Debtwatch No. 42: The economic case against Bernanke

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The US Senate should not reappoint Ben Bernanke. As Obama's reaction to the loss of Ted Kennedy's seat showed, real change in policy only occurs after political scalps have been taken. An economic scalp of this scale might finally shake America from the unsustainable path that reckless and feckless Federal Reserve behavior set it on over 20 years ago.

Some may think this would be an unfair outcome for Bernanke. It is not. There are solid economic reasons why Bernanke should pay the ultimate political price.

Haste is necessary, since Senator Reid's proposal to hold a cloture vote could result in a decision as early as this Wednesday, and with only 51 votes being needed for his reappointment rather than 60 as at present. This document will therefore consider only the most fundamental reason not to reappoint him, and leave additional reasons for a later update.

Misunderstanding the Great Depression

Bernanke is popularly portrayed as an expert on the Great Depression—the person whose intimate knowledge of what went wrong in the 1930s saved us from a similar fate in 2009.

In fact, his ignorance of the factors that really caused the Great Depression is a major reason why the Global Financial Crisis occurred in the first place.

The best contemporary explanation of the Great Depression was given by the US economist Irving Fisher in his 1933 paper "The Debt-Deflation Theory of Great Depressions". Fisher had previously been a cheerleader for the Stock Market bubble of the 1930s, and he is unfortunately famous for the prediction, right in the middle of the 1929 Crash, that it was merely a blip that would soon pass:

“ Stock prices have reached what looks like a permanently high plateau. I do not feel that there will soon, if ever, be a fifty or sixty point break below present levels, such as Mr. Babson has predicted. I expect to see the stock market a good deal higher than it is today within a few months.”  (Irving Fisher, New York Times, October 15 1929)

When events proved this prediction to be spectacularly wrong, Fisher to his credit tried to find an explanaton. The analysis he developed completely inverted the economic model on which he had previously relied.

His pre-Great Depression model treated  finance as just like any other market, with supply and demand setting an equilibrium price. In building his models, he made two assumptions to handle the fact that, unlike the market for, say, apples, transactions in finance markets involved receiving something now (a loan) in return for payments made in the future. Fisher assumed

“ (A) The market must be cleared—and cleared with respect to every interval of time.

(B) The debts must be paid.”  (Fisher 1930, The Theory of Interest, p. 495)[1]

I don't need to point out how absurd those assumptions are, and how wrong they proved to be when the Great Depression hit—Fisher himself was one of the many whose fortunes were wiped out by margin calls they were unable to meet.  After this experience, he realized that his equilibrium assumption blinded him to the forces that led to the Great Depression. The real action in the economy occurs in disequilibrium:

We may tentatively assume that, ordinarily and within wide limits, all, or almost all, economic variables tend, in a general way, toward a stable equilibrium... But the exact equilibrium thus sought is seldom reached and never long maintained. New disturbances are, humanly speaking, sure to occur, so that, in actual fact, any variable is almost always above or below the ideal equilibrium...

It is as absurd to assume that, for any long period of time, the variables in the economic organization, or any part of them, will "stay put," in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave. (Fisher 1933, p. 339)

A disequilibrium-based analysis was therefore needed, and that is what Fisher provided. He had to identify the key variables whose disequilibrium levels led to a Depression, and here he argued that the two key factors were "over-indebtedness to start with and deflation following soon after". He ruled out other factors—such as mere overconfidence—in a very poignant passage, given what ultimately happened to his own highly leveraged  personal financial position:

I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt. (p. 341)

Fisher then argued that a starting position of over-indebtedness and low inflation in the 1920s led to a chain reaction that caused the Great Depression:

"(1) Debt liquidation leads to distress selling and to

(2) Con­trac­tion of deposit cur­rency, as bank loans are paid off, and to a slow­ing down of veloc­ity of cir­cu­la­tion. This con­trac­tion of deposits and of their veloc­ity, pre­cip­i­tated by dis­tress sell­ing, causes

(3) A fall in the level of prices, in other words, a swelling of the dol­lar. Assum­ing, as above stated, that this fall of prices is not inter­fered with by refla­tion or oth­er­wise, there must be

(4) A still greater fall in the net worths of busi­ness, pre­cip­i­tat­ing bank­rupt­cies and

(5) A like fall in prof­its, which in a “cap­i­tal­is­tic,” that is, a private-profit soci­ety, leads the con­cerns which are run­ning at a loss to make

