubble in the stock market in 1928 and 1929 that White assembled was strengthened by the findings of J. Bradford De Long and Andre Shleifer (1991). They examined closed-end mutual funds, a type of fund where investors wishing to liquidate must sell their shares to other individual investors allowing its fundamental value to be exactly measurable.— Using evidence from these funds, De Long and Shleifer estimated that in the summer of 1929, the Standard and Poor’s composite stock price index was overvalued about 30 percent due to excessive investor optimism. Rappoport and White (1993 and 1994) found other evidence that supported a bubble in the stock market in 1928 and 1929. There was a sharp divergence between the growth of stock prices and dividends; there were increasing premiums on call and time brokers’ loans in 1928 and 1929; margin requirements rose; and stock market volatility rose in the wake of the 1929 stock market crash.

There are several reasons for the creation of such a bubble. First, the fundamental values of earnings and dividends become difficult to assess when there are major industrial changes, such as the rapid changes in the automobile industry, the new electric utilities, and the new radio industry.— Eugene White (1990) suggests that “While investors had every reason to expect earnings to grow, they lacked the means to evaluate easily the future path of dividends.” As a result investors bid up prices as they were swept up in the ongoing stock market boom. Second, participation in the stock market widened noticeably in the twenties. The new investors were relatively unsophisticated, and they were more likely to be caught up in the euphoria of the boom and bid prices upward.— New, inexperienced commission sales personnel were hired to sell stocks and they promised glowing returns on stocks they knew little about.

These observations were strengthened by the experimental work of economist Vernon Smith. (Bishop, 1987) In a number of experiments over a three-year period using students and Tucson businessmen and businesswomen, bubbles developed as inexperienced investors valued stocks differently and engaged in price speculation. As these investors in the experiments began to realize that speculative profits were unsustainable and uncertain, their dividend expectations changed, the market crashed, and ultimately stocks began trading at their fundamental dividend values. These bubbles and crashes occurred repeatedly, leading Smith to conjecture that there are few regulatory steps that can be taken to prevent a crash.

Though the bubble of 1928 and 1929 made some downward adjustment in stock prices inevitable, as Barsky and De Long have shown, changes in fundamentals govern the overall movements. And the end of the long bull market was almost certainly governed by this. In late 1928 and early 1929 there was a striking rise in economic activity, but a decline began somewhere between May and July of that year and was clearly evident by August of 1929. By the middle of August, the rise in stock prices had slowed down as better information on the contraction was received. There were repeated statements by leading figures that stocks were “overpriced” and the Federal Reserve System sharply increased the discount rate in August 1929 was well as continuing its call for banks to reduce their margin lending. As this information was assessed, the number of speculators selling stocks increased, and the number buying decreased. With the decreased demand, stock prices began to fall, and as more accurate information on the nature and extent of the decline was received, stock prices fell more. The late October crash made the decline occur much more rapidly, and the margin purchases and consequent forced selling of many of those stocks contributed to a more severe price fall. The recovery of stock prices from November 13 into April of 1930 suggests that stock prices may have been driven somewhat too low during the crash.

There is now widespread agreement that the 1929 stock market crash did not cause the Great Depression. Instead, the initial downturn in economic activity was a primary determinant of the ending of the 1928-29 stock market bubble. The stock market crash did make the downturn become more severe beginning in November 1929. It reduced discretionary consumption spending (Romer, 1990) and created greater income uncertainty helping to bring on the contraction (Flacco and Parker, 1992). Though stock market prices reached a bottom and began to recover following November 13, 1929, the continuing decline in economic activity took its toll and by May 1930 stock prices resumed their decline and continued to fall through the summer of 1932.

Domestic Trade

In the nineteenth century, a complex array of wholesalers, jobbers, and retailers had developed, but changes in the postbellum period reduced the role of the wholesalers and jobbers and strengthened the importance of the retailers in domestic trade. (Cochran, 1977; Chandler, 1977; Marburg, 1951; Clewett, 1951) The appearance of the department store in the major cities and the rise of mail order firms in the postbellum period changed the retailing market.

Department Stores

A department store is a combination of specialty stores organized as departments within one general store. A. T. Stewart’s huge 1846 dry goods store in New York City is often referred to as the first department store. (Resseguie, 1965; Sobel-Sicilia, 1986) R. H. Macy started his dry goods store in 1858 and Wanamaker’s in Philadelphia opened in 1876. By the end of the nineteenth century, every city of any size had at least one major department store. (Appel, 1930; Benson, 1986; Hendrickson, 1979; Hower, 1946; Sobel, 1974) Until the late twenties, the department store field was dominated by independent stores, though some department stores in the largest cities had opened a few suburban branches and stores in other cities. In the interwar period department stores accounted for about 8 percent of retail sales.

The department stores relied on a “one-price” policy, which Stewart is credited with beginning. In the antebellum period and into the postbellum period, it was common not to post a specific price on an item; rather, each purchaser haggled with a sales clerk over what the price would be. Stewart posted fixed prices on the various dry goods sold, and the customer could either decide to buy or not buy at the fixed price. The policy dramatically lowered transactions costs for both the retailer and the purchaser. Prices were reduced with a smaller markup over the wholesale price, and a large sales volume and a quicker turnover of the store’s inventory generated profits.

Mail Order Firms

What changed the department store field in the twenties was the entrance of Sears Roebuck and Montgomery Ward, the two dominant mail order firms in the United States. (Emmet-Jeuck, 1950; Chandler, 1962, 1977) Both firms had begun in the late nineteenth century and by 1914 the younger Sears Roebuck had surpassed Montgomery Ward. Both located in Chicago due to its central location in the nation’s rail network and both had benefited from the advent of Rural Free Delivery in 1896 and low cost Parcel Post Service in 1912.

In 1924 Sears hired Robert C. Wood, who was able to convince Sears Roebuck to open retail stores. Wood believed that the declining rural population and the growing urban population forecast the gradual demise of the mail order business; survival of the mail order firms required a move into retail sales. By 1925 Sears Roebuck had opened 8 retail stores, and by 1929 it had 324 stores. Montgomery Ward quickly followed suit. Rather than locating these in the central business district (CBD), Wood located many on major streets closer to the residential areas. These moves of Sears Roebuck and Montgomery Ward expanded department store retailing and provided a new type of chain store.

Chain Stores

Though chain stores grew rapidly in the first two decades of the twentieth century, they date back to the 1860s when George F. Gilman and George Huntington Hartford opened a string of New York City A&P (Atlantic and Pacific) stores exclusively to sell tea. (Beckman-Nolen, 1938; Lebhar, 1963; Bullock, 1933) Stores were opened in other regions and in 1912 their first “cash-and-carry” full-range grocery was opened. Soon they were opening 50 of these stores each week and by the 1920s A&P had 14,000 stores. They then phased out the small stores to reduce the chain to 4,000 full-range, supermarket-type stores. A&P’s success led to new grocery store chains such as Kroger, Jewel Tea, and Safeway.

Prior to A&P’s cash-and-carry policy, it was common for grocery stores, produce (or green) grocers, and meat markets to provide home delivery and credit, both of which were costly. As a result, retail prices were generally marked up well above the wholesale prices. In cash-and-carry stores, items were sold only for cash; no credit was extended, and no expensive home deliveries were provided. Markups on prices could be much lower because other costs were much lower. Consumers liked the lower prices and were willing to pay cash and carry their groceries, and the policy became common by the twenties.

Chains also developed in other retail product lines. In 1879 Frank W. Woolworth developed a “5 and 10 Cent Store,” or dime store, and there were over 1,000 F. W. Woolworth stores by the mid-1920s. (Winkler, 1940) Other firms such as Kresge, Kress, and McCrory successfully imitated Woolworth’s dime store chain. J.C. Penney’s dry goods chain store began in 1901 (Beasley, 1948), Walgreen’s drug store chain began in 1909, and shoes, jewelry, cigars, and other lines of merchandise also began to be sold through chain stores.

Self-Service Policies

In 1916 Clarence Saunders, a grocer in Memphis, Tennessee, built upon the one-price policy and began offering self-service at his Piggly Wiggly store. Previously, customers handed a clerk a list or asked for the items desired, which the clerk then collected and the customer paid for. With self-service, items for sale were placed on open shelves among which the customers could walk, carrying a shopping bag or pushing a shopping cart. Each customer could then browse as he or she pleased, picking out whatever was desired. Saunders and other retailers who adopted the self-service method of retail selling found that customers often purchased more because of exposure to the array of products on the shelves; as well, self-service lowered the labor required for retail sales and therefore lowered costs.

Shopping Centers

Shopping Centers, another innovation in retailing that began in the twenties, was not destined to become a major force in retail development until after the Second World War. The ultimate cause of this innovation was the widening ownership and use of the automobile. By the 1920s, as the ownership and use of the car began expanding, population began to move out of the crowded central cities toward the more open suburbs. When General Robert Wood set Sears off on its development of urban stores, he located these not in the central business district, CBD, but as free-standing stores on major arteries away from the CBD with sufficient space for parking.

At about the same time, a few entrepreneurs began to develop shopping centers. Yehoshua Cohen (1972) says, “The owner of such a center was responsible for maintenance of the center, its parking lot, as well as other services to consumers and retailers in the center.” Perhaps the earliest such shopping center was the Country Club Plaza built in 1922 by the J. C. Nichols Company in Kansas City, Missouri. Other early shopping centers appeared in Baltimore and Dallas. By the mid-1930s the concept of a planned shopping center was well known and was expected to be the means to capture the trade of the growing number of suburban consumers.

International Trade and Finance

In the twenties a gold exchange standard was developed to replace the gold standard of the prewar world. Under a gold standard, each country’s currency carried a fixed exchange rate with gold, and the currency had to be backed up by gold. As a result, all countries on the gold standard had fixed exchange rates with all other countries. Adjustments to balance international trade flows were made by gold flows. If a country had a deficit in its trade balance, gold would leave the country, forcing the money stock to decline and prices to fall. Falling prices made the deficit countries’ exports more attractive and imports more costly, reducing the deficit. Countries with a surplus imported gold, which increased the money stock and caused prices to rise. This made the surplus countries’ exports less attractive and imports more attractive, decreasing the surplus. Most economists who have studied the prewar gold standard contend that it did not work as the conventional textbook model says, because capital flows frequently reduced or eliminated the need for gold flows for long periods of time. However, there is no consensus on whether fortuitous circumstances, rather than the gold standard, saved the international economy from periodic convulsions or whether the gold standard as it did work was sufficient to promote stability and growth in international transactions.

After the First World War it was argued that there was a “shortage” of fluid monetary gold to use for the gold standard, so some method of “economizing” on gold had to be found. To do this, two basic changes were made. First, most nations, other than the United States, stopped domestic circulation of gold. Second, the “gold exchange” system was created. Most countries held their international reserves in the form of U.S. dollars or British pounds and international transactions used dollars or pounds, as long as the United States and Great Britain stood ready to exchange their currencies for gold at fixed exchange rates. However, the overvaluation of the pound and the undervaluation of the franc threatened these arrangements. The British trade deficit led to a capital outflow, higher interest rates, and a weak economy. In the late twenties, the French trade surplus led to the importation of gold that they did not allow to expand the money supply.

