Bubbles, Smoot-Hawley and the Great Crash Jude Wanniski August 13, 2005

From:Jude Wanniski jwanniski@polyconomics.com
To: James K. Galbraith <galbraith@* * * * *.edu>
Re: Bubbles, Smoot-Hawley and the Great Crash
10 am 8/13/05

Of course, when S-H took effect (and even before), there had to be a sharp decline in the demand for liquidity. The Fed would have been obliged to sell bonds to mop up the surplus, to keep gold at $20.67 oz. In 1930, the stock market had only declined by a third, from 360 to 220 or so. It was the  foreign retaliation that chipped away at equities, then the Hoover tax increase of 1931-32 that sent the DJIA to 41. The banking crisis occurred, of course, because these destructive policies -- supported by the AFL throughout, caused the need for one-third less liquidity and a lot fewer banks. Friedman insisted the Depression could have been avoided if the Fed had simply inflated the money supply, but it could not do that because of the gold standard. In any case, it would only have aggravated the core problem by inducing a Great Stagflation. When FDR raised the gold price to $35 from $20.67, remember, the Depression only deepened, although the general price level began to rise. The DJIA also came off its lows, but some of that was because of the nominal increase in prices due to the dollar devaluation.

JW

At 10:32 AM 8/13/2005, you wrote:

The effect of Smoot-Hawley on the banking crisis is very specific, and quite different from the very general (and, in any case, largely wrong- footed) claim that economists have made about the effect of protection per se on the Depression.

You can easily accommodate almost every house under the current estate tax ceilings; the few which cannot be accommodated (like the one I grew up in, incidentally) should be turned into community colleges, museums and nursing homes anyway.

Jamie

I'm getting e-mail from people who say they wish there was a housing bubble, because they are making good money and can't afford a decent house.  We should eliminate the estate tax so they can inherit their daddy's house without having to give most of it to the government.

8/13/05 8:59 am

Hello again Jamie...

I don't know of any monetarists who say the Crash was due to the Fed. I think Milton saw it as a bubble. At any rate, he does not believe markets are always rational. It is the Austrian, Rothbardian school that says the Crash was due to the Fed's excessive creation of money in the 1920s, which Rothbard described as an inflationary era, even though price indices were flat or falling throughout. The only way you and JKG can ignore my hypothesis is by pretending it didn't happen as I documented it in Chapter VII. And of course all economists that I know of accept the idea that S-H "contributed" to the Great Depression after it was signed into law in June 1930. They also pretend the Senate's switch in October 1929 from opposition to support had nothing to do with the Crash.

I'm getting e-mail from people who say they wish there was a housing bubble, because they are making good money and can't afford a decent house.  We should eliminate the estate tax so they can inherit their daddy's house without having to give most of it to the government.

JW

At 12:29 AM 8/13/2005, you wrote:

Jude,

Three quick points on your latest, not necessarily of great import.

1)The economics profession has surely not uniformly accepted JKG's view of the 1929 crash as a bubble.  Monetarists blame the crash on the Fed (as always), Eichengreen looks for the cause in the international monetary environment; others (Temin, I believe, is in this camp, though I don't have the articles in front of me) look for it in alleged weaknesses in real demand in the summer of 1929. It's true that bubble theories have become more respectable to neoclassicals in recent years than they were, say, in 1980. But I'm not aware of a general consensus that credits JKG, certainly not in those quarters.

2) While neither JKG nor I buy into your claim that the news of Smoot- Hawley's progress precipitated the crash itself in 1929,  JKG's Great Crash does give S-H an important role in the subsequent banking crisis of 1930. The banks were heavily exposed to Latin America, the passage of S-H cut off the export earnings of the Latin countries, and they responded by defaulting on their debts.

3) That said, I'm also a housing bubble skeptic -- unless Greenspan crashes the sector with high interest rates, as you say.  A bubble in commercial real estate is a real problem, for it leads to a long-lasting overhang of excess inventory in empty office buildings -- very hard to get rid of, and a major obstacle to new construction.  But residential housing markets tend to adjust; if any housing gets abandoned in the end, it tends to be the crummy stuff at the bottom of the pyramid.

In the meanwhile, if values fall, people don't abandon their homes; the main consequence will be that  households will simply hold off on adding new equity loans, which they use to finance purchases of other kinds. You could a recession that way, but it would fairly easy to counter it with an expansionary fiscal policy.

I read you on Iran especially these days with keen interest.

Jamie