[Marxism] Another 1937?

Louis Proyect lnp3 at panix.com
Fri Aug 12 11:10:36 MDT 2011

NY Times August 12, 2011
Aftershock to Economy Has a Precedent That Holds Lessons

Like earthquakes, financial crises seem to be accompanied by 
aftershocks, like the one we’ve been living through this week. 
They can feel every bit as bad as the crisis itself. But economic 
history and academic research suggest they can set the stage for a 
sustainable recovery — and eventual sharp stock market gains.

  The events of the last few weeks — gridlock in Washington, 
brinksmanship over raising the debt ceiling, Standard & Poor’s 
downgrade of long-term Treasuries, renewed fears about European 
debt and a dizzying plunge in the stock market — bear an 
intriguing resemblance to some of the events of 1937-38, the 
so-called recession within the Depression, with a major caveat: it 
was a lot worse back then. The Dow Jones industrial average 
dropped 49 percent from its peak in 1937. Manufacturing output 
fell by 37 percent, a steeper decline than in 1929-33. 
Unemployment, which had been slowly declining, to 14 percent from 
25 percent, surged to 19 percent. Price declines led to deflation.

  “The parallels to what is happening now are very strong,” Robert 
McElvaine, author of “The Great Depression: America, 1929-1941” 
and a professor of history at Millsaps College, said this week. 
Then as now, policy makers were struggling with how and when to 
turn off the fiscal stimulus and monetary easing that had been 
used to combat the initial crisis.

Are we at similar risk today? David Bianco, chief investment 
strategist for Merrill Lynch Bank of America, told me this week 
that “the market is collapsing faster than any fundamentals would 
warrant.” The possibility that the United States faces a recession 
as bad as 1937’s seems far-fetched. Nonetheless, the risk of 
another recession has soared, by Mr. Bianco’s estimate, to an 80 
percent probability, one that would be worse than the 1991 
recession. He noted that there had been only three instances when 
such a steep market decline was not followed by recession: 1966, 
1987 (after the October stock market crash) and 1998 (after the 
implosion of Long Term Capital Management.) “Confidence is shaken 
and rapidly falling,” he said, a problem worsened by falling stock 

By 1937 an economic recovery seemed to be in full swing, giving 
policy makers every reason to believe the economy was strong 
enough to withdraw government stimulus. Growth from 1933 to 1936 
averaged a booming 9 percent a year (rivaling modern-day China’s), 
albeit from a very low base. The federal debt had swelled to 40 
percent of gross domestic product in 1936 (from 16 percent in 
1929.). Faced with strident calls from both Republicans and 
members of his own party to balance the federal budget, President 
Franklin D. Roosevelt and Congress raised income taxes, levied a 
Social Security tax (which preceded by several years any payments 
of benefits) and slashed federal spending in an effort to balance 
the federal budget. Income-tax revenue grew by 66 percent between 
1936 and 1937 and the marginal tax rate on incomes over $4,000 
nearly doubled, to 11.6 percent from an average marginal rate of 
6.4 percent. (The marginal tax rate on the rich — those making 
over $1 million — went to 75 percent, from 59 percent.)

The Federal Reserve did its part to throw the economy back into 
recession by tightening credit. Wholesale prices were rising in 
1936, setting off inflation fears. There was concern that the 
Fed’s accommodative monetary policies of the 1920s had led to 
asset speculation that precipitated the 1929 crash and ensuing 
Depression. The Fed responded by increasing banks’ reserve 
requirements in several stages, leading to a drop in the money supply.

The possible causes of the ensuing stock market plunge and steep 
contraction in the economy provide fodder for just about everyone 
in the current political debate. Republicans can point to the 
Roosevelt tax increases. Democrats have the spending reductions, 
which coincides with Mr. McElvaine’s view. “It appears clear to me 
that the cause was policies put into effect in 1936-37, mainly 
cutting spending when F.D.R. believed his re-election was 
secured,” he said.

