The Global Impact of the Great Depression 1929-1939

Dietmar Rothermund

• Publisher: Routledge
• Year: 2002
• ISBN:
  9781134815678
• Edition: 1
• Topic: History
• Subtopic: World History
• Index: History

This study broadens the conventional focus of the Great Depression to include its impact on the countries of Africa, Asia and Latin America. It covers the economic background and causes, from the international gold standard to agricultural over-production in the US. Other areas discussed include: the impact on the peasantry in developing countries; the political consequences, such as fascism in Europe; and the aftermath and the re-alignment of America, Europe and its colonies. Key areas, such as Keynesian theory, are explained in accessible terms.

1
INTRODUCTION
Economics and the depression

THE DEPRESSION AS A CHALLENGE TO ECONOMIC DOCTRINE

The Great Depression continues to be a challenge to economic doctrine which is based on the assumption of an equilibrium produced by the uninhibited working of market forces. There may be periodical deviations from such an equilibrium, but it will always be restored after a period of time. The projection of business cycles fits into such a general theory of an economic equilibrium as it postulates a regular sequence of upswings and downturns. Many attempts have been made to fit the Great Depression into such a regular pattern, but its impact was so sharp and unprecedented that it cannot be explained in this way. It seems that it was a unique event and such events can only be explained historically as they defy the laws of economics. Thus economists should have returned to ‘business as usual’, relegating the depression to the dustbin of history. But they continue to be fascinated by it and it has given rise to new departures in the field of economic theory.

First of all the depression has generated an abiding interest in theories concerning money and credit which had earlier played only a marginal role in economic thought. Economists used to concentrate on the exchange of goods, the laws of supply and demand, etc. In this sphere money was presumed to play a neutral role, it was a mere medium of exchange which could not affect the ‘real economy’ in a substantial way. But the depression upset many assumptions concerning the working of market forces in the ‘real economy’. Credit was suddenly contracted, prices fell to such an extent that the law of supply and demand seemed to be irrelevant, the international exchange of goods dwindled and many nations returned to the policy prescriptions of the mercantilists who had interpreted trade as a zero sum game in which gains in one place must invariably lead to losses elsewhere. The liberal theory of free trade as an engine of universal growth seemed to be discredited. The beneficial operations of the ‘invisible hand’ of market forces had obviously been upset by an arbitrary intervention of other forces. The credit system and monetary forces were obviously at fault, but it was not easy to arrive at new theories which would attribute an independent role to such forces, which had been regarded as dependent variables of economic activity.

Monetarism took a long time to come into its own. It attributes a dominant role to the steadiness of money supply in the field of economic growth and deprecates the knee jerk reactions of monetary authorities which may precipitate a downturn by restricting money supply, and unnecessarily fuel an upswing by a policy of easy money. The monetarists explained the causes of the Great Depression by fixing the blame for such knee jerk reactions on the Federal Reserve Board of the United States. This was certainly an important element among the causes of the depression. However, the focus on the Federal Reserve Board was somewhat myopic. In recent years the problems of the international gold standard have attracted attention and their analysis has given more depth and substance to the monetarist explanation of the depression. This will be discussed in detail in the next chapter.

In terms of economic theory monetarism is an attempt at rescuing the old doctrine of economic equilibrium by making money supply the independent variable which determines the working of the ‘real economy’. But whereas in the ‘real economy’ the forces of the market are supposed to generate equilibrium by themselves, in the monetary sphere equilibrium has to be induced by the careful working of the monetary authorities. While it owed a great deal to the test case of the Great Depression, monetarism would have been of no use in prescribing a cure for a world in depression, because it stresses the long term steadiness of money supply rather than short term interventions. It could only provide recommendations for a recovery in the long run. In this way it has triumphed in recent years after the lessons which J.M.Keynes derived from the depression have been largely discredited. But later generations of economists have been unfair to this great heretic who derived a theory of economic disequilibrium from his experience of the Great Depression. His critics took issue with his time bound policy prescriptions, his later admirers did even more harm to him by trying to reinterpret his theory so as to fit it into the mainstream of the doctrine of economic equilibrium. Since his work has left a deep imprint on the interpretation of the Great Depression a brief sketch of the development of his theory will be provided here. This sketch also serves as a survey of the terminology which the reader will encounter in subsequent chapters.