(6) A reduc­tion in out­put, in trade and in employ­ment of labor. These losses, bank­rupt­cies, and unem­ploy­ment, lead to

(7) Pes­simism and loss of con­fi­dence, which in turn lead to

(8) Hoard­ing and slow­ing down still more the veloc­ity of cir­cu­la­tion. The above eight changes cause

(9) Com­pli­cated dis­tur­bances in the rates of inter­est, in par­tic­u­lar, a fall in the nom­i­nal, or money, rates and a rise in the real, or com­mod­ity, rates of inter­est.” (p. 342)

Fisher con­fi­dently and sen­si­bly con­cluded that “Evi­dently debt and defla­tion go far toward explain­ing a great mass of phe­nom­ena in a very sim­ple log­i­cal way”.

So what did Ben Bernanke, the alleged mod­ern expert on the Great Depres­sion, make of Fisher’s argu­ment? In a nut­shell, he barely even con­sid­ered it.

Bernanke is a lead­ing mem­ber of the “neo­clas­si­cal” school of eco­nomic thought that dom­i­nates the aca­d­e­mic eco­nom­ics pro­fes­sion, and that school con­tin­ued Fisher’s pre-Great Depres­sion tra­di­tion of analysing the econ­omy as if it is always in equilibrium.

With his neo­clas­si­cal ori­en­ta­tion, Bernanke com­pletely ignored Fisher’s insis­tence that an equilibrium-oriented analy­sis was com­pletely use­less for analysing the econ­omy. His sum­mary of Fisher’s the­ory (in his Essays on the Great Depres­sion) is a barely recog­nis­able par­ody of Fisher’s clear argu­ments above:

Fisher envi­sioned a dynamic process in which falling asset and com­mod­ity prices cre­ated pres­sure on nom­i­nal debtors, forc­ing them into dis­tress sales of assets, which in turn led to fur­ther price declines and finan­cial dif­fi­cul­ties. His diag­no­sis led him to urge Pres­i­dent Roo­sevelt to sub­or­di­nate exchange-rate con­sid­er­a­tions to the need for refla­tion, advice that (ulti­mately) FDR fol­lowed. (Bernanke 2000, Essays on the Great Depres­sion, p. 24)

This “sum­mary” begins with falling prices, not with exces­sive debt, and though he uses the word “dynamic”, any idea of a dis­e­qui­lib­rium process is lost. His very next para­graph explains why. The neo­clas­si­cal school ignored Fisher’s dis­e­qui­lib­rium foun­da­tions, and instead con­sid­ered debt-deflation in an equi­lib­rium frame­work in which Fisher’s analy­sis made no sense:

Fisher’ s idea was less influ­en­tial in aca­d­e­mic cir­cles, though, because of the coun­ter­ar­gu­ment that debt-deflation rep­re­sented no more than a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors). Absent implau­si­bly large dif­fer­ences in mar­ginal spend­ing propen­si­ties among the groups, it was sug­gested, pure redis­tri­b­u­tions should have no sig­nif­i­cant macro­eco­nomic effects. ” (p. 24)

If the world were in equi­lib­rium, with debtors car­ry­ing the equi­lib­rium level of debt, all mar­kets clear­ing, and all debts being repaid, this neo­clas­si­cal con­clu­sion would be true. But in the real world, when debtors have taken on exces­sive debt, where the mar­ket doesn’t clear as it falls and where numer­ous debtors default, a debt-deflation isn’t merely “a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors)”, but a huge shock to aggre­gate demand.

Cru­cially, even though Bernanke notes at the begin­ning of his book that “the premise of this essay is that declines in aggre­gate demand were the dom­i­nant fac­tor in the onset of the Depres­sion” (p. ix), his equi­lib­rium per­spec­tive made it impos­si­ble for him to see the obvi­ous cause of the decline: the change from ris­ing debt boost­ing aggre­gate demand to falling debt reduc­ing it.

In equi­lib­rium, aggre­gate demand equals aggre­gate sup­ply (GDP), and defla­tion sim­ply trans­fers some demand from debtors to cred­i­tors (since the real rate of inter­est is higher when prices are falling). But in dis­e­qui­lib­rium, aggre­gate demand is the sum of GDP plus the change in debt. Ris­ing debt thus aug­ments demand dur­ing a boom; but falling debt sub­stracts from it dur­ing a slump

In the 1920s, pri­vate debt reached unprece­dented lev­els, and this ris­ing debt was a large part of the appar­ent pros­per­ity of the Roar­ing Twen­ties: debt was the fuel that made the Stock Mar­ket soar. But when the Stock Mar­ket Crash hit, debt reduc­tion took the place of debt expan­sion, and reduc­tion in debt was the source of the fall in aggre­gate demand that caused the Great Depression.

