As I’ve written before, it is widely acknowledged that the economic health of the United States is a major national security concern. For one, last year Dennis Blair, Director of National Intelligence declared that the economic crisis had become the U.S.’s “primary near-term security concern.” I decided to read John Kenneth Galbraith’s The Great Crash 1929 to see what lessons can be gleaned from history. Why did the stock market crash of 1929 occur? Who was responsible? Unfortunately, as I suppose is characteristic of economics, the search for answers leads us down a landslide of uncertainties.
As Galbraith writes, the crash “was implicit in the speculation that went before.” So what caused the speculative bubble whose rupture by 1929 had become inevitable? Can we blame the Federal Reserve? They cut the rediscount rate in 1927 from 4 to 3.5 percent, but as Galbraith notes, “[t]here were times before and there have been long periods since when credit was plentiful and cheap – far cheaper than in 1927-29 – and when speculation was negligible.” Can we blame President Coolidge? Possibly. Galbraith writes that Coolidge genuinely did not perceive a problem, but even if he did, he believed dealing with speculative bubbles to be the Federal Reserve’s job. Can we blame Hoover? After all, Hoover was Coolidge’s Secretary of Commerce. Apparently, though, Hoover was deeply worried about the speculative bubble. Under Coolidge, Galbraith writes, Hoover “had sought nothing so much as to get the market under control,” though Galbraith doesn’t elaborate on Hoover’s proposed solutions, nor does he explain why Hoover did not successfully implement them once he assumed the presidency.
So we don’t really know what led to the bubble, but what should have been done once it got going? Here, Galbraith seems to lay responsibility at the feet of the Federal Reserve. The Fed’s options were limited. Raising the rediscount rate would have done no good, Galbraith notes, because returns on speculative investments were so enormous that even high interest rates wouldn’t discourage speculators. Selling all of its $228 million in government securities “might possibly have had some effect” by taking money out of the market, but this move would have been drastic and came with various side effects. But Galbraith argues that “the Federal Reserve was helpless only because it wanted to be.” He continues:
Had it been determined to do something, it could for example have asked Congress for authority to halt trading on margin by granting the Board the power to set margin requirements. Margins were not low in 1929; a residue of caution had caused most brokers to require customers to put up in cash 45 to 50 per cent of the value of the stocks they were buying. However, this was all the cash numerous of their customers had. An increase in the margins to, say, 75 per cent in January 1929, or even a serious proposal to do so, would have caused many small speculators and quite a few big ones to sell. The boom would have come to a sudden and perhaps spectacular end.
But this drastic measure was actually unnecessary because:
…a robust denunciation of speculators and speculation by someone in high authority and a warning that the market was too high would almost certainly have broken the spell. It would have brought some people back from the world of make-believe. Those who were planning to stay in the market as long as possible but still get out (or go short) in time would have got out or gone short.
But the Fed did not want to be blamed for busting the bubble, so it took some comparatively milder measures. It raised the rediscount rate from 5 to 6 per cent in early 1929 and sold some government securities throughout the first half of the year but then stopped. It also declared that it would not lend money to be used in speculation, though this still allowed speculation to continue. Galbraith demonstrates that the Fed’s fear was not irrational. There were a lot of Peter Schiffs in 1929…
…and the treatment of the 1929 Peter Schiffs very much resembled the treatment of the actual Peter Schiff in 2006. They were derided. And the problem of booms is this:
Booms, it must be noted, are not stopped until after they have started. And after they have started the action will always look, as it did to the frightened men in the Federal Reserve Board in February 1929, like a decision in favor of immediate as against ultimate death. As we have seen, the immediate death not only has the disadvantage of being immediate but of identifying the executioner.
So the main lesson that can be gleaned is that no one will want to claim responsibility for ending a speculative bubble out of fear of invoking adverse political consequences. Even the Fed, in theory shielded from the vicissitudes of political will, is not immune to this anxiety.
