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7/28/2019 Lecture 10 Class
1/23
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10. The collapse of the internationaleconomy and the Great Depression
Today
Disintegration of the World Economy during and afterWorld War I
Attempts to restore the pre-WWI situation: thereestablishment of the Gold standard
The Great Depression
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Reminder: First Globalization Transition from (relatively) isolated local, regional and national markets to
an Atlantic World Economy
Development of a center-periphery world economy according to thedifferent factor endowments
Northwestern Europe is the center. It has relatively lots of labor andcapital, but relatively scarce land
The periphery (especially that of recent European Settlement, like US,Canada, Argentina, Brazil. Australia): large amounts of land for potentialcultivation, but little labor and little capital (young and sparsepopulation)
From this disequilibrium result commercial flows (raw materials and foodfrom the periphery to the center and manufactured goods from the center tothe periphery), also investments (in infrastructure and production outsideEurope, especially in the European Offshoots and some colonies like India railways, canals, etc.) and migration
This leads to (incomplete) convergence of commodity and factor pricesbetween center and periphery
The problem of globalization backlash The convergence of prices and factor remunerations decreases the
incentives for further integration (if the wedge becomes smaller thegains from reducing it become smaller, too)
At the same time we see that integration affects income distribution in
the center as well as in the periphery. In the center especially the prices for agricultural goods drop and
decrease land rents relative to salaries; this leads somegovernments to impose grain tariffs to (partially) offset these effects.(Exceptions: United Kingdom and Denmark; in the US we find hightariffs on manufactured goods, following the same logic the otherway round)
Regarding migration we observe the opposite impact: salariesincrease less in the periphery, which changes the incomedistribution in favor of landowners and skilled workers, and againstunskilled workers. This (together with changing demand in labor)leads to increasing barriers to immigration and/or quality tests
(literacy, etc.)
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The rise of a new leader: USA Large internal market, with relatively high purchasing power per
person and good infrastructure. This makes the US relatively lessdependent on international markets on the eve of WWI
Large investments (first from Europe, but increasingly from theirown sources) in infrastructure, plants and mining
Mechanization of production, massive use of capital, energy andnatural resources; mass-production and economies of scale,standardized products, oligopolistic competition (and monopolies) American system of production
With it, the modern industrial enterprise rises to fame, with itsmanagerial hierarchies, marketing and distribution, and itsdepartments of research and development (directly applied to thesystem of production to assure the even more efficient use ofcapital and the other factors of production)
A new energy source (electricity) incorporated into the system
World War I
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Economic consequences of the First World War Direct consequences:
Stopped the first globalization (war causes disruptions)
Destroyed lives (and human capital) and physical capital(infrastructure, plants, etc.)
Affects state finance/budgets (war finance)
Leads to structural changes (increase in cultivated land,
national heavy industry) and social tensions Indirect consequences: the peace of Versailles and the
Reparations
Consequences of the attempt to restore the internationaleconomic system: the return to the Gold Standard
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Offenheitsgrade ausgewhlter Volkswirtschaften,
ca. 1820-1990
0
0.1
0.2
0.3
0.4
0.5
0.6
1815
1825
1835
1845
1855
1865
1875
1885
1895
1905
1915
1925
1935
1945
1955
1965
1975
1985
Frankreich
Schweden
Vereinigtes
Knigreich
Sources: B.R.Mitchell (2003), International Historical Statistics. Europe 1750-2003 (5th ed.), Houndmills: Palgrave; RodneyEdvinsson (2005), Historical national accounts for Sweden 1800-2000, Version 1.0 (online: http://www.historia.se)
Degree of openness in selected countries(imports+exports)/GDP)
France
Sweden
UK
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International capital flows in history (stylized graph)
Source: Obstfeld and Taylor (2004), p. 127.