Fig­ure 1 shows the scale of debt dur­ing the 1920s and 1930s, ver­sus the level of nom­i­nal GDP.

Fig­ure 1: Debt and GDP 1920–1940

Fig­ure 2 shows the annual change in pri­vate debt and GDP, and aggre­gate demand (which is the sum of the two). Note how much higher aggre­gate demand was than GDP dur­ing the late 1920s, and how aggre­gate demand fell well below GDP dur­ing the worst years of the Great Depression.

Fig­ure 2: Change in Debt and Aggre­gate Demand 1920–1940

Fig­ure 3 shows how much the change in debt con­tributed to aggre­gate demand—which I define as GDP plus the change in debt (the for­mula behind this graph is “The Change in Debt, divided by the Sum of GDP plus the Change in Debt”).

Fig­ure 3: Debt con­tri­bu­tion to Aggre­gate Demand 1920–1940

So dur­ing the 1920s boom, the change in debt was respon­si­ble for up to 10 per­cent of aggre­gate demand in the 1920s. But when delever­ag­ing began, the change in debt reduced aggre­gate demand by up to 25 per­cent. That was the real cause of the Great Depression.

That is not a chart that you will find any­where in Bernanke’s Essays on the Great Depres­sion. The real cause of the Great Depres­sion lay out­side his view, because with his neo­clas­si­cal eyes, he couldn’t even see the role that debt plays in the real world.

Bernanke’s fail­ure

If this were just about the inter­pre­ta­tion of his­tory, then it would be no big deal. But because they ignored the obvi­ous role of debt in caus­ing the Great Depres­sion, neo­clas­si­cal econ­o­mists have stood by while debt has risen to far higher lev­els than even dur­ing the Roar­ing Twenties.

Worse still, Bernanke and his pre­de­ces­sor Alan Greenspan oper­ated as vir­tual cheer­lead­ers for ris­ing debt lev­els, jus­ti­fy­ing every new debt instru­ment that the finance sec­tor invented, and every new tar­get for lend­ing that it iden­ti­fied, as improv­ing the func­tion­ing of mar­kets and democ­ra­tiz­ing access to credit.

The next three charts show what that dere­lic­tion of reg­u­la­tory duty has led to. Firstly, the level of debt has once again risen to lev­els far above that of GDP (Fig­ure 4).

Fig­ure 4: Debt and GDP 1990–2010

Sec­ondly the annual change in debt con­tributed far more to demand dur­ing the 1990s and early 2000s than it ever had dur­ing the Roar­ing Twen­ties. Demand was run­ning well above GDP ever since the early 1990s (Fig­ure 5). The annual increase in debt accounted for 20 per­cent or more of aggre­gate demand on var­i­ous occa­sions in the last 15 years, twice as much as it had ever con­tributed dur­ing the Roar­ing Twenties.

Fig­ure 5: Change in Debt and Aggre­gate Demand 1990–2010

Thirdly, now that the debt party is over, the attempt by the pri­vate sec­tor to reduce its gear­ing has taken a huge slice out of aggre­gate demand. The reduc­tion in aggre­gate demand to date hasn’t reached the lev­els we expe­ri­enced in the Great Depression—a mere 10% reduc­tion, ver­sus the over 20 per­cent reduc­tion dur­ing the dark days of 1931–33. But since debt today is so much larger (rel­a­tive to GDP) than it was at the start of the Great Depres­sion, the dan­gers are either that the fall in demand could be steeper, or that the decline could be much more drawn out than in the 1930s.

Fig­ure 6: Debt con­tri­bu­tion to Aggre­gate Demand 1990–2010


Bernanke, as the neo­clas­si­cal econ­o­mist most respon­si­ble for bury­ing Fisher’s accu­rate expla­na­tion of why the Great Depres­sion occurred, is there­fore an emi­nently suit­able tar­get for the polit­i­cal sac­ri­fice that Amer­ica today des­per­ately needs. His extreme actions once the cri­sis hit have helped reduce the imme­di­ate impact of the cri­sis, but with­out the igno­rance he helped spread about the real cause of the Great Depres­sion, there would not have been a cri­sis in the first place. As I will also doc­u­ment in an update in early Feb­ru­ary, some of his advice has made America’s recov­ery less effec­tive than it could have been.