Economizing on gold by no longer allowing its domestic circulation and by using key currencies as international monetary reserves was really an attempt to place the domestic economies under the control of the nations’ politicians and make them independent of international events. Unfortunately, in doing this politicians eliminated the equilibrating mechanism of the gold standard but had nothing with which to replace it. The new international monetary arrangements of the twenties were potentially destabilizing because they were not allowed to operate as a price mechanism promoting equilibrating adjustments.

There were other problems with international economic activity in the twenties. Because of the war, the United States was abruptly transformed from a debtor to a creditor on international accounts. Though the United States did not want reparations payments from Germany, it did insist that Allied governments repay American loans. The Allied governments then insisted on war reparations from Germany. These initial reparations assessments were quite large. The Allied Reparations Commission collected the charges by supervising Germany’s foreign trade and by internal controls on the German economy, and it was authorized to increase the reparations if it was felt that Germany could pay more. The treaty allowed France to occupy the Ruhr after Germany defaulted in 1923.

Ultimately, this tangled web of debts and reparations, which was a major factor in the course of international trade, depended upon two principal actions. First, the United States had to run an import surplus or, on net, export capital out of the United States to provide a pool of dollars overseas. Germany then had either to have an export surplus or else import American capital so as to build up dollar reserves—that is, the dollars the United States was exporting. In effect, these dollars were paid by Germany to Great Britain, France, and other countries that then shipped them back to the United States as payment on their U.S. debts. If these conditions did not occur, (and note that the “new” gold standard of the twenties had lost its flexibility because the price adjustment mechanism had been eliminated) disruption in international activity could easily occur and be transmitted to the domestic economies.

In the wake of the 1920-21 depression Congress passed the Emergency Tariff Act, which raised tariffs, particularly on manufactured goods. (Figures 26 and 27) The Fordney-McCumber Tariff of 1922 continued the Emergency Tariff of 1921, and its protection on many items was extremely high, ranging from 60 to 100 percent ad valorem (or as a percent of the price of the item). The increases in the Fordney-McCumber tariff were as large and sometimes larger than the more famous (or “infamous”) Smoot-Hawley tariff of 1930. As farm product prices fell at the end of the decade presidential candidate Herbert Hoover proposed, as part of his platform, tariff increases and other changes to aid the farmers. In January 1929, after Hoover’s election, but before he took office, a tariff bill was introduced into Congress. Special interests succeeded in gaining additional (or new) protection for most domestically produced commodities and the goal of greater protection for the farmers tended to get lost in the increased protection for multitudes of American manufactured products. In spite of widespread condemnation by economists, President Hoover signed the Smoot-Hawley Tariff in June 1930 and rates rose sharply.

Following the First World War, the U.S. government actively promoted American exports, and in each of the postwar years through 1929, the United States recorded a surplus in its balance of trade. (Figure 28) However, the surplus declined in the 1930s as both exports and imports fell sharply after 1929. From the mid-1920s on finished manufactures were the most important exports, while agricultural products dominated American imports.

The majority of the funds that allowed Germany to make its reparations payments to France and Great Britain and hence allowed those countries to pay their debts to the United States came from the net flow of capital out of the United States in the form of direct investment in real assets and investments in long- and short-term foreign financial assets. After the devastating German hyperinflation of 1922 and 1923, the Dawes Plan reformed the German economy and currency and accelerated the U.S. capital outflow. American investors began to actively and aggressively pursue foreign investments, particularly loans (Lewis, 1938) and in the late twenties there was a marked deterioration in the quality of foreign bonds sold in the United States. (Mintz, 1951)

The system, then, worked well as long as there was a net outflow of American capital, but this did not continue. In the middle of 1928, the flow of short-term capital began to decline. In 1928 the flow of “other long-term” capital out of the United States was 752 million dollars, but in 1929 it was only 34 million dollars. Though arguments now exist as to whether the booming stock market in the United States was to blame for this, it had far-reaching effects on the international economic system and the various domestic economies.

The Start of the Depression

The United States had the majority of the world’s monetary gold, about 40 percent, by 1920. In the latter part of the twenties, France also began accumulating gold as its share of the world’s monetary gold rose from 9 percent in 1927 to 17 percent in 1929 and 22 percent by 1931. In 1927 the Federal Reserve System had reduced discount rates (the interest rate at which they lent reserves to member commercial banks) and engaged in open market purchases (purchasing U.S. government securities on the open market to increase the reserves of the banking system) to push down interest rates and assist Great Britain in staying on the gold standard. By early 1928 the Federal Reserve System was worried about its loss of gold due to this policy as well as the ongoing boom in the stock market. It began to raise the discount rate to stop these outflows. Gold was also entering the United States so that foreigners could obtain dollars to invest in stocks and bonds. As the United States and France accumulated more and more of the world’s monetary gold, other countries’ central banks took contractionary steps to stem the loss of gold. In country after country these deflationary strategies began contracting economic activity and by 1928 some countries in Europe, Asia, and South America had entered into a depression. More countries’ economies began to decline in 1929, including the United States, and by 1930 a depression was in force for almost all of the world’s market economies. (Temin, 1989; Eichengreen, 1992)

Monetary and Fiscal Policies in the 1920s

Fiscal Policies

As a tool to promote stability in aggregate economic activity, fiscal policy is largely a post-Second World War phenomenon. Prior to 1930 the federal government’s spending and taxing decisions were largely, but not completely, based on the perceived “need” for government-provided public goods and services.

Though the fiscal policy concept had not been developed, this does not mean that during the twenties no concept of the government’s role in stimulating economic activity existed. Herbert Stein (1990) points out that in the twenties Herbert Hoover and some of his contemporaries shared two ideas about the proper role of the federal government. The first was that federal spending on public works could be an important force in reducin Smiley and Keehn, 1995.  investment. Both concepts fit the ideas held by Hoover and others of his persuasion that the U.S. economy of the twenties was not the result of laissez-faire workings but of “deliberate social engineering.”

The federal personal income tax was enacted in 1913. Though mildly progressive, its rates were low and topped out at 7 percent on taxable income in excess of $750,000. (Table 4) As the United States prepared for war in 1916, rates were increased and reached a maximum marginal rate of 12 percent. With the onset of the First World War, the rates were dramatically increased. To obtain additional revenue in 1918, marginal rates were again increased. The share of federal revenue generated by income taxes rose from 11 percent in 1914 to 69 percent in 1920. The tax rates had been extended downward so that more than 30 percent of the nation’s income recipients were subject to income taxes by 1918. However, through the purchase of tax exempt state and local securities and through steps taken by corporations to avoid the cash distribution of profits, the number of high income taxpayers and their share of total taxes paid declined as Congress kept increasing the tax rates. The normal (or base) tax rate was reduced slightly for 1919 but the surtax rates, which made the income tax highly progressive, were retained. (Smiley-Keehn, 1995)

President Harding’s new Secretary of the Treasury, Andrew Mellon, proposed cutting the tax rates, arguing that the rates in the higher brackets had “passed the point of productivity” and rates in excess of 70 percent simply could not be collected. Though most agreed that the rates were too high, there was sharp disagreement on how the rates should be cut. Democrats and  Smiley and Keehn, 1995.  Progressive Republicans argued for rate cuts targeted for the lower income taxpayers while maintaining most of the steep progressivity of the tax rates. They believed that remedies could be found to change the tax laws to stop the legal avoidance of federal income taxes. Republicans argued for sharper cuts that reduced the progressivity of the rates. Mellon proposed a maximum rate of 25 percent.

Though the federal income tax rates were reduced and made less progressive, it took three tax rate cuts in 1921, 1924, and 1925 before Mellon’s goal was finally achieved. The highest marginal tax rate was reduced from 73 percent to 58 percent to 46 percent and finally to 25 percent for the 1925 tax year. All of the other rates were also reduced and exemptions increased. By 1926, only about the top 10 percent of income recipients were subject to federal income taxes. As tax rates were reduced, the number of high income tax returns increased and the share of total federal personal income taxes paid rose. (Tables 5 and 6) Even with the dramatic income tax rate cuts and reductions in the number of low income taxpayers, federal personal income tax revenue continued to rise during the 1920s. Though early estimates of the distribution of personal income showed sharp increases in income inequality during the 1920s (Kuznets, 1953; Holt, 1977), more recent estimates have found that the increases in inequality were considerably less and these appear largely to be related to the sharp rise in capital gains due to the booming stock market in the late twenties. (Smiley, 1998 and 2000)

Each year in the twenties the federal government generated a surplus, in some years as much as 1 percent of GNP. The surpluses were used to reduce the federal deficit and it declined by 25 percent between 1920 and 1930. Contrary to simple macroeconomic models that argue a federal government budget surplus must be contractionary and tend to stop an economy from reaching full employment, the American economy operated at full-employment or close to it throughout the twenties and saw significant economic growth. In this case, the surpluses were not contractionary because the dollars were circulated back into the economy through the purchase of outstanding federal debt rather than pulled out as currency and held in a vault somewhere.

Monetary Policies

In 1913 fear of the “money trust” and their monopoly power led Congress to create 12 central banks when they created the Federal Reserve System. The new central banks were to control money and credit and act as lenders of last resort to end banking panics. The role of the Federal Reserve Board, located in Washington, D.C., was to coordinate the policies of the 12 district banks; it was composed of five presidential appointees and the current secretary of the treasury and comptroller of the currency. All national banks had to become members of the Federal Reserve System, the Fed, and any state bank meeting the qualifications could elect to do so.

The act specified fixed reserve requirements on demand and time deposits, all of which had to be on deposit in the district bank. Commercial banks were allowed to rediscount commercial paper and given Federal Reserve currency. Initially, each district bank set its own rediscount rate. To provide additional income when there was little rediscounting, the district banks were allowed to engage in open market operations that involved the purchasing and selling of federal government securities, short-term securities of state and local governments issued in anticipation of taxes, foreign exchange, and domestic bills of exchange. The district banks were also designated to act as fiscal agents for the federal government. Finally, the Federal Reserve System provided a central check clearinghouse for the entire banking system.

When the Federal Reserve System was originally set up, it was believed that its primary role was to be a lender of last resort to prevent banking panics and become a check-clearing mechanism for the nation’s banks. Both the Federal Reserve Board and the Governors of the District Banks were bodies established to jointly exercise these activities. The division of functions was not clear, and a struggle for power ensued, mainly between the New York Federal Reserve Bank, which was led by J. P. Morgan’s protege, Benjamin Strong, through 1928, and the Federal Reserve Board. By the thirties the Federal Reserve Board had achieved dominance.

