I would like to do a longer post on this at some point, but would like to make just a quick observation on how I have found it useful to think about developments from 1929 onwards.
America has been blessed as a nation, and one can find most things one needs within the country. For many Americans, what happens abroad is simply of little relevance. This has tended for many years to shape the culture, such that there is a general neglect – even at the highest levels – of the influence of international developments in shaping events at home. The narrative of the 1930s depression in the US has tended in cartoonish form to link the stock market boom of the 20s to the depression that followed, and the depression is often thought to have been both caused and triggered by the stock market crash of 1929.
Scott Sumner, a man who, for both good and ill, is very much a product of his era, succumbs to this narrative. Because there seemed to be no apparent immediate real economy effect of the 1929 stock market crash, he denies that there was any financial market crisis until 1931, when there was a wave of US bank runs that had severe contractionary effects on the real economy. This fits nicely into the narrative he wants to paint, which is that depressions and downturns are caused entirely by overly tight monetary policy during the bust (and not at all by fundamental misalignments induced by prior overly easy monetary policy during the boom). He is a man of his era, because this stripping of context, and wanting to view events as being the linear product of direct causes is very much a feature of left hemisphere consciousness (as described by Iain McGilchrist). He actually goes on to accuse all previous authors of having misunderstood the situation, accusing editors of neglect of their duties in allowing such sloppiness to pass by unchecked. Such an absence of humility is quite a sight to behold!
Unfortunately for him and – given the likely appeal of his kind of thinking to a broader audience – for us, he is very much mistaken. It simply isn’t right to look only at the US equity market when, as Martin Armstrong points out, the bond market was very much bigger and the great preponderance of issuers went on to default, in one way or other. October 1929 was when the Bank Austria (central bank) cut off discount window financing to the BodenKreditAnstalt and forced it to merge with Credit-Anstalt. It was the failure of the new entity that was to kick off the acute phase of the crisis in 1931. So there is a direct continuity between the events of 1931 and those of late 1929.
I reproduce a couple of comments I made to his blog here. He does not really respond to these.
Scott Sumner – the bond market in the late 20s was bigger than the stock market, and almost every sovereign issuer ended up defaulting. The private sector didn’t fare so well either. So you might want to look at credit spreads rather than equity prices. Obviously if the market is closed to new issuance and to refinancings, that starts to become a problem some time before the situation gets bad enough to reach the stage of bank runs.
One should also consider the international aspect, since Europe was in many ways the epicentre of the crisis. The BodenKreditAnstalt had trouble financing itself as early as October 1929 when the Bank Austria (central bank) closed the discount window. The forced merger with Credit-Anstalt created the new entity that was to kick off the acute phase of the crisis in 1931.
So I do not understand why you write with such certainty that there was no crisis until 1931. The fire ignited in 1929 but was not noticed till some time later.
To say there was no crisis in the US in 1929 is like saying there was no peripheral crisis in Europe in 2007. The whole thing was one rotten episode that took its time to spread. But in 2008 it was inevitable that the recognition of trouble in the US would inevitably lead to recognition of underlying problems down the line in Europe, no matter how aggressively the ECB eased. The problem wasn’t that the ECB tightened too much, and didn’t ease enough. The problem was that trusting German Landesbankers had lent money at stupidly low interest rates to countries that didn’t make good use of the money nor have an alternative financing source when the Germans awoke. All the liquidity in the world isn’t going to make that problem go away.
The 1987 equity market crash was in part a recognition of trouble that had been brewing in the bond market since the beginning of the year. This being said, the credit market stayed open. That is really the key point, and the reason why 1931 should be seen as part of the same episode that began in 1929, just as the European peripheral crisis of 2011 should be seen as having begun in 2007-2008.
It is astonishing that somebody can speak of linkages between financial markets and the real economy without giving any evidence of understanding the tremendous importance of the credit markets.
28. March 2012 at 17:19
Dr Sumner – why do you plot the stock market when it is the credit market that matters for assessing whether there is a fincancial crisis or not, and the credit market was larger than the stock market?
The European credit market was where the crisis began.
You don’t consider the inability of the BodenKreditAnstalt to finance itself the beginning of the crisis? Why not?
28. March 2012 at 17:21
Dr Sumner would you care to enumerate in history those instances that saw the bursting of a bubble in the credit market where the central bank acted sufficiently fast and vigorously that everything worked out fine and there was not hell to pay?