Obama came to office promis­ing change you can believe in. If the Sen­ate votes against Bernanke’s reap­point­ment, that change might finally start to arrive.


This is an advance ver­sion of my monthly Debt­watch Report for Feb­ru­ary 2010. Click here for the PDF ver­sion. Please feel free to dis­trib­ute this to any­one you think may be interested–especially peo­ple who may be in a posi­tion to influ­ence the Senate’s vote.

Pro­fes­sor Steve Keen

[1] This book was an untimely relaunch of his 1907 PhD thesis.

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368 Responses to Debtwatch No. 42: The economic case against Bernanke

  1. Erik Nelson says:

    Thank you very much for your reply.

    Sav­ing (to pay down debt) diverts cur­rency from spend­ing. Thus, the flow of cur­rency towards debt repay­ment rep­re­sents fore­gone spend­ing. In the early 1930s, debt repay­ment increased to nearly 25% of aggre­gate spend­ing. So, in the absence of sav­ing (to pay down debt), spend­ing could have been up to 25% higher ?

    Con­versely, “over-spending” (on new debt) increases spend­ing. In the 1920s, debt gen­er­a­tion increased to nearly 10% of aggre­gate spend­ing. So, in the absence of “over-spending” (on credit), spend­ing would have been up to 10% lower ?

    The swing in spend­ing, from “over-spending” on new debt by +10%, to “under-spending” to reduce old debt by –25%, is com­pa­ra­ble to the swing in accounted GDP. And, that swing in spend­ing (-35%) is com­pa­ra­ble to the swing in unem­ploy­ment (+20%), by Okun’s Law which equates –2% of spend­ing to +1% of unemployment.

    i offer that the debt-fueled “Roar­ing Twen­ties” arti­fi­cially increased spend­ing, and decreased unem­ploy­ment, beyond nat­ural lev­els; and that the Great Depres­sion, which arti­fi­cially decreased spend­ing (for sav­ing to pay down debt), and increased unem­ploy­ment (para­dox of thrift), was made to appear all the worse, by the swift swing from over-spending (on new debt) to under-spending (whilst sav­ing against old debt).

    The net flow of money into sav­ings (to pay down debt) was diverted away from spend­ings, and (numer­i­cally) accounts for the drop in GDP. Roger Farmer observes that spend­ing depends more on (net) wealth than on income. Thus, asset price bub­bles increase spend­ing (on new debt), and price col­lapses decrease spend­ing (for sav­ing against old debt). Debt seems to have played a piv­otal part in the Great Depres­sion eighty years ago, and in the ‘Great Reces­sion’ today.

    Tan­gen­tially, for the USA, the ratio of GDP to wages & salaries is 2:1. And GDP rep­re­sents aggre­gate sales rev­enues. And if rev­enues decrease, busi­nesses try to trim expenses to match. So if (US) GDP decreases 2%, wages decrease 1%. And wage expenses are reduced by dis­em­ploy­ing work­ers. So per­haps Okun’s Law reflects the ratio of GDP to wages, and rep­re­sents the aggre­gate effects of busi­nesses match­ing expenses (wages) to rev­enues (GDP) ?

  2. Erik Nelson says:

    Accord­ing to data from Richard T. Froyen’s Macro­eco­nom­ics (6th ed.) (p.345), in the late 1920s, US banks began dip­ping into their Excess Reserves, thereby gen­er­at­ing $2-3B in extra loans; whereas in the early 1930s, US banks began hold­ing extra Excess Reserves, thereby fore­go­ing $5–10 in poten­tial loans. If so, then US credit-markets, like prod­uct mar­kets, “whiplashed” from before to after the 1929 stock-market crash — US banks who had been draw­ing down ERs to make extra risky loans, sud­denly switched to build­ing up ERs and fore­go­ing even safe loans. The total net effect may have amounted to $15B in fore­gone poten­tial money. If so, then the demand for money by US banks was an impor­tant fac­tor in the defla­tion after the 1929 stock-market crash.

