Remembering 1937

When the “Great Recession” hit, many comparisons were made with the “Great Depression” (see Eichengreen and O´Rourke Vox columns which according to the editor shattered all Vox readership records with over 450,000 views). Eight years after the 2007 peak, now there are “reminders” of 1937, also eight years after the 1929 peak!

Robert Samuelson has a piece:

How fast should the Federal Reserve tighten monetary policy? Should it tighten at all? I recently wrote about these issues but didn’t have the space to explore a fascinating aspect of the debate: the mostly forgotten 1937-38 recession. To many, it’s a cautionary tale against adopting tighter policies too soon. The latest to sound the alarm is Ray Dalio, the respected founder of Bridgewater Associates, a huge hedge fund group. His recent memo to clients inspired a Page 1 story in the Financial Times, headlined “Dalio warns Fed of 1937-style rate risk.”

And goes on to discuss what may have “caused” that event. The “best” candidate:

A final explanation involves gold. Since 1934, the United States had been receiving large gold inflows — reflecting fears of political instability or war in Europe — that stimulated economic expansion. The reason was simple. When the gold arrived here, it had to be sold to the government for dollars. Those dollars were then spent or lent, giving the economy a boost. But in late 1936, the Treasury — again, to quash incipient inflation — decided to offset this boost by draining money from the economy. In economic jargon, the gold flows were “sterilized.”

This turned out to be a massive miscalculation. The sterilization created a “pronounced monetary shock,” argues a paper by Dartmouth economist Douglas Irwin. Growth in the money supply, which had been rapid, halted. Stock prices fell, and interest rates rose. After the Treasury reversed its policy on sterilization in 1938, the economy recovered.

A nominal visual of the period following the Depression trough in March 1933:

1937_1

1937_2

1937_3

1937_4

Footnote: Orphanides has an enlightening article on the Fed during the Great Depression. Following the downturn in 1937 we read:

Though the extent of the sharp decline in activity was not immediately evident, by Fall it became fully clear to the Committee that the economy was thrown back to a severe recession, once again.

The following evaluation of the situation by (John) Williams at the November 1937 meeting is informative, both for offering a frank admission that the FOMC apparently wished for a slowdown to occur and also for outlining the case that the recession, nonetheless, had nothing to do with the monetary tightening that preceded it.

Particularly enlightening is the reasoning offered by Williams as to why a reversal of the earlier tightening action would be ill advised. We all know how it developed. There was a feeling last spring that things were going pretty fast … we had about six months of incipient boom conditions with rapid rise of prices, price and wage spirals and forward buying and you will recall that last spring there were dangers of a run-away situation which would bring the recovery prematurely to a close. We all felt, as a result of that, that some recession was desirable … We have had continued ease of money all through the depression. We have never had a recovery like that. It follows from that that we can’t count upon a policy of monetary ease as a major corrective. …[Doesn´t that sound familiar?]

In response to an inquiry by Mr. Davis as to how the increase in reserve requirements has been in the picture, Mr. Williams stated that it was not the cause but rather the occasion for the change. … It is a coincidence in time. …

If action is taken now it will be rationalized that, in the event of recovery, the action was what was needed and the System was the cause of the downturn. It makes a bad record and confused thinking. I am convinced that the thing is primarily non-monetary and I would like to see it through on that ground. There is no good reason now for a major depression and that being the case there is a good chance of a non-monetary program working out and I would rather not muddy the record with action that might be misinterpreted. (FOMC Meeting, November 29, 1937. Transcript of notes taken on the statement by Mr. Williams.)

Coincidentally, at present there´s also a John Williams at the FOMC!

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