WWI - Human costs Millions of dead and wounded soldiers and civilians
8 million soldiers die in combat, 2 million from diseases militarylosses are higher than in all wars of the 19th Century together
About 21.2 million wounded soldiers (many of them permanentlydisabled)
About 6 or 7 million civilians dead due to the war
The war dead sum up to about 3.5% of the European population in1913 (incl. Russia)
Additionally:
Deficit of births
Spanish flu epidemic causes 25 to 50 million mortal victims in 1918-20 (more than the war, but partially because of nutritional standardetc. as a consequence of the war)
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Financial and material costs
Military costs (expenses for warfare): 180-230 thousandmillion US dollars (prices of 1914) four or five times the US
GDP in 1914, or 6-8 times all government debts of the 19thcentury
This does not include the long-term costs for incapacitatedveterans and the loss of human capital
Indirect costs (destroyed and damaged buildings, plants and
infrastructures) add another 150 thousand million dollars
The most affected areas are Belgium, Northern France,Northeastern Italy (Veneto) and much of Eastern Europe
How was such a massive warfinanced?
As there was no prior experience withwarfare at this scale, there were alsono established mechanisms for
financing it Possibilities
Increase government revenues(higher taxes)
Print money and pay with it(causes inflation)
Internal public debt (borrow fromyour population)
External public debt (borrow fromother governments and theirpopulation)
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Increase in government spending (% GDP)
14Out of control Controlled late Controlled early
Inflation without precedentsCUADRO 5.3. ndices de precios al consumo, 1913-1929 (1914=100)
Austria Alemania Francia Italia EE.UU. R.Unido Holanda Suecia Suiza
1914 100 100 100 100 100 100 100 100 100
1915 158 125 120 109 102 124 115 115 115
1916 337 165 135 155 115 143 128 130 1341917 672 246 163 224 138 176 136 159 171
1918 1.163 304 213 289 169 200 162 219 204
1919 2.492 403 268 331 193 219 176 257 222
1920 5.115 990 371 467 194 248 194 269 224
1921 9.981 1.301 333 467 169 224 169 247 200
1922 263.938 14.602 315 467 165 181 149 198 164
1923 76 15.437mma 344 481 168 176 144 178 164
1924 86 128 395 580 168 176 145 174 169
1925 97 140 424 618 173 176 144 177 168
1926 103 141 560 547 171 171 138 173 162
1927 106 148 593 511 167 167 138 171 160
1928 108 152 584 503 165 167 139 172 161
1929 111 154 621 476 165 167 138 170 161
(a)= 15.437.000.000.000, respecto 1914=100
Fuente: Maddison (1991)
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How much debt did the allied forces incur?
All were indebted with the United States (they in turn do notowe to no one, except their own population)
Great Britain is only indebted with the US, but
France and others are indebted with the United Kingdom (andthe US)
Others (for example Italy) also are indebted with France
All of the want the losers to pay for their damagereparations, so they can pay back their debts
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The debt chain of the allied forces (US$ mio.)
Source: Kindleberger, Charles P.: Die Weltwirtschaftskrise, Mnchen: dtv, 1973, p. 40.Graph from a presentation by Ulrich Pfister
France
3500
Othercountries
United KingdomUSA4700
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Reparations The winners of the war had to confront the reconstruction of their
structures and economies
For this, they needed money (especially France, Belgium and Italy)
There was also a desire for vengeance (in France, due to massivereparation payments to Germany in 1871ff)
These countries demanded that Germany should pay all damages(Reparations)
But this would suffocate the German government and economy and leadto social chaos
What can be done? Two positions
France and the UK tried to connect the Reparations with theirinternational debts (so the reparations would cancel the debts, or arenegotiation of the debts would lead to lower reparation needs)
US: we cant suffocate Germany, but the commercial credits given toother countries have to be paid back (no connection between the two)
The final sum: $33,000 million dollars (I)
That was potentially less than costs and damages of the allied(but the sums given on slide 14 include Germany, Austria, Russia,etc.)
Every annual installment would be c. 6% of Germanys GDP (but
GDPs were not known at that time), and the debt burden wasactually impossible to bear
The allied forces wanted payments in gold (as Germany hadreceived from France after 1871)
But this would mean that Germany would have to export morethan it imported (to get gold for the excess exports)
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The final sum: $33,000 million dollars (II) But German prices were very high because of the post-war
inflation,
so this would require deflation, that is, cost cuts (lower wages)and decrease in the amount of money in circulation (which hadincreased during the war) higher interest rates, creditconstraints for domestic agents leading to a contraction ofthe German economy
Effects on other countries would also be partially negative,because they would have to buy the (then) cheap German goods(without exporting to Germany in the same way), therebysubstituting German for domestic products, which could causeunemployment in these countries (and the need for deflation, etc.)