  3. Erik Nelson says:

    From 1929–33, Excess Reserves (ER) in US banks rose from $1.8B to $3.0B, whilst nom­i­nal interest-rates (i) fell from 5.9% to 1.0%. Interest-rates are the price of credit, and prices reflect the ratio of demand-to-supply (i ~ D/S of credit). If ER reflect the sup­ply of loan­able funds, then the fact that interest-rates fell much more than ER rose, implies that the demand for credit fell. Quan­ti­ta­tively, defin­ing a demand for credit (D = ER x i), then that D fell from $110M to $30M from 1929–33. So, even as US banks were accu­mu­lat­ing ER, they were drop­ping their interest-rates, imply­ing that they were try­ing to attract bor­row­ers. Ipso facto, the col­lapse of the US money sup­ply (M1) from 1929–33 was “demand dri­ven” (nobody bor­row­ing), not “sup­ply dri­ven” (banks had extra ER to lend). Accord­ing to the plots pro­vided by Prof. Keen, US pri­vate debt was being paid down from 1929–33.

    Thus, a clear & con­sis­tent pic­ture emerges — from 1929–33, the US entered a “Bal­ance Sheet Reces­sion” (Richard Koo) dur­ing which nobody was bor­row­ing, because every­body was pay­ing down debt, so that banks were accu­mu­lat­ing extra ER, with­out being able to on-lend the money back into cir­cu­la­tion. If those extra ER had been bor­rowed, then from 1929–33, the US money sup­ply could have grown by nearly $12B, an aver­age rate of bor­row­ing of $3B/year. The veloc­ity (VM1) dur­ing that period was approx­i­mately 3, so that recir­cu­lat­ing $3B/year by bor­row­ing might have gen­er­ated $9B/year of total spend­ing, or nearly 14% of GDP. By Okun’s Law, that extra spend­ing would have reduced unem­ploy­ment by nearly 7%. Then, unem­ploy­ment, which had fallen to 22% in 1934, would have fallen fur­ther to 15%, i.e. nearly back down to pre-Depression lev­els. For, accord­ing to “The Great Depres­sion” by Paul Jef­fers (p.21), the US unem­ploy­ment rate dur­ing the term of Pres. Calvin Coolidge (1923–28) ranged from 5–13%, due to increas­ing pro­duc­tiv­ity, owing to the increas­ing use of cap­i­tal equip­ment. Use of trac­tors on farms, and machines in fac­to­ries, led to over-production, falling prices for crops & com­modi­ties, and high unemployment.

    So, the pay-down of old debt, and the non-borrowing of new debt, from 1929–33, con­tracted the US money sup­ply, and sequestered sav­ings out of cir­cu­la­tion, thereby reduc­ing spend­ing, and increas­ing unem­ploy­ment. Such seem­ingly sup­ports the impor­tance of debt in the Great Depres­sion (Steve Keen), inter­pretable as a Balance-Sheet Reces­sion (Richard Koo).

  4. Erik Nelson says:

    If Prices & Wages can be “sticky”, then per­haps interest-rates can also be “sticky” ?

  5. Erik Nelson says:

    interest-rates are the “price” of credit, so reflect­ing the ratio of demand-to-supply of credit. Dur­ing reces­sions, the rate of deposit­ing (new deposits in banks), rel­a­tive to the amount of cur­rency, falls — unem­ploy­ment rises, wages fall, peo­ple put less money into banks. Thus, reces­sions restrict the sup­ply of loan­able credit, usu­ally dri­ving up inter­est rates. But, dur­ing depres­sions (e.g. Great Depres­sion, 1991), the demand for loan­able credit evap­o­rates, so that interest-rates actu­ally fall. Inex­pertly, depres­sions (severe reces­sions) seem asso­ci­ated with falling interest-rates, so that not only is unem­ploy­ment high & out­put (and sav­ings) low, but nobody is bor­row­ing either. If so, then such high­lights the impor­tant role of credit & new-debt in the (stream of spend­ing of the) econ­omy — the sig­nal of “bad times” is neg­li­gi­ble bor­row­ing (and low interest-rates).