There were really two conflicting criteria upon which monetary actions were ostensibly based: the Gold Standard and the Real Bills Doctrine. The Gold Standard was supposed to be quasi-automatic, with an effective limit to the quantity of money. However, the Real Bills Doctrine (which required that all loans be made on short-term, self-liquidating commercial paper) had no effective limit on the quantity of money. The rediscounting of eligible commercial paper was supposed to lead to the required “elasticity” of the stock of money to “accommodate” the needs of industry and business. Actually the rediscounting of commercial paper, open market purchases, and gold inflows all had the same effects on the money stock.

The 1920-21 Depression

During the First World War, the Fed kept discount rates low and granted discounts on banks’ customer loans used to purchase V-bonds in order to help finance the war. The final Victory Loan had not been floated when the Armistice was signed in November of 1918: in fact, it took until October of 1919 for the government to fully sell this last loan issue. The Treasury, with the secretary of the treasury sitting on the Federal Reserve Board, persuaded the Federal Reserve System to maintain low interest rates and discount the Victory bonds necessary to keep bond prices high until this last issue had been floated. As a result, during this period the money supply grew rapidly and prices rose sharply.

A shift from a federal deficit to a surplus and supply disruptions due to steel and coal strikes in 1919 and a railroad strike in early 1920 contributed to the end of the boom. But the most—common view is that the Fed’s monetary policy was the main determinant of the end of the expansion and inflation and the beginning of the subsequent contraction and severe deflation. When the Fed was released from its informal agreement with the Treasury in November of 1919, it raised the discount rate from 4 to 4.75 percent. Benjamin Strong (the governor of the New York bank) was beginning to believe that the time for strong action was past and that the Federal Reserve System’s actions should be moderate. However, with Strong out of the country, the Federal Reserve Board increased the discount rate from 4.75 to 6 percent in late January of 1920 and to 7 percent on June 1, 1920. By the middle of 1920, economic activity and employment were rapidly falling, and prices had begun their downward spiral in one of the sharpest price declines in American history. The Federal Reserve System kept the discount rate at 7 percent until May 5, 1921, when it was lowered to 6.5 percent. By June of 1922, the rate had been lowered yet again to 4 percent. (Friedman and Schwartz, 1963)

The Federal Reserve System authorities received considerable criticism then and later for their actions. Milton Friedman and Anna Schwartz (1963) contend that the discount rate was raised too much too late and then kept too high for too long, causing the decline to be more severe and the price deflation to be greater. In their opinion the Fed acted in this manner due to the necessity of meeting the legal reserve requirement with a safe margin of gold reserves. Elmus Wicker (1966), however, argues that the gold reserve ratio was not the main factor determining the Federal Reserve policy in the episode. Rather, the Fed knowingly pursued a deflationary policy because it felt that the money supply was simply too large and prices too high. To return to the prewar parity for gold required lowering the price level, and there was an excessive stock of money because the additional money had been used to finance the war, not to produce consumer goods. Finally, the outstanding indebtedness was too large due to the creation of Fed credit.

Whether statutory gold reserve requirements to maintain the gold standard or domestic credit conditions were the most important determinant of Fed policy is still an open question, though both certainly had some influence. Regardless of the answer to that question, the Federal Reserve System’s first major undertaking in the years immediately following the First World War demonstrated poor policy formulation.

Federal Reserve Policies from 1922 to 1930

By 1921 the district banks began to recognize that their open market purchases had effects on interest rates, the money stock, and economic activity. For the next several years, economists in the Federal Reserve System discussed how this worked and how it could be related to discounting by member banks. A committee was created to coordinate the open market purchases of the district banks.

The recovery from the 1920-1921 depression had proceeded smoothly with moderate price increases. In early 1923 the Fed sold some securities and increased the discount rate from 4 percent as they believed the recovery was too rapid. However, by the fall of 1923 there were some signs of a business slump. McMillin and Parker (1994) argue that this contraction, as well as the 1927 contraction, were related to oil price shocks. By October of 1923 Benjamin Strong was advocating securities purchases to counter this. Between then and September 1924 the Federal Reserve System increased its securities holdings by over $500 million. Between April and August of 1924 the Fed reduced the discount rate to 3 percent in a series of three separate steps. In addition to moderating the mild business slump, the expansionary policy was also intended to reduce American interest rates relative to British interest rates. This reversed the gold flow back toward Great Britain allowing Britain to return to the gold standard in 1925. At the time it appeared that the Fed’s monetary policy had successfully accomplished its goals.

By the summer of 1924 the business slump was over and the economy again began to grow rapidly. By the mid-1920s real estate speculation had arisen in many urban areas in the United States and especially in Southeastern Florida. Land prices were rising sharply. Stock market prices had also begun rising more rapidly. The Fed expressed some worry about these developments and in 1926 sold some securities to gently slow the real estate and stock market boom. Amid hurricanes and supply bottlenecks the Florida real estate boom collapsed but the stock market boom continued.

The American economy entered into another mild business recession in the fall of 1926 that lasted until the fall of 1927. One of the factors in this was Henry’s Ford’s shut down of all of his factories to changeover from the Model T to the Model A. His employees were left without a job and without income for over six months. International concerns also reappeared. France, which was preparing to return to the gold standard, had begun accumulating gold and gold continued to flow into the United States. Some of this gold came from Great Britain making it difficult for the British to remain on the gold standard. This occasioned a new experiment in central bank cooperation. In July 1927 Benjamin Strong arranged a conference with Governor Montagu Norman of the Bank of England, Governor Hjalmar Schacht of the Reichsbank, and Deputy Governor Charles Ritt of the Bank of France in an attempt to promote cooperation among the world’s central bankers. By the time the conference began the Fed had already taken steps to counteract the business slump and reduce the gold inflow. In early 1927 the Fed reduced discount rates and made large securities purchases. One result of this was that the gold stock fell from $4.3 billion in mid-1927 to $3.8 billion in mid-1928. Some of the gold exports went to France and France returned to the gold standard with its undervalued currency. The loss of gold from Britain eased allowing it to maintain the gold standard.

By early 1928 the Fed was again becoming worried. Stock market prices were rising even faster and the apparent speculative bubble in the stock market was of some concern to Fed authorities. The Fed was also concerned about the loss of gold and wanted to bring that to an end. To do this they sold securities and, in three steps, raised the discount rate to 5 percent by July 1928. To this point the Federal Reserve Board had largely agreed with district Bank policy changes. However, problems began to develop.

During the stock market boom of the late 1920s the Federal Reserve Board preferred to use “moral suasion” rather than increases in discount rates to lessen member bank borrowing. The New York City bank insisted that moral suasion would not work unless backed up by literal credit rationing on a bank by bank basis which they, and the other district banks, were unwilling to do. They insisted that discount rates had to be increased. The Federal Reserve Board countered that this general policy change would slow down economic activity in general rather than be specifically targeted to stock market speculation. The result was that little was done for a year. Rates were not raised but no open market purchases were undertaken. Rates were finally raised to 6 percent in August of 1929. By that time the contraction had already begun. In late October the stock market crashed, and America slid into the Great Depression.

In November, following the stock market crash the Fed reduced discount rates to 4.5 percent. In January they again decreased discount rates and began a series of discount rate decreases until the rate reached 2.5 percent at the end of 1930. No further open market operations were undertaken for the next six months. As banks reduced their discounting in 1930, the stock of money declined. There was a banking crisis in the southeast in November and December of 1930, and in its wake the public’s holding of currency relative to deposits and banks’ reserve ratios began to rise and continued to do so through the end of the Great Depression.

Conclusion

Though some disagree, there is growing evidence that the behavior of the American economy in the 1920s did not cause the Great Depression. The depressed 1930s were not “retribution” for the exuberant growth of the 1920s. The weakness of a few economic sectors in the 1920s did not forecast the contraction from 1929 to 1933. Rather it was the depression of the 1930s and the Second World War that interrupted the economic growth begun in the 1920s and resumed after the Second World War. Just as the construction of skyscrapers that began in the 1920s resumed in the 1950s, so did real economic growth and progress resume. In retrospect we can see that the introduction and expansion of new technologies and industries in the 1920s, such as autos, household electric appliances, radio, and electric utilities, are echoed in the 1990s in the effects of the expanding use and development of the personal computer and the rise of the internet. The 1920s have much to teach us about the growth and development of the American economy.

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The Dust Bowl

Geoff Cunfer, Southwest Minnesota State University

What Was “The Dust Bowl”?

The phrase “Dust Bowl” holds a powerful place in the American imagination. It connotes a confusing mixture of concepts. Is the Dust Bowl a place? Was it an event? An era? American popular culture employs the term in all three ways. Ask most people about the Dust Bowl and they can place it in the Middle West, though in the imagination it wanders widely, from the Rocky Mountains, through the Great Plains, to Illinois and Indiana. Many people can situate the event in the 1930s. Ask what happened then, and a variety of stories emerge. A combination of severe drought and economic depression created destitution among farmers. Millions of desperate people took to the roads, seeking relief in California where they became exploited itinerant farm laborers. Farmers plowed up a pristine wilderness for profit, and suffered ecological collapse because of their recklessness. Dust Bowl stories, like its definitions, are legion, and now approach the mythological.

The words also evoke powerful graphic images taken from art and literature. Consider these lines from the opening chapter of John Steinbeck’s The Grapes of Wrath (1939):

“Now the wind grew strong and hard and it worked at the rain crust in the corn fields. Little by little the sky was darkened by the mixing dust, and carried away. The wind grew stronger. The rain crust broke and the dust lifted up out of the fields and drove gray plumes into the air like sluggish smoke. The corn threshed the wind and made a dry, rushing sound. The finest dust did not settle back to earth now, but disappeared into the darkening sky. … The people came out of their houses and smelled the hot stinging air and covered their noses from it. And the children came out of the houses, but they did not run or shout as they would have done after a rain. Men stood by their fences and looked at the ruined corn, drying fast now, only a little green showing through the film of dust. The men were silent and they did not move often. And the women came out of the houses to stand beside their men – to feel whether this time the men would break.”

When Americans hear the words “Dust Bowl,” grainy black and white photographs of devastated landscapes and destitute people leap to mind. Dorothea Lange and Arthur Rothstein classics bring the Dust Bowl vividly to life in our imaginations (Figures [1] [2] [3] [4]). For the musically inclined, Woody Guthrie’s Dust Bowl ballads define the event with evocative lyrics such as those in “The Great Dust Storm” (Figure 5). Some of America’s most memorable art – literature, photography, music – emerged from the Dust Bowl and that art helped to define the event and build the myth in American popular culture.

The Dust Bowl was an event defined by artists and by government bureaucrats. It has become part of American mythology, an episode in the nation’s progression from the Pilgrims to Lexington and Concord, through Civil War and frontier settlement, to industrial modernization, Depression, and Dust Bowl. Many of the great themes of American history are tied up in the Dust Bowl story: agricultural settlement and frontier struggle; industrial mechanization with the arrival of tractors; the migration from farm to city, the transformation from rural to urban. Add the Great Depression and the rise of a powerful federal government, and we have covered many of the themes of a standard U.S. history survey course.