KEYNES AND THE THEORY OF ECONOMIC DISEQUILIBRIUM

Keynes was mainly interested in monetary theory and he had worked in this field long before he encountered the Great Depression. He noticed the deep gap between the theory of the exchange of goods and monetary theory and made a lasting contribution to economics by introducing central issues discussed in the first field to the discourse of monetary economics. Monetary theory had so far concentrated on the quantity of money and the velocity of its circulation and its impact on prices. Elasticities of supply and demand which were discussed with regard to the exchange of goods were not even mentioned in monetary theory as they were considered to be irrelevant in this sphere. Pre-Keynesian monetary theory was also wedded to a rather mechanical doctrine of equilibrium and to the basic assumption of the neutrality of money as a medium of exchange. The great insight of Keynes, that money links the present with the future and is therefore linked to all elements of uncertainty which beset predictions of the future course of events, was of no concern to earlier monetary theorists.

In his early works on monetary theory Keynes did not question neoclassical doctrine and the quantity theory of money. But he was already grappling with the phenomenon of ‘liquidity preference’, i.e. the propensity to hold on to money rather than to invest it or to spend it on goods and services. He had come across this phenomenon in his work on Indian Currency and Finance (1913) where he referred to liquidity preference as a strong passion of the Indian people which was detrimental to the creation of real wealth. But this work was dedicated to the advocacy of a gold exchange standard for India, i.e. a standard based on gold but without the circulation of gold coins. The reference to Indian ‘liquidity preference’ was an ancillary argument in this context; it was not yet a major issue for Keynes.

In his work A Treatise on Money he discussed liquidity preference in detail, but he was not quite satisfied with his conclusions and moved towards a closer integration of monetary theory with other fields of economic theory. The experience of the depression influenced the development of his thought at that time. In 1932 he suddenly changed the title of his lecture course at Cambridge from ‘A Pure Theory of Money’ to ‘A Theory of Money and Production’. In this context liquidity preference acquired a new meaning: it referred to the speculative demand for money as an element of instability of financial markets due to the uncertain character of expectations about the future level of the interest rate. Such speculative demand could upset the economy and called for active intervention of the monetary authorities. Keynes highlighted the potential of disruptive activities as well as the necessity of countervailing measures. In his General Theory of Employment, Interest and Money he presented his conclusions in a provocative manner. He deliberately emphasised those points which had been neglected by the prevailing economic doctrine. The theory of the exchange of goods had been dominated by supply-side economics, whereas he stressed the crucial importance of demand. In monetary theory, which was characterised by demand-side economics, he pointed to speculative liquidity preference which determined the supply of funds available for investment and expenditure on goods and services. In discussing liquidity preference in this way he introduced the discourse concerning the elasticities of supply and demand into monetary theory.

Neoclassical theory on the exchange of goods had been based on the assumption that supply would always create a corresponding demand because there would always be a clearing of the market. Inelasticies of supply and demand were marginal phenomena: an oversupply of goods may not be cleared even at a very low price and some goods could not be provided even at a much higher price. The labour market was seen as an analogy to the market for goods. All labour offered in the market would find employment, though perhaps at a low wage; involuntary unemployment was therefore inconceivable. Inelasticities of supply and demand in the labour market or in the money market were not taken into consideration. Just as labour would find employment, income had either to be saved, and thus available for investment, or it would be spent on goods and services. Hoarding of money was, of course, known to economists but they thought of it as a kind of marginal friction just as there may be frictions in the labour market when labour set free in one place would take time to shift to new employment elsewhere.

In keeping with these assumptions the universal prescription of employers under the impact of the depression was a lowering of wages, which had become sticky. Actually, during the depression nominal wages proved to be very sticky indeed, and real wages increased because prices fell. Thus the complaint of the employers seemed to have some substance. Keynes held against this that the lowering of wages would only reduce the demand for goods and services and the money saved by employers after a reduction of wages would not necessarily be available for investment due to their liquidity preference which was bound to be particularly strong in a depression. According to these basic assumptions the interest rate which had so far been considered to be the price of money determined by the demand for it was to Keynes rather the premium to be paid to the holder of money so as to entice him to give up his liquidity preference.

In the crucial Chapter 19 of his General Theory Keynes could thus attack the clamour for the reduction of wages by pointing out that such a reduction without a change in money supply would at best have the same effect on the interest rate as an increase in money supply without a reduction of wages. The first course would be much more difficult to follow than the latter. To those who would argue that an increase in money supply would fuel inflation, Keynes answered that this fear was unfounded as long as there was no full employment. He highlighted the asymmetry of deflation and inflation: deflation depressed effective demand below the level of full employment and reduced both prices and employment whereas inflation would push up prices only once the level of full employment had been reached. He conceded that prices might rise slightly even before full employment had been achieved.