  6. Erik Nelson says:

    Both dur­ing the Great Depres­sion, and in recent decades, the veloc­ity of spend­ing (V1 = Y/M1) tracks the veloc­ity of net sav­ing (VS = new deposits / cur­rency) and the veloc­ity of net (on-)lending (VL = new loans / cur­rency; loans = deposits — reserves). The for­mer tends to be 4-5x faster than the lat­ter; the lat­ter tends to be much more volatile, respond­ing much more sen­si­tively to down­turns. Inex­pertly, recir­cu­la­tion of money through banks is an impor­tant part of aggre­gate spend­ing, under­ly­ing per­haps 20–25% of spend­ing, such that decreas­ing (net) deposit­ing & bor­row­ing dur­ing down­turns can reduce over­all spend­ing by between a fifth to a quarter:

  7. Erik Nelson says:

    Dur­ing the GD,

    Gov­ern­ment sta­tis­ti­cians decided that every­one work­ing in these Fed­er­ally spon­sored “make-work” pro­grams would have been unem­ployed oth­er­wise. Con­se­quently, they decided to count these mil­lions of Amer­i­cans as unem­ployed… After adjust­ing for peo­ple who were actu­ally work­ing but were counted as unem­ployed, he found a max­i­mum unem­ploy­ment rate of 17% [not 25%]” (Miller & Ben­jamin. Eco­nom­ics of Macro Issues, p.49–52)

    Thus, as early as 1933, New Deal pro­grams were pay­ing ~4 mil­lion peo­ple, reduc­ing total unem­ploy­ment by ~8%. The offi­cial sta­tis­tics only report “pri­vate sec­tor unem­ploy­ment”, and thereby mask the effec­tive­ness of the Fis­cal stim­u­lus. If offi­cial “pri­vate sec­tor unem­ploy­ment” was 17% in 1939; and if “pub­lic employ­ment” was 10–20 mil­lion, or about 5–10% of the work­force, then “total unem­ploy­ment” was actu­ally only 7–12%.

    Today, sta­tis­tics still seem mis­lead­ing — mil­lions of Amer­i­cans are on pub­lic doles, but off offi­cial unemployment:

    Since 1990, the num­ber of peo­ple receiv­ing dis­abil­ity pay­ments from the Social Secu­rity Admin­is­tra­tion has more than tripled to over 8 mil­lion [because] the real value of monthly ben­e­fits a per­son can col­lect has risen more than 50% in the past thirty years… Indeed, those receiv­ing dis­abil­ity pay­ments make up the largest group of the 2 mil­lion or so who left the labor force dur­ing the lat­est [1990] recession”

    To com­pare cur­rent unem­ploy­ment stats, to those dur­ing the GD, would require either sub­tract­ing “pub­lic employ­ment” from the lat­ter, or adding “pub­lic dole” to the for­mer. Either way, the cur­rent econ­omy looks allot less healthy, than the “dou­bly mis­lead­ing” offi­cial sta­tis­tics suggest.

  8. Erik Nelson says:

    Inex­pertly, those who “ran” on the banks were those who had lost con­fi­dence in those banks. And, banks had, in fact, made many bad loans, to and for spec­u­la­tion, on the stock mar­ket. And, only a few per­cent of the US pop­u­la­tion had (being wealthy & sophis­ti­cated enough) par­taken in stock-market spec­u­la­tion. So, per­haps banks had taken deposits of “many poorer blue col­lar work­ers”, and used their money, for loans to “fewer richer white col­lar spec­u­la­tors” (or spec­u­lated directly them­selves). When the stock-market crashed, and word got out, the masses “ran” to the banks, to “get their money back”. Bank runs imply a loss of con­fi­dence, in banks, whose bal­ance sheets were tied to the stock-market. Peo­ple were walk­ing away with cur­rency, pre­fer­ring to hold it them­selves than risk it to “spec­u­lat­ing bankers”; and, thereby, emp­ty­ing the banks of the same, and moti­vat­ing FDR’s exec­u­tive order to return gold to banks.

    i per­ceive the fol­low­ing aspects of the GD:

    spec­u­la­tive bub­ble (stock)
    loss of con­fi­dence in banks (stock assets)
    con­sumer debt (houses, cars, appli­ances)
    cor­po­rate debt (wages ??)
    spec­u­la­tor debt (banks ??)