Despite the multiple uses of the phrase “Dust Bowl” it was an event which occurred in a specific place and time. The Dust Bowl was a coincidence of drought, severe wind erosion, and economic depression that occurred on the Southern and Central Great Plains during the 1930s. The drought – the longest and deepest in over a century of systematic meteorological observation – began in 1933 and continued through 1940. In 1941 rain poured down on the region, dust storms ceased, crops thrived, economic prosperity returned, and the Dust Bowl was over. But for those eight years crops failed, sandy soils blew and drifted over failed croplands, and rural people, unable to meet cash obligations, suffered through tax delinquency, farm foreclosure, business failure, and out-migration. The Dust Bowl was defined by a combination of:

  • extended severe drought and unusually high temperatures
  • episodic regional dust storms and routine localized wind erosion
  • agricultural failure, including both cropland and livestock operations
  • the collapse of the rural economy, affecting farmers, rural businesses, and local governments
  • an aggressive reform movement by the federal government
  • migration from rural to urban areas and out of the region

The Dust Bowl on the Great Plains coincided with the Great Depression. Though few plainsmen suffered directly from the 1929 stock market crash, they were too intimately connected to national and world markets to be immune from economic repercussions. The farm recession had begun in the 1920s; after the 1919 Armistice transformed Europe from an importer to an exporter of agricultural products, American farmers again faced their constant nemesis: production so high that prices were pushed downward. Farmers grew more cotton, wheat, and corn, than the market could consume, and prices fell, fell more, and then hit rock bottom by the early 1930s. Cotton, one of the staple crops of the southern plains, for example, sold for 36 cents per pound in 1919, dropped to 18 cents in 1928, then collapsed to a dismal 6 cents per pound in 1931. One irony of the Dust Bowl is that the world could not really buy all of the crops Great Plains farmers produced. Even the severe drought and crop failures of the 1930s had little impact on the flood of farm commodities inundating the world market.

Routine Dust Storms on the Southern and Central Plains

The location of the drought and the dust storms shifted from place to place between 1934 and 1940 (Figure 6 [large]). The core of the Dust Bowl was in the Texas and Oklahoma panhandles, southwestern Kansas and southeastern Colorado. The drought began on the Great Plains, from the Dakotas through Texas and New Mexico, in 1931. The following year was wetter, but 1933 and 1934 set low rainfall records across the plains. In some places is did not rain at all. Others quickly accumulated a deep deficit. Figure 7 [large] shows percent difference from average rainfall over five-year periods, with the location of the shifting Dust Bowl over top. Only a handful of counties (mapped in blue) had more rain than average between 1932 and 1940. And few counties fall into the 0 to -10 percent range. Most counties were 10 percent drier than average, or more, and more than eighty counties were at least 20 percent drier. Scientists now believe that the 1930s drought coincided with a severe La Nina event in the Pacific Ocean. Cool sea surface temperatures reduced the amount of moisture entering the jet stream and directed it south of the continental U.S. The drought was deep, extensive, and persisted for more than a decade.

Whenever there is drought on the southern and central plains dust blows. The flat topography and continental climate mean that winds are routinely high. When soil moisture declines, plant cover, whether native plants or crops, diminishes in tandem. Normally dry conditions mean that native plants typically cover less than 60 percent of the ground surface, leaving the other 40+ percent in bare, exposed soils. During the driest conditions native prairie vegetation sometimes covers less than 20 percent of the ground surface, exposing 80 percent or more of the soil to strong prairie winds. Failed crop fields are completely bare of vegetation. In these circumstances soil blows. Local wind erosion can drift soil from one field into ridges and ripples in a neighboring field (Figure 8). Stronger regional dust storms can move dirt many miles before it drifts down along fence lines and around buildings (Figure 9). In rare instances very large dust storms carry soils high into the air where they can travel for many hundreds of miles. These “black blizzards” are the most spectacular and memorable of dust storms, but happen only infrequently (Figure 10).

When wind erosion and dust storms began in the 1930s experienced plains residents hardly welcomed the development, but neither did it surprise them. Dust storms were an occasional spring occurrence from Texas and New Mexico through Kansas and Colorado. They did not happen every year, but often enough to be treated casually. This series of excerpts from the Salina, Kansas Journal and Herald in 1879 indicates that dust storms were a routine part of plains life in dry years:

“For the past few days the gentle winds have enveloped the city with dust decorations. And some of this time it has been intensely hot. Imagine the pleasantness of the situation.”

“During the past few days we have had several exhibitions of what dust can do when propelled by a gale. We had the disagreeable March winds, and saw with ample disgust the evolutions and gyrations of the dust. We have had enough of it, but will undoubtedly get much more of the same kind during this very disagreeable month.”

“Real estate moved considerably this week.”

“Another ‘hardest’ blow ever seen in Kansas … Salina was tantalized with a small sprinkle of rain Thursday afternoon. The wind and dust soon resumed full sway.”

“People have just got through digging from the pores of the skin the dirt driven there by the furious dust storms which for several days since our last issue have been lifting this county ‘clean off its toes.’ Even sinners have stood some chance of being translated with such favoring gales.”

“The wind which held high carnival in this section last Thursday, filled the air with such clouds of dust that darkness of the ‘consistency of twilight’ prevailed. Buildings across the street could not be distinguished. The title of all land about for a while was not worth a cotton hat – it was so ‘unsettled.’ It was of the nature of personal property, because it was not a ‘fixture’ and very moveable. The air was so filled with dust as to be stifling even within houses.”

The Salina newspapers reported dust storms many springs through the late nineteenth century. An item in the Journal in 1885 epitomizes the local attitude: “When the March winds commenced raising dust Monday, the average citizen calmly smiled and whispered ‘so natural!'”

What Made the 1930s Different?

Dust storms were not new to the region in the 1930s, but a number of demographic and cultural factors were new. First there were a lot more people living in the region in the 1930s than there had been in the 1880s. The population of the Great Plains – 450 counties stretching from Texas and New Mexico to the Dakotas and Montana – stood at only 800,000 in 1880; it was seven times that, at 5.6 million in 1930. The dust storms affected many more people than they had ever done before. And many of those people were relative newcomers, having only arrived in recent years. They had no personal or family memory of life in the plains, and many interpreted the arrival of episodic dust storms as an entirely new phenomenon. An example is the reminiscence by Minnie Zeller Doehring, written in 1981. Having moved with her family to western Kansas in 1906, at age 7, she reported “I remember the first Dirt storm in Western Kansas. I think it was about 1911. And a drouth that year followed by a severe winter.” Neither she nor her family had experienced any of the nineteenth century dust storms reported in local newspapers, so when one arrived during a dry spring five years after they arrived, it seemed like a brand new development.

Second, this drought and sequence of dust storms coincided with an international economic depression, the worst in two centuries of American history. The financial stresses and personal misery of the Depression blended seamlessly into the environmental disasters of drought, crop failure, farm loss, and dust. It was difficult to assign blame. Were farmers failing because of the economic crisis? Bank failures? Landlords squeezing tenants? Drought? Dust storms? In the midst of these concurrent crises emerged an activist and newly powerful federal government. Franklin Roosevelt’s New Deal roared into Washington in 1933 with a landslide mandate from voters to fix all of the ills plaguing the nation: depression, bank failures, unemployment, agricultural overproduction, underconsumption, the list went on and on. And several items quickly added to that list of ills to be fixed were rural poverty, agricultural land use, soil erosion, and dust storms.

The drought and dust storms were certainly hard on farmers. Crop failure was widespread and repeated. In 1935 46.6 million acres of crops failed on the Great Plains, with over 130 counties losing more than half their planted acreage. Many farmers lived on the edge of financial failure. In debt for land, tractor, automobile, and even for last year’s seed, one or two years with reduced income often meant bankruptcy. Tax delinquency became a serious problem throughout the plains. As land owners fell behind on their local property tax payments, county governments grew desperate. Many counties had delinquency rates over 40 percent for several consecutive years, and were faced with laying off teachers, police, and other employees. A few counties considered closing county government altogether and merging with neighboring counties. Their only alternative was to foreclose on now nearly worthless farms which they could neither rent nor sell. Many families behind on mortgage payments and taxes simply packed up and left without notice. The crisis was not restricted to farmers, bankers, and county employees. Throughout the plains sales of tractors, automobiles, and fertilizer declined in the early 1930s, affecting small town merchants across the board.

Consider the example of William and Sallie DeLoach, typical southern plains farmers who moved from farm to farm through the early twentieth century, repeatedly trying to buy land and repeatedly losing it to the bank in the face of drought or low crop prices. After an earlier failed attempt to buy land, the family invested in a 177 acre cotton farm in Lamb County, Texas in 1924, paying 30 dollars per acre. A month later they passed up a chance to sell it for 35 dollars an acre. Within three months of the purchase late summer rains failed to arrive, the cotton crop bloomed late, and the first freeze of winter killed it. Unable to make the upcoming mortgage payment, the DeLoaches forfeited their land and the 200 dollars they had already paid toward it. One bad season meant default. Through the rest of the 1920s the DeLoaches rented from Sallie’s father and farmed cotton in Lamb County. In September, 1929, just weeks before the stock market crashed, William thought the time auspicious to invest in land again, and bought 90 acres. He farmed it, then rented part of it to another farmer. Rain was plentiful in 1931, and by the end of that year DeLoach had repaid back rent to his father-in-law, paid off all outstanding debts except his land mortgage, and started 1932 in good shape. But the 1930s were hard on the southern plains, with the extended drought, dust storms, and widespread poverty. The one bright spot for farmers was the farm subsidies instituted by Franklin Roosevelt’s New Deal. In 1933 DeLoach plowed up 55 acres of already growing cotton in exchange for a check from the federal government. Lamb County led the state in the cotton reduction program, bringing nearly 1.4 million dollars into the county in 1933. Drought lingered over the Texas panhandle through 1934 and 1935, and by early 1936 DeLoach was beleaguered again. When the Supreme Court declared the Agricultural Adjustment Act (AAA) unconstitutional it appeared that federal farm subsidies would disappear. A few weeks after that decision DeLoach had a visit from his real estate agent:

Mr. Gholson came by this A.M. and wanted to know what I was going to do about my land notes. I told him I could do nothing, only let them have the land back. … I told him I had payed the school tax for 1934. Owed the state and county for 1935, also the state for 1934. All tole [sic] about $37.50. He said he would pay that and we (wife & I) could deed the land back to the Nugent people. I hate to lose the land and what I have payed on it, but I can’t do any thing else. ‘Big fish eat the little ones.’ The law is take from the poor devil that wants a home, give to the rich. I have lost about $1000.00 on the land.

A week later:

Mr. Gholson came by. Told me about the deed he had drawn in Dallas. … He said if I would pay for the deed and stamps, which would be $5.00, the deal would be closed. I asked him if that meant just as the land stood now. He said yes. He said they would pay the balance of taxes. Well, they ought to. I have payed $800.00 or better on the land, but got behind and could not do any thing else. Any way my mind is at ease. I do not think Gholson or any of the cold blooded land grafters would lose any sleep on account of taking a home away from any poor devil.