The Nobel-prize winning economist Milton Friedman blamed the Fed 
and the contraction in the money supply in his epic “Monetary 
History of the U.S.” And the stock market itself may have been a 
culprit, falling so steeply that it wiped out the wealth effect of 
rising prices, undermined confidence and brought back painful 
memories of the crash. But taken together, they suggest that 
policy makers moved too quickly to withdraw government support for 
the economy.

In the current context, it’s hard to blame the Fed for being too 
restrictive in its monetary policy, as the Fed was in 1937. If 
anything, critics fault it for being too accommodating, raising 
many of the same issues that led the Fed to tighten in 1937. Ben 
S. Bernanke, the Fed chairman, is a student of Depression history 
and is well aware of Mr. Friedman’s monetary analysis. “He won’t 
make the same mistake,” Jeremy Siegel, professor of finance at the 
Wharton School of the University of Pennsylvania, said.

The Fed’s pledge this week to keep interest rates near zero not 
just for a vague “extended period” but for a full two years 
rendered two-year Treasuries virtually risk-free and depressed 
their yields to a record low of 0.19 percent. This should lead 
investors to seek income from riskier assets, leading to lower 
interest rates across the spectrum, including mortgage rates.

Despite a brief stock market rally after the Fed’s announcement, 
Mr. Bianco said he believed investors might be underestimating the 
significance of the Fed’s move. “You will see household funding 
costs go down. That will be a benefit and should boost 
confidence.” At the least, “The Fed has not abandoned us. They’re 
doing what they can,” he said.

But monetary policy can only do so much, especially if fiscal 
policy is moving in the opposite direction.

Christina Romer, a professor at the University of California, 
Berkeley, who has written extensively about the Great Depression, 
declared two years ago while chairman of President Obama’s Council 
of Economic Advisors: “The urge to declare victory and get back to 
normal after an economic crisis is strong. That urge needs to be 

Yet both political parties have strapped themselves to the mast of 
deficit reduction, one through spending cuts, the other tax 
increases. The recent market plunge may reflect not the largely 
symbolic S.& P. downgrade of United States Treasuries or worries 
about political gridlock, but widespread investor fears that both 
approaches risk a renewed recession by withdrawing stimulus from a 
fragile economy too soon. No one seriously disagrees that the 
budget deficit has to be addressed, either through spending cuts 
or tax increases or in some combination of the two. The question 
is when.

The good news about the 1937-38 recession, severe though it was, 
is that it lasted just a year, from May 1937 to June 1938 by most 
calculations. The precipitous 1937 stock market decline and 
surging unemployment jolted Washington into action. The Fed 
reversed its higher bank reserves policy and cut the discount rate 
to 1 percent. In April, President Roosevelt announced a $2 billion 
“spend-lend” program and embraced deficit spending. But the tax 
increases remained in effect. Economic growth resumed in June 1938 
and was stronger than it had been in the 1933-37 period. Stock 
prices surged.

Of course, history never repeats itself exactly, and unfortunately 
for today’s policy makers, the causes of the 1938 economic rebound 
seem less clear than the causes of the recession. While Keynesians 
have embraced the Roosevelt stimulus package to support their 
arguments for government intervention, others argue it came too 
late and was too small to account for the recovery. A Federal 
Reserve Bank of Chicago senior economist, François Velde, 
concluded that while traditional monetary and fiscal analyses 
tended to account for the severity of the 1937 downturn, other 
still-unidentified factors are needed to explain why the economy 
“rebounded so strongly.”

Still, the sense that Washington was doing something to address 
the problems may have played a key role by bolstering confidence, 
which was reinforced by rising stock prices.

Historians can’t know if the 1938 recovery, strong as it was, 
would have been enough to finally end the Great Depression. World 
War II intervened. But nothing today seems nearly as dire as the 
problems facing the world in 1938. The 1937 aftershocks had the 
effect of galvanizing policy makers who had grown complacent about 
the recovery. The result was renewed economic growth, higher 
employment, higher wages and productivity — and higher stock 
prices. Investors who had the courage to buy stocks at their 1937 
lows were looking at a 60 percent gain less than a year later.

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