    If so, then the debt-fueled “roar­ing” 1920s left per­sons, busi­nesses, and spec­u­la­tors (banks) deep in debt; every­body had been bor­row­ing to spend beyond their means. Then, with the stock-market crash, and loss of con­fi­dence in banks, the credit mar­ket was “attacked” with bank-runs. To cash out depos­i­tors, banks began call­ing in all their own loans. The bank runs “pulled the plug”, induc­ing banks to switch, from lend­ing, to demand­ing pay­ment. In turn, non-bank pri­vate lenders demanded repay­ment, too. So, every­body began pay­ing down debts (total pri­vate debt declined $50B from 1929–33), ulti­mately to banks (total deposits declined by $15 dur­ing that period, imply­ing that bank loans, mir­ror­ing the same on bank bal­ance sheets, declined by a sim­i­lar amount). Thus, the pub­lic loss of con­fi­dence in banks, and the pub­lic “attack” on banks with bank-runs, induced a cas­cade of demanded-loan-repayments — the pub­lic demanded money from banks, who demanded money from investors, who demanded money from oth­ers. Thereby, the US econ­omy switched from debt-fueled spend­ing beyond means (“super-spending mode”), to debt-repayment (“super-saving mode”).

    Then, to top it all off, what money was accu­mu­lat­ing back into banks (excess reserves) was not being bor­rowed (since every­body was pay­ing down debts, not tak­ing out new ones). Given the money-multiplier (x10), those accu­mu­lat­ing excess reserves could have gen­er­ated bil­lions of dol­lars in new loans… but didn’t. Interest-rates fell, imply­ing banks were try­ing, and fail­ing, to push loans. In 1929, 10% of US GDP spend­ing was done on credit; in the early 1930s, debt repay­ments amounted to 25% of US GDP. Thus, the switch from “over-spending” by +10%, to “under-spending” (for sav­ing) by –25%, accounts for almost all of the drop in GDP.

    so, i per­ceive that:

    spec­u­la­tive bub­ble led to loss of con­fi­dence in banks
    pub­lic “attack run” on banks induced cas­cade of demanded debt repay­ments
    econ­omy switched from “over-spending” +10% on new debt, to “under-spending” –25% to pay down old debt
    aggre­gate spend­ing (GDP) fell by 40%
    loss of con­fi­dence in banks kept new cash out of banks, and left their cash reserves un-borrowed
    nobody was bor­row­ing, every­body was sav­ing, few peo­ple were spend­ing, GDP fell
    few peo­ple were deposit­ing into banks, nobody was bor­row­ing from banks, money stopped cir­cu­lat­ing, lead­ing to deflation


  9. Erik Nelson says:

    exec­u­tive order 6102[/URL] stopped Great Depression ?

    i per­ceive, that pub­lic “attack runs” on banks induced a domino-cascade of called loans, which switched the US econ­omy, from debt-fueled expan­sion, to debt-repaying con­trac­tion. The fol­low­ing fig­ures show, that after 1933, US banks stopped fail­ing; and US pri­vate debt-levels (which had been falling -$10B / year) sta­bi­lized. Then, US aggre­gate spend­ing (GDP) promptly began improv­ing. Thus, as soon as FDR ended the bank-runs, banks (and pri­vate lenders) stopped run­ning on their debtors. Pri­vate debt sta­bi­lized, with a trickle of new loans pre­sum­ably off­set­ting grad­ual repay­ment of old loans. Pub­lic debt, from the New Deal, increased, mak­ing up for the lethar­gic pri­vate sec­tor, and improv­ing the US economy:

  10. Erik Nelson says:

    exec­u­tive order 6102 stopped Great Depres­sion ?
    i per­ceive, that pub­lic “attack runs” on banks induced a domino-cascade of called loans, which switched the US econ­omy, from debt-fueled expan­sion, to debt-repaying con­trac­tion. The fol­low­ing fig­ures show, that after 1933, US banks stopped fail­ing; and US pri­vate debt-levels (which had been falling -$10B / year) sta­bi­lized. Then, US aggre­gate spend­ing (GDP) promptly began improv­ing. Thus, as soon as FDR ended the bank-runs, banks (and pri­vate lenders) stopped run­ning on their debtors. Pri­vate debt sta­bi­lized, with a trickle of new loans pre­sum­ably off­set­ting grad­ual repay­ment of old loans. Pub­lic debt, from the New Deal, increased, mak­ing up for the lethar­gic pri­vate sec­tor, and improv­ing the US economy:

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  12. Erik Nelson says:

    From 1929–1933, total pri­vate debt declined by about 25% (from about $160B to $120B), sta­bi­liz­ing after­wards. Mean­while, price-levels declined by about 25%, sta­bi­liz­ing after­wards. The two data series (declin­ing nom­i­nal pri­vate debt, deflat­ing price level) seem strongly cor­re­lated. Inex­pertly, that cor­rob­o­rates, that defla­tion moti­vated debt repay­ment, in sup­port of the debt-deflation explanation.