For the third time in his career DeLoach defaulted and turned over his farm. Later that month Congress rewrote the AAA legislation to meet Constitutional requirements, and the farm programs have continued ever since. With federal program income again assured, DeLoach purchased yet another 68 acre farm in September, 1936, moved the family onto it, and tried again. Other families were not as persistent, and when crop failure led to bankruptcy they packed up and left the region. The term popularly assigned to such emigrants, “Dust Bowl refugees,” assigned a single cause – dust storms – to what was in fact a complex and multi-causal event (Figure 11).

Like dust storms and agricultural setbacks, high out-migration was not new to the plains. Throughout the settlement period, from about 1870 to 1920, there was very high turnover in population. Many people moved into the region, but many moved out also. James Malin found that 10 year population turnover on the western Kansas frontier ranged from 41 to 67 percent between 1895 and 1930. Many people were half farmers, half land speculators, buying frontier land cheap (or homesteading it for free), then selling a few years later on a rising market. People moved from farm to farm, always looking for a better opportunity, often following a succession of frontiers over a lifetime, from Ohio to Illinois to Kansas to Colorado. Outmigration from the Great Plains in the 1930s was not considerably higher than it had been over the previous 50 years. What changed in the 1930s was that new immigrants stopped moving in to replace those leaving. Many rural areas of the grassland began a slow population decline that had not yet bottomed out in 2000.

The New Deal Response to Drought and Dust Storms

Emigrants from the Great Plains were not new in the 1930s. Neither was drought, agricultural crisis, or dust storms. This drought and these dust storms were certainly more severe than those that wracked the plains in 1879-1880, in the mid 1890s, and again in 1911. And more people were adversely affected because total population was higher. But what was most different about the 1930s was the response of the federal government. In past crises, when farmers went bankrupt, when grassland counties lost 20 percent of their population, when dust storms descended, the federal government stood aloof. It felt no responsibility for the problems, no popular mandate to solve them. Just the opposite was the case in the 1930s. The New Deal set out to solve the nation’s problems, and in the process contributed to the creation of the Dust Bowl as an historic event of mythological proportions.

The economic and agricultural disaster of the 1930s provided an opening for experimentation with federal land use management. The idea had begun among economists in agricultural colleges in the 1920s who proposed removing “submarginal” land from crop production. “Submarginal” referred to land low in productivity, unsuited for the production of farm crops, or incapable of profitable cultivation. A “land utilization” movement emerged in the 1920s to classify farm land as good, poor, marginal, or submarginal, and to forcibly retire the latter from production. Such rational planning aimed to reduce farm poverty, contract chronic overproduction of farm crops, and protect land vulnerable to damage. M.L. Wilson, of Montana State Agricultural College, focused the academic movement while Lewis C. Gray, at the Bureau of Agricultural Economics (BAE), led the effort within the U.S. Department of Agriculture. The land utilization movement began well before the 1930s, but the drought and dust storms of that decade provided a fortuitous justification for a land use policy already on the table, and newly created agencies like the Soil Conservation Service (SCS), the Resettlement Administration (RA), and the Farm Security Administration (FSA) were the loudest to publicize and deplore the Dust Bowl wracking America’s heartland.

Whereas the land use adjustment movement had begun as an attempt to solve chronic rural poverty, the arrival of dust storms in 1934 provided a second justification for aggressive federal action to change land use practices. Federal bureaucrats created the central narrative of the Dust Bowl, in part because it emphasized the need for these new reform agencies. The FSA launched a sophisticated public relations campaign to publicize the disaster unfolding in the Great Plains. It hired world class photographers to document the suffering of plains people, giving them specific instructions from Washington to photograph the most eroded landscapes and the most destitute people. Dorothea Lange’s photographs of emigrants on the road to California still stand as some of the most evocative images in American history (Figures 1213). The Resettlement Administration also hired filmmaker Pare Lorentz the make a series of movies, including “The Plow that Broke the Plains.”

The narrative behind this publicity campaign was this: in the nineteenth and early twentieth centuries farmers had come to the dry western plains, encouraged by a misguided Homestead Act, where they plowed up land unsuited for farming. The grassland should have been left in native grass for grazing, but small farmers, hoping to make profits growing cash crops like wheat had plowed the land, exposing soils to relentless winds. When serious drought struck in the 1930s the wounded landscape succumbed to dust storms that devastated farms, farmers, and local economies. The result was a mass exodus of desperately poor people, a social failure caused by misuse of land. The profit motive and private land ownership were behind this failure, and only a scientifically grounded federal bureaucracy could manage land use wisely in the interests of all Americans, rather than for the profit of a few individuals. Federal agents would retire land from cultivation, return it to grassland, and teach remaining farmers how to use their land more carefully to prevent erosion. This effort would, of course, require large budgets and thousands of employees, but it was vital to resolving a rural disaster.

The New Deal government, with Congressional support and appropriations, began to put reform plan into place. A host of new agencies vied to manage the program, including the FSA, the SCS, the RA, and the Agricultural Adjustment Administration (AAA). Each implemented a variety of reforms. The RA began purchasing “submarginal” land from farmers, eventually acquiring some 10 million acres for former farmland in the Great Plains. (These lands are now mostly managed by the U.S. Forest Service as National Grasslands leased to nearby private ranchers for grazing.) The RA and the FSA worked to relocate destitute farmers on better lands, or move them out of farming altogether. The SCS established demonstration projects in counties across the nation, where local cooperator farmers implemented recommended soils conservation techniques on their farms, such as fallowing, strip cropping, contour plowing, terracing, growing cover crops, and a variety of cultivation techniques. There were efforts in each county to establish Land Use Planning Committees made of local farmers and federal agents who would have authority over land use practices on private farms. These committees functioned for several years in the late 1930s, but ended in most places by the early 1940s. The most important and expensive measure was the AAA’s development of a comprehensive system of farm subsidies, which paid farmers cash for reducing their acreage of commodity crops. The subsidies, created as an emergency Depression measure, have become routine and persist 70 years later. They brought millions of dollars into nearly every farming county in the U.S. and permanently transformed the economics of agriculture. In a multitude of innovative ways the federal government set out to remake American farming. The Dust Bowl narrative served exceedingly well to justify these massive and revolutionary changes in farming, America’s most common occupation for most of its history.

Conclusion

The Dust Bowl finally ended in 1941 with the arrival of drenching rains on the southern and central plains and with the advent of World War II. The rains restored crops and settled the dust. The war diverted public and government attention from the plains. In a telling move, the FSA photography corps was reconstituted as the Office of War Information, the propaganda wing of the government’s war effort. The narrative of World War II replaced the Dust Bowl narrative in the public’s attention. Congress diverted funding away from the Great Plains and toward mobilization. The Land Utilization Program stopped buying submarginal land and the county Land Use Planning Committees ceased. Some of the New Deal reforms became permanent. The AAA subsidy system continued through the present and the Soil Conservation Service (now the Natural Resources Conservation Service) created a stable niche promoting wise agricultural land management and soil mapping.

Ironically, overall land use on the Great Plains had changed little during the decade. About the same amount of land was devoted to crops in the second half of the twentieth century as in the first half. Farmers grew the same crops in the same mixtures. Many implemented the milder reforms promoted by New Dealers – contour plowing, terracing – but little cropland was converted back to pasture. The “submarginal” regions have continued to grow wheat, sorghum, and other crops in roughly the same quantities. Despite these facts the public has generally adopted the Dust Bowl narrative. If asked, most will identify the Dust Bowl as caused by misuse of land. The descendants of the federal agencies created in the 1930s still claim to have played a leading role in solving the crisis. Periodic droughts and dust storms have returned to the region since 1941, notably in the early 1950s and again in the 1970s. Towns in the core dust storm region still have dust storms in dry years. Lubbock, Texas, for example, experienced 35 dust storms in 1973-74. Rural depopulation continues in the Great Plains (although cities in the region have grown even faster than rural places have declined). None of these droughts, dust storms, or periods of depopulation have received the concentrated public attention that those of the 1930s did. Nonetheless, environmentalists and critics of modern agricultural systems continue to warn that unless we reform modern farming the Dust Bowl may return.

References and Additional Reading

Bonnifield, Mathew P. The Dust Bowl: Men, Dirt, and Depression. Albuquerque: University of New Mexico Press, 1979.

Cronon, William. “A Place for Stories: Nature, History, and Narrative.” Journal of American History 78 (March 1992): 1347-1376.

Cunfer, Geoff. “Causes of the Dust Bowl.” In Past Time, Past Place: GIS for History, edited by Anne Kelly Knowles, 93-104. Redlands, CA: ESRI Press, 2002.

Cunfer, Geoff. “The New Deal’s Land Utilization Program in the Great Plains.” Great Plains Quarterly 21 (Summer 2001): 193-210.

Cunfer, Geoff. On the Great Plains: Agriculture and Environment. Texas A&M University Press, 2005.

The Future of the Great Plains: Report of the Great Plains Committee. Washington: Government Printing Office, 1936.

Ganzel, Bill. Dust Bowl Descent. Lincoln: University of Nebraska Press, 1984.

Great Plains Quarterly 6 (Spring 1986), special issue on the Dust Bowl.

Gregory, James N. American Exodus: The Dust Bowl Migration and Okie Culture in California. New York: Oxford University Press, 1989.

Guthrie, Woody. Dust Bowl Ballads. New York: Folkway Records, 1964.

Gutmann, Myron P. and Geoff Cunfer. “A New Look at the Causes of the Dust Bowl.” Charles L. Wood Agricultural History Lecture Series, no. 99-1. Lubbock: International Center for Arid and Semiarid Land Studies, Texas Tech University, 1999.

Hansen, Zeynep K. and Gary D. Libecap. “Small Farms, Externalities, and the Dust Bowl of the 1930s.” Journal of Political Economy 112 (2004): 665-694.

Hurt, R. Douglas. The Dust Bowl: An Agricultural and Social History. Chicago: Nelson-Hall, 1981.

Lookingbill, Brad. Dust Bowl USA: Depression America and the Ecological Imagination, 1929-1941. Athens: Ohio University Press, 2001.

Lorentz, Pare. The Plow that Broke the Plains. Washington: Resettlement Administration, 1936.

Malin, James C. “Dust Storms, 1850-1900.” Kansas Historical Quarterly 14 (May, August, and November 1946): 129-144, 265-296; 391-413.

Malin, James C. Essays on Historiography. Ann Arbor, Michigan: Edwards Brothers, 1946.

Malin, James C. The Grassland of North America: Prolegomena to Its History. Lawrence, Kansas, privately printed, 1961.

Riney-Kehrberg, Pamela. Rooted in Dust: Surviving Drought and Depression in Southwestern Kansas. Lawrence: University Press of Kansas, 1994.

Riney-Kehrberg, Pamela, editor. Waiting on the Bounty: The Dust Bowl Diary of Mary Knackstedt Dyck. Iowa City: University of Iowa Press, 1999.