This ‘general theory’ was designed so as to apply to a closed national economy. It could be argued that Keynes used this as an expository device and refrained from dealing with the international context because this would have complicated his work. But there was more to it than this: Keynes was actually facing a national economy in Great Britain which could be treated as a kind of closed economy after the gold standard had been abandoned in 1931 and the management of the British economy was no longer geared to maintaining London as a centre of world finance. In fact, Keynes was wise in restricting the exposition of his theory to a closed national economy. If he had commented on the international context at that time, he would have shown his hand as a convinced neo-mercantilist. This would have attracted even more criticism than that which he provoked with his General Theory anyhow. His respect for the mercantilists did show up in a passage of his General Theory where he argued that even in a closed national economy the interest rate may not reach a sufficiently low level to encourage investment and production. Intervention may be required to reach such a level. The mercantilists, so he said, had devoted much attention to full employment and the interest rate whereas the classical economists of a later age had neglected this field.

In the days of the Great Depression the actual influence of Keynes on economic policy was restricted to his recommendations concerning money supply whereas his fiscal prescriptions, which he considered more important (deficit spending, etc.), were not taken up. The prevailing orthodoxy with regard to a balanced budget was only one reason for this disregard of fiscal measures. There was also the practical reason that governments at that time did not have sufficient statistical information to monitor fiscal policy. Parallel to the Keynesian revolution there was a quiet and imperceptible revolution in statistics and national accounting which enabled economists and governments at a later stage to know what they were doing when following a Keynesian policy. Keynes himself did not yet benefit from this quiet revolution and therefore his later critics could complain that his theory was mostly based on qualitative statements and not on econometric research. Nevertheless his contribution will always be remembered as he answered the challenge of the Great Depression by means of a provocative theory.

NEO-MERCANTILISM OR 'BEGGAR-THY-NEIGHBOUR'

The problem of international economic relations which Keynes did not discuss in the General Theory was boldly addressed by his young contemporary Joan Robinson, who stated that under the impact of the depression most nations had adopted the principle of ‘beggar-thy-neighbour’. They had adopted a policy of protectionism, competitive devaluation and similar devices all aimed at restoring their own benefits from trade at the cost of others. She referred to the remarks which Keynes had made on mercantilism and argued that in times of worldwide unemployment a country may very well increase its employment and total output by increasing its trade balance at the expense of its competitors.

The most obvious means of correcting a negative trade balance is the devaluation of the national currency as this makes exports cheaper and imports more expensive and is thus immediately much more effective than a combination of protective tariffs with export subsidies. The problem with a devaluation is, of course, that there may not be a great deal of elasticity of demand for a country’s exports, i.e. their availability at a cheaper price would not attract more buyers, and on the other hand the demand for imports may not decline if it concerns essential supplies such as investment goods and petroleum. In the latter case the country may actually import an inflation as the higher prices of imports push up domestic prices in general. Another problem faced by a country after devalution is how to restrain the absorption capacity of the domestic economy. If this capacity keeps pace with the increase of exportable output not much of it may be left. This absorption capacity tends to adjust to the new conditions and therefore the first devaluation is often followed by another one.

Under the impact of the depression most devaluations were precipitated by an acute balance of payments crisis which left the respective government no other choice. But there were also voluntary and rather deliberate ones, the most prominent of them being the devaluation of the US dollar in 1933, which was not caused by any external problems but was rather aimed at importing a certain dose of inflation so as to reflate the domestic economy. The imported inflation which usually comes as an unwanted consequence of a devaluation was deliberately induced in this way by President Roosevelt and his advisers.

Devaluations in the proper sense of the term are always ‘pegged’ ones, i.e. the respective government renounces the prevalent exchange rate and proclaims a new rate defined in terms of gold or a prominent foreign currency. ‘Pegging’ has the disadvantage that it is very difficult to know whether the new rate is either too high or too low. The more elegant way of adjusting the currency is to renounce the relation of the currency to gold or any other currency, just letting it ‘float’ until it finds its new value in the international market. Such ‘floating’ is often announced with the declared intention to ‘peg’ the currency at a later stage when it has found its proper level. But often ‘floating’ proves to be so attractive that ‘pegging’ is postponed the ‘floating pound’ is a case in point, about which more will be said in subsequent chapters. The problem with ‘floating’ is that it makes transactions in the respective currency unpredictable and forces merchants to refer to a foreign currency when settling their bills. It is therefore more likely that a prominent currency is allowed to ‘float’ whereas others are bound to be ‘pegged’.

