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Wednesday, April 18, 2012

The crash of 29

The Crash of 1929
The history of the slump begins about 1927 when France stabilized the franc de facto at a level at which it was devalued and undervalued.
This led to a great demand for francs. The Bank of France sold francs in return for foreign exchange.
The francs were created as credit in France, thus giving an inflationary effect which can be seen in the behavior of French prices in 1926-1928.
By 1928 the Bank of France found that it held foreign exchange to the value of 32 billion francs(about $1.2 billion).
At this point the Bank of France began to transfer its exchange holdings into gold, buying the metal chiefly in London and New York.
To prevent the resulting outflow of gold from having a deflationary effect which might injure business, the New York Federal Reserve Bank dropped its discount rate from 4 percent to 3 ½ percent.
When the French gold purchases became noticeable in 1928, the Federal Reserve Bank adopted open market operations to counterbalance them, buying securities to a value equal to the French purchases of gold.
As a result there was no reduction in money in the United States. This money,however, was going increasingly into stock-market speculation rather than into production of real wealth.
Credit Was Diverted from Production to Speculation
Increasing amounts of funds were being drained from the economic system into the stock market, where they circulated around and around, building up the prices of securities.
In other countries, funds tended to flow to the United States where they could expect to roll up extraordinary earnings in capital gains in a relatively short time.
This was especially true of funds from Britain where the stock-market boom ceased after the end of 1928. By that time the fundamentally unsound economic conditions were beginning to break through the facade.
The decline in foreign loans by both London and New York began to be noticeable by the last half of 1928 and made it evident that the chief support of the facade was vanishing.
But the continued rise of security prices in New York continued to draw money from the rest of the world and from the productive and consumptive systems of the United States itself.
This resulted in A Financial Disaster of Unparalleled Magnitude.

In April 1929, the Federal Reserve authorities called upon the member banks to reduce their loans on stock-exchange collateral.
At the same time, it engaged in open-market operations which reduced its holdings of bankers' acceptances from about $300 million to about $150 million. The sterilization of gold was made more drastic.
It was hoped in this way to reduce the amount of credit available for speculation.
Instead, the available credit went more and more to speculation and decreasingly to productive business.
In August, the Federal Reserve discount rate was raised to 6 percent.
By this time it was becoming evident that the prices of stocks were far above any value based on earning power and that this earning power was beginning to decline because of the weakening of industrial activity.
At this critical moment, on September 26, 1929, a minor financial panic in London caused the Bank of England to raise its bank rate from 4 ½ percent to 6 ½ percent.
This was enough.
British funds began to leave Wall Street, and the overinflated market commenced to sag. By the middle of October, the fall had become a panic.
The stock-market crash reduced the volume of foreign lending from the United States to Europe, and these two events together tore away the facade which until then had concealed the fundamental maladjustments between production and consumption, between debts and ability to pay, between creditors and willingness to receive goods.
Not only were these maladjustments revealed but they began to be readjusted with a severity of degree and speed made all the worse by the fact that the adjustments had been so long delayed.
Production began to fall to the level of consumption, creating idle men, idle factories, idle money, and idle resources.
Debtors were called to account and found deficient.
Creditors who had refused repayment now sought it, but in vain. All values of real wealth shrank drastically.
Not only were these
maladjustments revealed but they began to be readjusted with a severity of degree and
speed made all the worse by the fact that the adjustments had been so long delayed.
Production began to fall to the level of consumption, creating idle men, idle factories, idle
money, and idle resources. Debtors were called to account and found deficient. Creditors
who had refused repayment now sought it, but in vain. All values of real wealth shrank
drastically.
The financial and banking crisis began in central Europe early in 1931, reached London by the end of that year, spread to the United States and France in 1932, bringing the United States to the acute stage in 1933, and France in 1934.
Results:
The British Suspension of Gold (by necessity, not by choice.)
As a result of the British abandonment of the gold standard the central core of the world's financial system was disrupted.
Thus the world tended to divide into two financial groups—the sterling bloc organized bout Britain and the gold bloc organized about the United States, France, Belgium, the etherlands, and Switzerland.
Te countries still on gold began to adopt new trade barriers, such as
tariffs and quotas, to prevent Britain from using the advantage of epreciated currency to icrease her exports to them.
The depreciation of sterling did result in an improvement in the foreign trade alance, exports rising very slightly and imports falling 12 percent in 1932 in comparison ith 1931.
This led to a revival of confidence in sterling and a simultaneous decline in The depreciation of sterling did result in an improvement in the foreign trade
balance, exports rising very slightly and imports falling 12 percent in 1932 in comparison
with 1931. This led to a revival of confidence in sterling and a simultaneous decline in confidence in The depreciation of sterling did result in an improvement in the foreign trade
balance, exports rising very slightly and imports falling 12 percent in 1932 in comparison
with 1931. This led to a revival of confidence in sterling and a simultaneous decline in confidence in the gold-standard currencies. Foreign funds began to flow to London.

The flow of capital into Britain early in 1932 resulted in an appreciation of sterling in respect to the gold currencies. This was unwelcome to the British government since it would destroy her newly acquired trade advantage.
Control of the credit structure was left to the Bank of England, while control of the exchanges went to the Exchange Equalization Fund.
This made it possible for Britain to adopt a policy of easy and plentiful credit within the country without being deterred by a flight of capital from the country.
The easy credit policies of Britain (designed to encourage business activity) had thus to be combined with deflationary prices (designed to prevent any powerful flight of capital).
The bank rate was dropped to 2 percent by July 1932, and an embargo was placed on new foreign capital issues to keep this easy money at home.
Cheap credit permitted a shift of economic activity from the old lines (like coal, steel, textiles) to new lines (like chemicals, motors, electrical products).
The tariff permitted a rapid growth of cartels and monopolies whose process of creation provided at least a temporary revival of economic activity.
The improvement in Britain was not shared by the countries still on gold. As a result of the competition of depreciated sterling, they found their balances of trade pushed toward the unfavorable side and their deflation in prices increased.
Tariffs had to be raised, quotas and exchange controls set up.

Taken from Tragedy and Hope Carrol Quigley
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