Svobida, Lawrence. Farming the Dust Bowl: A Firsthand Account from Kansas. Lawrence: University Press of Kansas, 1986.

Wooten, H.H. The Land Utilization Program, 1934 to 1964: Origin, Development, and Present Status. U.S.D.A. Economic Research Service Agricultural Economic Report no. 85. Washington: Government Printing Office, 1965.

Worster, Donald. Dust Bowl: The Southern Plains in the 1930s. New York: Oxford University Press, 1979.

Wunder, John R., Frances W. Kaye, and Vernon Carstensen. Americans View Their Dust Bowl Experience. Niwot: University Press of Colorado, 1999.

Citation: Cunfer, Geoff. “The Dust Bowl”. EH.Net Encyclopedia, edited by Robert Whaples. August 18, 2004. URL http://eh.net/encyclopedia/the-dust-bowl/

The Depression of 1893

David O. Whitten, Auburn University

The Depression of 1893 was one of the worst in American history with the unemployment rate exceeding ten percent for half a decade. This article describes economic developments in the decades leading up to the depression; the performance of the economy during the 1890s; domestic and international causes of the depression; and political and social responses to the depression.

The Depression of 1893 can be seen as a watershed event in American history. It was accompanied by violent strikes, the climax of the Populist and free silver political crusades, the creation of a new political balance, the continuing transformation of the country’s economy, major changes in national policy, and far-reaching social and intellectual developments. Business contraction shaped the decade that ushered out the nineteenth century.

Unemployment Estimates

One way to measure the severity of the depression is to examine the unemployment rate. Table 1 provides estimates of unemployment, which are derived from data on output — annual unemployment was not directly measured until 1929, so there is no consensus on the precise magnitude of the unemployment rate of the 1890s. Despite the differences in the two series, however, it is obvious that the Depression of 1893 was an important event. The unemployment rate exceeded ten percent for five or six consecutive years. The only other time this occurred in the history of the US economy was during the Great Depression of the 1930s.

Timing and Depth of the Depression

The National Bureau of Economic Research estimates that the economic contraction began in January 1893 and continued until June 1894. The economy then grew until December 1895, but it was then hit by a second recession that lasted until June 1897. Estimates of annual real gross national product (which adjust for this period’s deflation) are fairly crude, but they generally suggest that real GNP fell about 4% from 1892 to 1893 and another 6% from 1893 to 1894. By 1895 the economy had grown past its earlier peak, but GDP fell about 2.5% from 1895 to 1896. During this period population grew at about 2% per year, so real GNP per person didn’t surpass its 1892 level until 1899. Immigration, which had averaged over 500,000 people per year in the 1880s and which would surpass one million people per year in the first decade of the 1900s, averaged only 270,000 from 1894 to 1898.

Table 1
Estimates of Unemployment during the 1890s

Year Lebergott Romer
1890 4.0% 4.0%
1891 5.4 4.8
1892 3.0 3.7
1893 11.7 8.1
1894 18.4 12.3
1895 13.7 11.1
1896 14.5 12.0
1897 14.5 12.4
1898 12.4 11.6
1899 6.5 8,7
1900 5.0 5.0

Source: Romer, 1984

The depression struck an economy that was more like the economy of 1993 than that of 1793. By 1890, the US economy generated one of the highest levels of output per person in the world — below that in Britain, but higher than the rest of Europe. Agriculture no longer dominated the economy, producing only about 19 percent of GNP, well below the 30 percent produced in manufacturing and mining. Agriculture’s share of the labor force, which had been about 74% in 1800, and 60% in 1860, had fallen to roughly 40% in 1890. As Table 2 shows, only the South remained a predominantly agricultural region. Throughout the country few families were self-sufficient, most relied on selling their output or labor in the market — unlike those living in the country one hundred years earlier.

Table 2
Agriculture’s Share of the Labor Force by Region, 1890

Northeast 15%
Middle Atlantic 17%
Midwest 43%
South Atlantic 63%
South Central 67%
West 29%

Economic Trends Preceding the 1890s

Between 1870 and 1890 the number of farms in the United States rose by nearly 80 percent, to 4.5 million, and increased by another 25 percent by the end of the century. Farm property value grew by 75 percent, to $16.5 billion, and by 1900 had increased by another 25 percent. The advancing checkerboard of tilled fields in the nation’s heartland represented a vast indebtedness. Nationwide about 29% of farmers were encumbered by mortgages. One contemporary observer estimated 2.3 million farm mortgages nationwide in 1890 worth over $2.2 billion. But farmers in the plains were much more likely to be in debt. Kansas croplands were mortgaged to 45 percent of their true value, those in South Dakota to 46 percent, in Minnesota to 44, in Montana 41, and in Colorado 34 percent. Debt covered a comparable proportion of all farmlands in those states. Under favorable conditions the millions of dollars of annual charges on farm mortgages could be borne, but a declining economy brought foreclosures and tax sales.

Railroads opened new areas to agriculture, linking these to rapidly changing national and international markets. Mechanization, the development of improved crops, and the introduction of new techniques increased productivity and fueled a rapid expansion of farming operations. The output of staples skyrocketed. Yields of wheat, corn, and cotton doubled between 1870 and 1890 though the nation’s population rose by only two-thirds. Grain and fiber flooded the domestic market. Moreover, competition in world markets was fierce: Egypt and India emerged as rival sources of cotton; other areas poured out a growing stream of cereals. Farmers in the United States read the disappointing results in falling prices. Over 1870-73, corn and wheat averaged $0.463 and $1.174 per bushel and cotton $0.152 per pound; twenty years later they brought but $0.412 and $0.707 a bushel and $0.078 a pound. In 1889 corn fell to ten cents in Kansas, about half the estimated cost of production. Some farmers in need of cash to meet debts tried to increase income by increasing output of crops whose overproduction had already demoralized prices and cut farm receipts.

Railroad construction was an important spur to economic growth. Expansion peaked between 1879 and 1883, when eight thousand miles a year, on average, were built including the Southern Pacific, Northern Pacific and Santa Fe. An even higher peak was reached in the late 1880s, and the roads provided important markets for lumber, coal, iron, steel, and rolling stock.

The post-Civil War generation saw an enormous growth of manufacturing. Industrial output rose by some 296 percent, reaching in 1890 a value of almost $9.4 billion. In that year the nation’s 350,000 industrial firms employed nearly 4,750,000 workers. Iron and steel paced the progress of manufacturing. Farm and forest continued to provide raw materials for such established enterprises as cotton textiles, food, and lumber production. Heralding the machine age, however, was the growing importance of extractives — raw materials for a lengthening list of consumer goods and for producing and fueling locomotives, railroad cars, industrial machinery and equipment, farm implements, and electrical equipment for commerce and industry. The swift expansion and diversification of manufacturing allowed a growing independence from European imports and was reflected in the prominence of new goods among US exports. Already the value of American manufactures was more than half the value of European manufactures and twice that of Britain.

Onset and Causes of the Depression

The depression, which was signaled by a financial panic in 1893, has been blamed on the deflation dating back to the Civil War, the gold standard and monetary policy, underconsumption (the economy was producing goods and services at a higher rate than society was consuming and the resulting inventory accumulation led firms to reduce employment and cut back production), a general economic unsoundness (a reference less to tangible economic difficulties and more to a feeling that the economy was not running properly), and government extravagance .

Economic indicators signaling an 1893 business recession in the United States were largely obscured. The economy had improved during the previous year. Business failures had declined, and the average liabilities of failed firms had fallen by 40 percent. The country’s position in international commerce was improved. During the late nineteenth century, the United States had a negative net balance of payments. Passenger and cargo fares paid to foreign ships that carried most American overseas commerce, insurance charges, tourists’ expenditures abroad, and returns to foreign investors ordinarily more than offset the effect of a positive merchandise balance. In 1892, however, improved agricultural exports had reduced the previous year’s net negative balance from $89 million to $20 million. Moreover, output of non-agricultural consumer goods had risen by more than 5 percent, and business firms were believed to have an ample backlog of unfilled orders as 1893 opened. The number checks cleared between banks in the nation at large and outside New York, factory employment, wholesale prices, and railroad freight ton mileage advanced through the early months of the new year.

Yet several monthly series of indicators showed that business was falling off. Building construction had peaked in April 1892, later moving irregularly downward, probably in reaction to over building. The decline continued until the turn of the century, when construction volume finally turned up again. Weakness in building was transmitted to the rest of the economy, dampening general activity through restricted investment opportunities and curtailed demand for construction materials. Meanwhile, a similar uneven downward drift in business activity after spring 1892 was evident from a composite index of cotton takings (cotton turned into yarn, cloth, etc.) and raw silk consumption, rubber imports, tin and tin plate imports, pig iron manufactures, bituminous and anthracite coal production, crude oil output, railroad freight ton mileage, and foreign trade volume. Pig iron production had crested in February, followed by stock prices and business incorporations six months later.

The economy exhibited other weaknesses as the March 1893 date for Grover Cleveland’s inauguration to the presidency drew near. One of the most serious was in agriculture. Storm, drought, and overproduction during the preceding half-dozen years had reversed the remarkable agricultural prosperity and expansion of the early 1880s in the wheat, corn, and cotton belts. Wheat prices tumbled twenty cents per bushel in 1892. Corn held steady, but at a low figure and on a fall of one-eighth in output. Twice as great a decline in production dealt a severe blow to the hopes of cotton growers: the season’s short crop canceled gains anticipated from a recovery of one cent in prices to 8.3 cents per pound, close to the average level of recent years. Midwestern and Southern farming regions seethed with discontent as growers watched staple prices fall by as much as two-thirds after 1870 and all farm prices by two-fifths; meanwhile, the general wholesale index fell by one-fourth. The situation was grave for many. Farmers’ terms of trade had worsened, and dollar debts willingly incurred in good times to permit agricultural expansion were becoming unbearable burdens. Debt payments and low prices restricted agrarian purchasing power and demand for goods and services. Significantly, both output and consumption of farm equipment began to fall as early as 1891, marking a decline in agricultural investment. Moreover, foreclosure of farm mortgages reduced the ability of mortgage companies, banks, and other lenders to convert their earning assets into cash because the willingness of investors to buy mortgage paper was reduced by the declining expectation that they would yield a positive return.

Slowing investment in railroads was an additional deflationary influence. Railroad expansion had long been a potent engine of economic growth, ranging from 15 to 20 percent of total national investment in the 1870s and 1880s. Construction was a rough index of railroad investment. The amount of new track laid yearly peaked at 12,984 miles in 1887, after which it fell off steeply. Capital outlays rose through 1891 to provide needed additions to plant and equipment, but the rate of growth could not be sustained. Unsatisfactory earnings and a low return for investors indicated the system was over built and overcapitalized, and reports of mismanagement were common. In 1892, only 44 percent of rail shares outstanding returned dividends, although twice that proportion of bonds paid interest. In the meantime, the completion of trunk lines dried up local capital sources. Political antagonism toward railroads, spurred by the roads’ immense size and power and by real and imagined discrimination against small shippers, made the industry less attractive to investors. Declining growth reduced investment opportunity even as rail securities became less appealing. Capital outlays fell in 1892 despite easy credit during much of the year. The markets for ancillary industries, like iron and steel, felt the impact of falling railroad investment as well; at times in the 1880s rails had accounted for 90 percent of the country’s rolled steel output. In an industry whose expansion had long played a vital role in creating new markets for suppliers, lagging capital expenditures loomed large in the onset of depression.