  13. Erik Nelson says:

    From 1929–1933, bank deposits decreased by nearly $16B, split equally between check­ing & sav­ings deposits. ($1.3B of which were wiped out in bank fail­ures.) Thus, amidst the flurry of delever­ag­ing, of debtors repay­ing cred­i­tors (e.g. busi­nesses pay­ing back bond-holders), money wended its way back to banks, to pay off bank loans (e.g. mort­gages), and “van­ished” (bank assets (loans) co-cancelling bank lia­bil­i­ties (deposits)), con­tract­ing the money supply.

    Now, in the 1920s, the speed of spend­ing (veloc­ity, MV1) had been about 3–4. Every dol­lar in cir­cu­la­tion [$] gen­er­ated 3–4 dol­lars of spend­ing per year [$/year], as it changed hands, over & over, across the econ­omy, over the course of the year. Thus, grad­u­ally elim­i­nat­ing MONEY [$16B, over 4 years] out of the stream of spend­ing, would have elim­i­nated 3-4x as much SPENDING [$50-60B per 4 years] by 3-4x as much. Indeed, from 1929–1933, nom­i­nal GDP fell by nearly $50B.

    Econ­o­mist Mike Kon­czal has argued that mort­gage debt explains the cur­rent US reces­sion. Micro­eco­nom­i­cally, com­mu­ni­ties hav­ing the high­est debt ratios have the slow­est spend­ing, and slug­gish employ­ment growth. Mort­gage debt peaked in 2008, and has been paid down for 4 years. The plot of mort­gage debt over time resem­bles the plot of pri­vate debt, in the orig­i­nal blog post above. Mort­gage debt is spe­cial, because it comes from banks, so repay­ing it con­tracts the money sup­ply. Money siphoned out of spend­ing, to pay off mort­gages, “van­ishes”, and elim­i­nates an amount of spend­ing, per dol­lar, equal to the cur­rent veloc­ity of money (8–10 in the US at present). Thus, pay­ing down nearly $1T, over 4 years, would be pre­dicted to reduce nom­i­nal spend­ing, by up to $2T per year ($8T over 4 years). Those kinds of fig­ures can account for the fall in US GDP.

    Per­haps debt reduc­tion is cru­cial, gen­er­ally; and deposit reduc­tion (pay­ing back banks, con­tract­ing the money sup­ply) is cru­cial, specifically ?

  14. Erik Nelson says:

    i’m try­ing to say, “per­haps every­body was always right”? Irv­ing Fisher’s crit­ics argued:

    debt-deflation rep­re­sented no more than a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors). Absent implau­si­bly large dif­fer­ences in mar­ginal spend­ing propen­si­ties among the groups … pure redis­tri­b­u­tions should have no sig­nif­i­cant macro­eco­nomic effects.”

    So, a busi­ness buys back its bonds, pay­ing off bond-holders, who then go golf­ing, and eat out at expen­sive restau­rants. When NON-BANK debt is repaid, money merely changes hands. The kind of spend­ing may change (busi­ness invest­ment to per­sonal con­sump­tion), but not the degree.

    But when BANK debt is repaid, the money “van­ishes”. Bank accoun­tants simul­ta­ne­ously co-cancel the loan, and the money (bank deposit) used to pay off the loan. The money sup­ply con­tracts. And “dis­ap­peared” money has ZERO propen­sity to be spent. Once the money is elim­i­nated, it can no longer change hands, and stim­u­late a series of spend­ings in the economy.

    So, BANK debt is dif­fer­ent from NON-BANK debt. Irv­ing Fisher’s crit­ics were cor­rect, about the lat­ter. But debt DEFLATION, from pay­ing back banks, and so con­tract­ing the money sup­ply, does not trans­fer money, but elim­i­nates money. Elim­i­nated money can­not be spent; its “propen­sity to be spent” is zero. That rep­re­sents a “sur­pris­ingly large” dif­fer­ence in spend­ing propen­sity, between debtors (e.g. mort­gaged home-owners, bor­row­ing money) and cred­i­tors (banks, trim­ming down their bal­ance sheets, elim­i­nat­ing money).

    So, every­body was always (par­tially) cor­rect. Debt reduc­tion is cru­cial to under­stand­ing depres­sions. And (per­haps) espe­cially BANK DEBT REDUCTION.

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