The period of the Great Depression offers many examples of more or less successful devaluations. But these experiences have not given rise to a ‘general theory’ and there is as yet no agreement on how monetary policy should be conducted at the international level. Joan Robinson drew attention to the problem by formulating her ‘beggar-thy-neighbour’ thesis, but she did not follow it up with more detailed work. The main problem is, of course, the reaction of the neighbours to this kind of policy. They can be expected to retaliate, thus starting a vicious circle which leads to a further contraction of trade and an increase of unemployment. Hit by the depression most countries concerned did not have much time to consider the consequences of their actions. Many countries accompanied the devaluation with a suspension of debt service to their foreign creditors. These creditors in turn retaliated by providing no further credit thus contributing to the worldwide credit contraction which deepened and lengthened the depression so that it really deserved to be called ‘great’.

The countries of the depressed world can be divided roughly into three categories: those who moved in sympathy with the British pound, those who looked to the US dollar, and those who tried to maintain their link with the gold standard. The first category, which included Portugal and the Scandinavian countries as well as the British colonies, followed the ‘floating pound’. Sweden did so by passing a specific law within a week of the British decision to abandon the gold standard. The Norwegian government could do so by decree as there was already a law on the statute book enabling it to take this decision should the need arise. The British colonial currencies remained linked to the pound and floated with it. South Africa, which was autonomous, could have stuck to the gold standard because as a gold producing country it had sufficient reserves, but it also devalued its currency in 1932, because so much had been talked about an impending devaluation that a great deal of capital had left the country. Finally the government had to take action: an exemplary case of a self-fulfilling prophecy. Australia was another special case, which will be discussed in detail later on.

The second category consisted mostly of the Latin American countries. Their devaluations were caused by acute difficulties as far as their balance of payments were concerned. Chile performed the most spectacular feat in this region. It had returned to the gold standard in 1926 but abandoned it in July 1931 even before Great Britain took that step. The currency was then allowed to float and depreciated by 40 per cent in relation to gold. Subsequently a socialist government, which was only in power for about three month, printed bank notes, thus increasing money supply in order to fight unemployment. The socialist government was eliminated by a military coup, but the inflationary policy was also pursued by the new rulers. This caused an internal depreciation of the currency which then led to a further devaluation. In this case the inflation was not an imported but a home-grown one. Other Latin American countries experienced similar developments, but none of them matched Chile in this.

The third category, which consisted of those countries which decided to stick to the gold standard, had a hard time in doing so while their neighbours devalued their currencies or permitted them to float. They had to adopt the most brutal mercantilist policies such as imposing an embargo on the export of gold as well as foreign exchange controls and conducting their foreign trade in terms of barter agreements. Most of them had to abandon the gold standard sooner or later. Japan provided a particularly striking case in point which will be discussed in detail later on. It had joined the gold stan...

Table of contents

• COVER PAGE
• TITLE PAGE
• COPYRIGHT PAGE
• PREFACE
• 1. INTRODUCTION: ECONOMICS AND THE DEPRESSION
• 2. THE TRAGEDY OF THE INTERNATIONAL GOLD STANDARD
• 3. THE DILEMMA OF WAR DEBTS AND REPARATIONS
• 4. WORLD PRODUCTION OF AGRICULTURAL PRODUCE
• 5. THE ORIGIN OF THE DEPRESSION IN AMERICA
• 6. THE TRANSMISSION OF THE CRISIS TO EUROPE
• 7. TURKEY AND EGYPT: MODERNISING STATES AT THE EUROPEAN PERIPHERY
• 8. AUSTRALIA'S REACTION: OVERPRODUCTION AND DEVALUATION
• 9. COLONIAL CRISIS MANAGEMENT: THE INDIAN EXPERIENCE
• 10. THE NEW ROLE OF THE STATE IN LATIN AMERICA
• 11. CONTRASTS IN EAST ASIA: CHINA AND JAPAN
• 12. REACTIONS TO THE DEPRESSION IN SOUTHEAST ASIA
• 13. THE FATE OF AFRICA
• 14. THE POLITICAL CONSEQUENCES OF THE DEPRESSION: FASCISM IN EUROPE, POPULISM IN LATIN AMERICA AND FREEDOM MOVEMENTS IN THE COLONIES
• 15. FROM DEPRESSION TO WAR: REARMAMENT AND ECONOMIC GROWTH
• 16. THE AFTERMATH