European Influences

European depression was a further source of weakness as 1893 began. Recession struck France in 1889, and business slackened in Germany and England the following year. Contemporaries dated the English downturn from a financial panic in November. Monetary stringency was a base cause of economic hard times. Because specie — gold and silver — was regarded as the only real money, and paper money was available in multiples of the specie supply, when people viewed the future with doubt they stockpiled specie and rejected paper. The availability of specie was limited, so the longer hard times prevailed the more difficult it was for anyone to secure hard money. In addition to monetary stringency, the collapse of extensive speculations in Australian, South African, and Argentine properties; and a sharp break in securities prices marked the advent of severe contraction. The great banking house of Baring and Brothers, caught with excessive holdings of Argentine securities in a falling market, shocked the financial world by suspending business on November 20, 1890. Within a year of the crisis, commercial stagnation had settled over most of Europe. The contraction was severe and long-lived. In England many indices fell to 80 percent of capacity; wholesale prices overall declined nearly 6 percent in two years and had declined 15 percent by 1894. An index of the prices of principal industrial products declined by almost as much. In Germany, contraction lasted three times as long as the average for the period 1879-1902. Not until mid-1895 did Europe begin to revive. Full prosperity returned a year or more later.

Panic in the United Kingdom and falling trade in Europe brought serious repercussions in the United States. The immediate result was near panic in New York City, the nation’s financial center, as British investors sold their American stocks to obtain funds. Uneasiness spread through the country, fostered by falling stock prices, monetary stringency, and an increase in business failures. Liabilities of failed firms during the last quarter of 1890 were $90 million — twice those in the preceding quarter. Only the normal year’s end grain exports, destined largely for England, averted a gold outflow.

Circumstances moderated during the early months of 1891, although gold flowed to Europe, and business failures remained high. Credit eased, if slowly: in response to pleas for relief, the federal treasury began the premature redemption of government bonds to put additional money into circulation, and the end of the harvest trade reduced demand for credit. Commerce quickened in the spring. Perhaps anticipation of brisk trade during the harvest season stimulated the revival of investment and business; in any event, the harvest of 1891 buoyed the economy. A bumper American wheat crop coincided with poor yields in Europe increase exports and the inflow of specie: US exports in fiscal 1892 were $150 million greater than in the preceding year, a full 1 percent of gross national product. The improved market for American crops was primarily responsible for a brief cycle of prosperity in the United States that Europe did not share. Business thrived until signs of recession began to appear in late 1892 and early 1893.

The business revival of 1891-92 only delayed an inevitable reckoning. While domestic factors led in precipitating a major downturn in the United States, the European contraction operated as a powerful depressant. Commercial stagnation in Europe decisively affected the flow of foreign investment funds to the United States. Although foreign investment in this country and American investment abroad rose overall during the 1890s, changing business conditions forced American funds going abroad and foreign funds flowing into the United States to reverse as Americans sold off foreign holdings and foreigners sold off their holdings of American assets. Initially, contraction abroad forced European investors to sell substantial holdings of American securities, then the rate of new foreign investment fell off. The repatriation of American securities prompted gold exports, deflating the money stock and depressing prices. A reduced inflow of foreign capital slowed expansion and may have exacerbated the declining growth of the railroads; undoubtedly, it dampened aggregate demand.

As foreign investors sold their holdings of American stocks for hard money, specie left the United States. Funds secured through foreign investment in domestic enterprise were important in helping the country meet its usual balance of payments deficit. Fewer funds invested during the 1890s was one of the factors that, with a continued negative balance of payments, forced the United States to export gold almost continuously from 1892 to 1896. The impact of depression abroad on the flow of capital to this country can be inferred from the history of new capital issues in Britain, the source of perhaps 75 percent of overseas investment in the United States. British issues varied as shown in Table 3.

Table 3
British New Capital Issues, 1890-1898 (millions of pounds, sterling)

1890 142.6
1891 104.6
1892 81.1
1893 49.1
1894 91.8
1895 104.7
1896 152.8
1897 157.3
1898 150.2

Source: Hoffmann, p. 193

Simultaneously, the share of new British investment sent abroad fell from one-fourth in 1891 to one-fifth two years later. Over that same period, British net capital flows abroad declined by about 60 percent; not until 1896 and 1897 did they resume earlier levels.

Thus, the recession that began in 1893 had deep roots. The slowdown in railroad expansion, decline in building construction, and foreign depression had reduced investment opportunities, and, following the brief upturn effected by the bumper wheat crop of 1891, agricultural prices fell as did exports and commerce in general. By the end of 1893, business failures numbering 15,242 averaging $22,751 in liabilities, had been reported. Plagued by successive contractions of credit, many essentially sound firms failed which would have survived under ordinary circumstances. Liabilities totaled a staggering $357 million. This was the crisis of 1893.

Response to the Depression

The financial crises of 1893 accelerated the recession that was evident early in the year into a major contraction that spread throughout the economy. Investment, commerce, prices, employment, and wages remained depressed for several years. Changing circumstances and expectations, and a persistent federal deficit, subjected the treasury gold reserve to intense pressure and generated sharp counterflows of gold. The treasury was driven four times between 1894 and 1896 to resort to bond issues totaling $260 million to obtain specie to augment the reserve. Meanwhile, restricted investment, income, and profits spelled low consumption, widespread suffering, and occasionally explosive labor and political struggles. An extensive but incomplete revival occurred in 1895. The Democratic nomination of William Jennings Bryan for the presidency on a free silver platform the following year amid an upsurge of silverite support contributed to a second downturn peculiar to the United States. Europe, just beginning to emerge from depression, was unaffected. Only in mid-1897 did recovery begin in this country; full prosperity returned gradually over the ensuing year and more.

The economy that emerged from the depression differed profoundly from that of 1893. Consolidation and the influence of investment bankers were more advanced. The nation’s international trade position was more advantageous: huge merchandise exports assured a positive net balance of payments despite large tourist expenditures abroad, foreign investments in the United States, and a continued reliance on foreign shipping to carry most of America’s overseas commerce. Moreover, new industries were rapidly moving to ascendancy, and manufactures were coming to replace farm produce as the staple products and exports of the country. The era revealed the outlines of an emerging industrial-urban economic order that portended great changes for the United States.

Hard times intensified social sensitivity to a wide range of problems accompanying industrialization, by making them more severe. Those whom depression struck hardest as well as much of the general public and major Protestant churches, shored up their civic consciousness about currency and banking reform, regulation of business in the public interest, and labor relations. Although nineteenth century liberalism and the tradition of administrative nihilism that it favored remained viable, public opinion began to slowly swing toward governmental activism and interventionism associated with modern, industrial societies, erecting in the process the intellectual foundation for the reform impulse that was to be called Progressivism in twentieth century America. Most important of all, these opposed tendencies in thought set the boundaries within which Americans for the next century debated the most vital questions of their shared experience. The depression was a reminder of business slumps, commonweal above avarice, and principle above principal.

Government responses to depression during the 1890s exhibited elements of complexity, confusion, and contradiction. Yet they also showed a pattern that confirmed the transitional character of the era and clarified the role of the business crisis in the emergence of modern America. Hard times, intimately related to developments issuing in an industrial economy characterized by increasingly vast business units and concentrations of financial and productive power, were a major influence on society, thought, politics, and thus, unavoidably, government. Awareness of, and proposals of means for adapting to, deep-rooted changes attending industrialization, urbanization, and other dimensions of the current transformation of the United States long antedated the economic contraction of the nineties.

Selected Bibliography

*I would like to thank Douglas Steeples, retired dean of the College of Liberal Arts and professor of history, emeritus, Mercer University. Much of this article has been taken from Democracy in Desperation: The Depression of 1893 by Douglas Steeples and David O. Whitten, which was declared an Exceptional Academic Title by Choice. Democracy in Desperation includes the most recent and extensive bibliography for the depression of 1893.

Clanton, Gene. Populism: The Humane Preference in America, 1890-1900. Boston: Twayne, 1991.

Friedman, Milton, and Anna Jacobson Schwartz. A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press, 1963.

Goodwyn, Lawrence. Democratic Promise: The Populist Movement in America. New York: Oxford University Press, 1976.

Grant, H. Roger. Self Help in the 1890s Depression. Ames: Iowa State University Press, 1983.

Higgs, Robert. The Transformation of the American Economy, 1865-1914. New York: Wiley, 1971.

Himmelberg, Robert F. The Rise of Big Business and the Beginnings of Antitrust and Railroad Regulation, 1870-1900. New York: Garland, 1994.

Hoffmann, Charles. The Depression of the Nineties: An Economic History. Westport, CT: Greenwood Publishing, 1970.

Jones, Stanley L. The Presidential Election of 1896. Madison: University of Wisconsin Press, 1964.

Kindleberger, Charles Poor. Manias, Panics, and Crashes: A History of Financial Crises. Revised Edition. New York: Basic Books, 1989.

Kolko, Gabriel. Railroads and Regulation, 1877-1916. Princeton: Princeton University Press, 1965.

Lamoreaux, Naomi R. The Great Merger Movement in American Business, 1895-1904. New York: Cambridge University Press, 1985.

Rees, Albert. Real Wages in Manufacturing, 1890-1914. Princeton, NJ: Princeton University Press, 1961.

Ritter, Gretchen. Goldbugs and Greenbacks: The Antimonopoly Tradition and the Politics of Finance in America. New York: Cambridge University Press, 1997.

Romer, Christina. “Spurious Volatility in Historical Unemployment Data.” Journal of Political Economy 94, no. 1. (1986): 1-37.

Schwantes, Carlos A. Coxey’s Army: An American Odyssey. Lincoln: University of Nebraska Press, 1985.

Steeples, Douglas, and David Whitten. Democracy in Desperation: The Depression of 1893. Westport, CT: Greenwood Press, 1998.

Timberlake, Richard. “Panic of 1893.” In Business Cycles and Depressions: An Encyclopedia, edited by David Glasner. New York: Garland, 1997.

White, Gerald Taylor. Years of Transition: The United States and the Problems of Recovery after 1893. University, AL: University of Alabama Press, 1982.

Citation: Whitten, David. “Depression of 1893”. EH.Net Encyclopedia, edited by Robert Whaples. August 14, 2001. URL http://eh.net/encyclopedia/the-depression-of-1893/

The First Bank of the United States

David Cowen

Birth of the Bank

In February 1791, the First Bank of the United States (1791-1811) received a unique national charter for twenty years. Alexander Hamilton’s brainchild, a semi-public national bank, was a crucial component in the building of the early U.S. economy. The Bank prospered for twenty years and performed traditional banking functions in exemplary fashion. With a main office in Philadelphia and eight branches nationwide to serve its customers, the Bank’s influence stretched along the entire Atlantic seaboard from Boston to Charleston and Savannah and westward along the Gulf Coast to New Orleans.