20Out of control Controlled late Controlled early
Inflation without precedentsCUADRO 5.3. ndices de precios al consumo, 1913-1929 (1914=100)
Austria Alemania Francia Italia EE.UU. R.Unido Holanda Suecia Suiza
1914 100 100 100 100 100 100 100 100 100
1915 158 125 120 109 102 124 115 115 115
1916 337 165 135 155 115 143 128 130 1341917 672 246 163 224 138 176 136 159 171
1918 1.163 304 213 289 169 200 162 219 204
1919 2.492 403 268 331 193 219 176 257 222
1920 5.115 990 371 467 194 248 194 269 224
1921 9.981 1.301 333 467 169 224 169 247 200
1922 263.938 14.602 315 467 165 181 149 198 164
1923 76 15.437mma 344 481 168 176 144 178 164
1924 86 128 395 580 168 176 145 174 169
1925 97 140 424 618 173 176 144 177 168
1926 103 141 560 547 171 171 138 173 162
1927 106 148 593 511 167 167 138 171 160
1928 108 152 584 503 165 167 139 172 161
1929 111 154 621 476 165 167 138 170 161
(a)= 15.437.000.000.000, respecto 1914=100
Fuente: Maddison (1991)
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Problems with the reparations (I) The Germans dont pay (only one complete annual payment)
France and Belgium occupy the Ruhr area (the heart of Germanheavy industry) to force the payment
Germany declares general strike in the occupied area (and paysthe workers with additionally printed money). This leads (moremoney in circulation, less production to be bought) to theultimate destabilization of the German economy in ahyperinflation (1923)
In the end, Germany restabilizes and the Allied forced resumenegotiations about the reparation
There were notes of 200,000,000,000mark in circulation that were notenough to pay a taxi; in the end, abread cost 105,000,000,000 and aliter of milk 26,000,000,000 mark
Source: http://einestages.spiegel.de/static/topicalbumbackground/4632/als_die_mark_vernichtet_wurde.html
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So, the secret against inflation is
Balanced government budgets
Severe deflationary politics if necessary
Drastic budget cuts
Tax increases
Restrictive monetary policy (high interest rates, potentialloss of real purchasing power of salaries)
_______________________________
So the price to pay for controlling inflation might be...
Less growth (less investments) and employment
Problems with the reparations (II)
Plan Dawes (1924): Germany pays annually, but not in gold andgets help with (private) credits from the US
Plan Young (1929): The amount is reduced to $26,350 million
and the period of payment is prolonged to 58.5 years (until1988), but in 1931 there was the Hoover Moratorium, and in1932 the Lausanne Conference declared the end of Germanreparations against a final payment (which never becameeffective)
Reparations, war debts and their payment had negative effectson the international financial markets
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Return to the Gold standard
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Return to the Gold standard (I) With all the destabilization in international markets and the problem of
inflation and hyperinflation in national economies, countries wanted to re-establish stability
They aimed to achieve this by going back to the pre-1914 gold standard
which had been suspended during the war Under the gold standard, the value of different currencies was fixed in
units of gold, and thereby the value of the currencies was fixed againsteach other, since gold could be freely traded
The central banks especially aimed at maintaining the gold-to-notesconvertibility
Reserve-to-circulation rates
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Interwar Gold Standard General problem: in countries with scarce reserves deflation (and
economic contraction) was necessary, while in countries withexcess reserves (because of undervalued currencies)
expansionist/inflationary politics were not required and notundertaken (France, US) this led to permanent latent imbalancesin balances of payments
The mechanisms are not necessarily symmetric. While underthe gold standard the country that has the balance of payment
deficit has to adjust, the surplus country can decide to hoardthe gold and not extend its monetary supply.
