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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  • Erik Nel­son

    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) ?

  • Erik Nel­son

    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.

  • Erik Nel­son

    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).

  • Erik Nel­son

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

  • Erik Nel­son

    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).

  • Erik Nel­son

    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:

  • Erik Nel­son

    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.

  • Erik Nel­son

    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


  • Erik Nel­son

    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:

  • Erik Nel­son

    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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  • Erik Nel­son

    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.

  • Erik Nel­son

    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 ?

  • Erik Nel­son

    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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