Hamilton’s Broad Economic Plan

When the Treasury Department was created by an Act of Congress in September 1789, President George Washington rewarded Hamilton with the post of Secretary. Hamilton quickly became the nation’s leading economic figure. When Congress asked Hamilton to submit an economic plan for the country, he was well prepared. The Secretary delivered several monumental state papers that forged the financial system for the nation: The Report on Public Credit (January 9, 1790), The Report on the Bank (December 13, 1790), The Establishment of a Mint (January, 1791), and The Report on Manufactures (December 5, 1791). Hamilton’s reports outlined the strategies that were part of a comprehensive Federalist economic and financial program. They included a sinking fund to extinguish the national debt and an excise tax to be collected on all distilled liquors.

A key component of Hamilton’s economic plan for the country was the national Bank, an institution that would safeguard all pecuniary transactions. The Bank would not only stimulate the economy but also enhance the shaky credit of the government. The English financial system, particularly the Bank of England, provided an important model for Hamilton.

The Bank’s Funding and Privileges

The Report on the Bank explained that the national Bank would be chartered for twenty years, during which time the Congress would agree not to establish another national bank. The seed capital would be $10 million: $8 million from private sources, and $2 million from the government. The Bank would have the right to issue notes or currency up to $10 million. The government would also pledge that the notes of the Bank would be unique in that they were valid for payments to the United States. In short, the notes would be suitable for payment of taxes, a feature that would provide the Bank with a strong advantage over its competitors.

The national Bank would confer many benefits on the government including a ready source of loans, a principal depository for federal monies that were transferable from city to city without charge, and a clearing agent for payments on the national debt. The government, as the largest stockholder, would share in the profits, but have no direct participation in the management.

Debate over Establishment of the Bank

The Bank bill was introduced into Congress on December 13, 1790, passed the Senate on January 20, 1791, the House on February 8, 1791, and therefore was forwarded to President Washington for his signature. It was unclear whether Washington would sign the bill into law. Powerful forces led by James Madison, Thomas Jefferson and the Attorney General, Edmund Randolph, argued to Washington that the Constitution had not granted the government the power to incorporate a Bank and therefore he should not sign the bill.

Washington Accepts Hamilton’s View on Implied Powers

Washington showed Hamilton the opposition’s argument and asked him to prepare a document explaining why he should sign the bill. The pressure was therefore on Hamilton to produce a flawless retort. His reply to Washington has been christened as the benchmark of a broad interpretation of the Constitution. Hamilton turned the tables on his opposition. If Thomas Jefferson, James Madison and Edmund Randolph argued that the power to incorporate was not available unless explicitly prescribed by the Constitution, then Alexander Hamilton retorted that a power was not unavailable unless so stated in the Constitution. Washington accepted Hamilton’s logic and signed the bill on February 25, 1791 to create the national Bank.

Most important, however, was not the political infighting, but rather that Hamilton’s view holding that implied governmental powers were a viable part of the Constitution had carried the day. Hamilton had accomplished his aim: his detractors defeated; his economic approach adopted. In the ensuing years the Bank of the United States occupied center stage of the American financial system.

Life of the Bank

Initial Stock Offering

On July 4, 1791, in the largest initial stock offering the country had ever witnessed, investors displayed confidence in the new funding system by scooping up $8 million in Bank of United States stock with unprecedented alacrity. Many notable members of the Congress were purchasers. Prices of receipts for the right to buy stock (i.e. not the stock itself), know as scripts, were driven from an initial offering price of $25 to the unsustainable height of over $300, and then tumbled to $150 within days, causing alarm in the markets. Secretary Hamilton calmed the storm much as a modern central banker would have by using public money to directly purchase government securities. However, the script bubble led many to blame the Bank for such rabid speculations.

Bank Branches

In the fall of 1791 the new stockholders met in Philadelphia to choose board members and decide on rules and regulations. While the Bank would be headquartered in Philadelphia, the stockholders clamored for and received branches, with four opening in Baltimore, Boston, Charleston, and New York in 1792, and eventually four more in Norfolk (1800), Washington (1802), Savannah (1802) and New Orleans (1805). The branches were of great concern to the existing state banks, which viewed the national Bank as a competitive threat.

The Bank’s First President and Cashiers

Thomas Willing accepted the title of president of the Bank and remained in that position until 1807. Willing possessed strong credentials as he had been president of the Bank of North America, Mayor of Philadelphia, the Secretary to the Congress of delegates at Albany, and a Judge of the Supreme court of Pennsylvania. As the day-to- day manager, the role of bank cashier was also important. At the head office in Philadelphia, John Kean was appointed the cashier; however, the most noteworthy was George Simpson, who held the post from 1795-1811.

The Bank’s Roles in the Economy

On December 12, 1791, the Bank opened for business in Philadelphia. The customers were merchants, politicians, manufacturers, landowners, and most importantly, the government of the United States. The Banks notes circulated countrywide and therefore infused a safe medium of paper money into the economy for business transactions. The sheer volume of deposits, loans, transfers and payments conducted by the Bank throughout the country made it far and away the single largest enterprise in the fledgling nation. Profits, however, were moderate during the operation of the Bank because its directors opted for stability over risk taking.

The Bank and the “Panic of 1792”

The Bank had an enormous impact on the economy within two months of opening its doors for business by flooding the market with its discounts (loans) and banknotes and then sharply reversing course and calling in many of the loans. Although the added liquidity initially helped push a rising securities market higher, the subsequent drain caused the very first U.S. securities market crash by forcing speculators to sell their stocks. The largest speculator caught in the financial crisis was William Duer. When he went insolvent in March 1792, the markets were temporarily paralyzed. This so-called “Panic of 1792” was short lived as again Secretary Hamilton (as in the previous year during the script bubble) injected funds by buying securities directly and on behalf of the sinking fund. Yet incidents like the Panic of 1792 and the script bubble would be remembered for many years by opponents of the Bank who were still in steadfast opposition to the Hamilton inspired institution.

The Bank’s Business with the National Government

The rest of Bank years were never as tumultuous as the events surrounding the Panic of 1792. Rather during its twenty-year lifespan the Bank performed many mundane pecuniary functions for its customers. The largest customer, the government, had many notable interactions with the Bank. One of the highlights of the relationship was the Bank’s efficient managing of the government’s fiscal affairs with respect to the Louisiana Purchase in 1803. In its earlier days, the Bank had lent heavily to its largest customer. By the end of 1795 the Bank had lent the government over $6 million, or 60% of its capital. At this point Willing and the other directors became alarmed and demanded the Government repay part of its loan. Since Government credit was still weak, the Treasury resorted to selling shares of its Bank stock. The sales began in 1796 and ended in 1802. With the proceeds from the sales of stock, the government repaid the Bank.

Central Banking Functions of the Bank

The Bank performed certain functions that today are associated with central banking. First, the Bank attempted to regulate state banks by curtailing those that had overissued their bank notes. Second, the Bank, in coordination with the Treasury department, discussed economic conditions and attempted to promote the safety of the entire credit system. Third, while the Philadelphia board gave each branch autonomy respecting lending to individuals, the Bank tried to coordinate aggregate policy changes, whether a loosening or tightening of lending credit, across the entire network of branches.

Death of the Bank

The anti-Bank forces had remained steadfast in their opposition to the Bank since its inception in 1791. By the time of the renewal debate in Congress, the Federalists were no longer in control. The Democrats now held the majority and were ready to act against the Federalist conceived institution. The opponents of the Bank included Henry Clay, William Branch Giles and Vice-President George Clinton. The Federalists supported renewal and were joined by two notable Democrats who crossed party lines, Treasury Secretary Albert Gallatin, who believed in the usefulness of the institution, and then President Madison, who had switched camps with respect to the Bank issue because he believed the matter had been settled by precedent.

Complaints about the Bank

The opponents charged that because three-fourths of the ownership of the stock was held by foreigners, that the Bank was under their direct influence. The charge was false, as foreigners were prohibited from electing directors. The opposition also charged that the Bank was concealing profits, operating in a mysterious fashion, unconstitutional, and simply a tool for loaning money to the Government.

Rechartering Suffers a Narrow Defeat in Congress

Although the charter did not expire until March 4, 1811, the renewal process commenced in the House on March 28, 1808 and in the Senate on April 20, 1808. The matter developed slowly and was referred to Secretary Gallatin for an opinion. On March 3, 1809 Gallatin communicated his beliefs to the House that the Bank charter should be renewed. The matter returned to the House on January 29, 1810 for Committee debate. On February 19th, the committee recommended in favor of renewing the charter and sent the bill to the floor of the House. Floor debate opened on April 13th, and the bill was stopped dead in its tracks. Stockholders resubmitted the bill on December 10th, and despite an intense three-month debate, the bill was killed. The vote in each section of the Congress was incredibly close. The bill was defeated in the House by a 65 to 64 margin on January 24, 1811, and in the Senate was deadlocked at 17 on February 20th before Vice-President Clinton, an enemy of both Madison and Gallatin, broke the tie with a negative vote. The Bank of the United States closed its doors on March 3, 1811.

The Bank and the Debate over Central Government Power

The reason the Bank lost its charter had precious little to do with banking. When charter renewal debate transpired in 1811 banking on the whole was flourishing. The Bank was born, lived, and eventually died a victim of politics. The Bank has been remembered not for what occurred during its operation — stimulating business, infusing safe paper money into the economy, supporting the credit of the country and national government, and with the Treasury department regulating the financial arena — but rather for what occurred during the stormy debates at its birth and death. The death of the Bank was another chapter in an ongoing debate between the early leaders of the country who were split between those who preferred a weak central government on the one hand and those who desired a strong central government on the other.

The chartering of a national economic institution, a Bank of the United States, marks the take-off of the Federalist financial revolution that began several years earlier with the signing of the Constitution. The political die of the United States was cast with that document, and by 1792 the economic base of Federalism was in place, first with the Federal funding of national and state war debts, and second, with a sound national Bank in place to give coherence to the developing U.S. financial system.

Further Reading:

Bowling, Kenneth R. “The Bank Bill, the Capital City and President Washington.” Capital Studies 1, no. 1 (1972).

Cowen, David J. “The First Bank of the United States and the Securities Market Crash of 1792.” Journal of Economic History 60, no. 4 (2000).

Cowen, David J. _The Origins and Economic Impact of the First Bank of the United States, 1791-1797_. New York: Garland Publishing, 2000.

Dewey, Davis Rich and John Thom Holdsworth. The First and Second Banks of the United States. Washington, D.C.: Government Printing Office, 1910.

Hammond, Bray. Banks and Politics in America: From the Revolution to the Civil War. Princeton: Princeton University Press, 1957.

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Citation: Cowen, David. “First Bank of the United States”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/the-first-bank-of-the-united-states/