General willingness to adjust internally declined (because ofextended franchise and workers understandably not willing to bearthe costs)
The Great Depression
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The Great Depression Real economy:
Industrial production, employment and world trade fell 19291932
Monetary economy
Deflation 1925/29-1932, especially in agricultural and other primaryproducts already since 1925
October 1929ff. Stock market crash (first in New York)
Banking and financial crisis 19301933
Many countries are unable to meet their public debt (default),
1931/33 Institutional level
Gold standard is abandoned in UK 1931, US 1933, France 1936
Protectionism: Increases in tariff rates, bilateral exchangeagreements (to balance the balance of payments not according tomarket outcomes, but after political negotiations)
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Industrial production index (1929=100)
Source: Bernanke, Ben / James, Harold: The Gold Standard, deflation, and financial crises in the GreatDepression: an international comparison, S. 3368 in Robert G. Hubbard (ed.), Financial markets and
financial crises, Chicago: Chicago University Press, 1991, p. 45. From a presentation by Ulrich Pfister(Mnster)
0
20
40
60
80
100
120
1929 1930 1931 1932 1933 1934 1935 1936
Germany
France
UK
Spain
US
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Industrial unemployment, 19201939 (%)
Source: Eichengreen, Barry / Hatton, T. J. (eds.): Interwar unemployment in international perspective,Dordrecht: Kluwer, 1988, pp. 6-. From a presentation by Ulrich Pfister (Mnster)
0
5
10
15
20
25
30
35
40
45
50
1920 1922 1924 1926 1928 1930 1932 1934 1936 1938
Un
employmentrate(%)
Germany
France
UK
US
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World trade,1929-1933
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Imbalances in international markets Problems on World agricultural markets
Due to the disruption of existing exchange structures new producersenter the market, often calculating potential productivity with the highprices due to disintegration
This means extensive growth (and decreasing marginal productivity)
Especially in European Offshoots (Canada, Australia, US) and intropical countries (cotton, rubber)
After the war, European production reemerges (and internationaltrade gets easier again)
Now we have supply>demand, which means falling prices (orincreasing stocks, which then lead to falling prices)
A general crisis in agriculture is the consequence (for example,because farmers took credits expecting the war gains in the long runand now face much lower profits)
36
Stock markets
In New York, and, less pronounced, in London stock pricesincrease from 1926
In New York, the stock prices increase until 1928 in line with the
evolution of dividends (reasonable)
Since 1928, it seems that there was a non-rational bubble evolving
Possibly, the Feds low interest policy contributed to the increasein (credit-financed) purchases of shares
From October 1929 the stock prices decrease dramatically, andthe expectations of the investors do also change, in part becauseof increase in interest rates, in part because of a deceleration ofgrowth in the real economy (a cyclical recession)
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Three-month-period index (Jan-Mar 1920=100) of the Dow Jones, and dividends paid by the joint-stockcompanies included in the Dow Jones index, 1920-30
Source: White, Eugene N. (ed.): Crashes and panics: the lessons from history, New York: Stern, 1990, p.154
Speculation or rational expectations?
Economic History38
The Crash of 1929
http://upload.wikimedia.org/wikipedia/commons/c/c5/1929_wall_street_crash_graph.svg7/28/2019 Lecture 10 Class
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Credit defaults and banking crisis Affects many small banks in the US and some large banks with large industrial
assets in Austria, Germany, etc.
Explanation: Deflation (because of overproduction or demand slump) increasesthe burden of debt:
Debt service has to be made in fixed installments, which are more difficult tomeet if deflation decreased nominal incomes/revenues/profits
This increases the rate of non-paid outstanding credits that banks have givento private entities
These credits in the US were based mainly on short-term sight deposits;
once the depositors started to fear that the banks would be unable to returntheir deposits they run to the bank and claim their deposits, therebycontributing to the banks effective illiquidity and insolvency
In part, this also happened to national governments, especially those of primaryproduct exporters who were hit hard by the deflation and depression and hencelacked revenues to meet their debt obligations
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The end of the Gold Standard As a consequence of the industrial, employment and banking crisis the
convertibility of the Pound into Gold is questioned in September 1931due to massive losses of gold (capital leaves the country, deficit balanceof payments). The Bank of England finally suspends the convertibility.
How could that happen? Little trust in the capacity of Bank of England and the government to
impose again severe deflationary politics (to keep and regain gold)confronting the threat of a general strike, etc.
On the free market, the Pound loses 30% of its value until December1931 (i.e., devaluation instead of deflation in the UK)
US follow in 1933, France in 1936
Germany since 1931: state administration of foreign exchange: theconvertibility of Marks into gold and the free exchange of currency issuspended. Who needs foreign exchange has to ask for a permit at thecentral bank.
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Summary: Causes of the Great Depression Fluctuations in prices and inventories of raw materials: During WWI
demand exceeded supply, prices rose. As a consequence of this (and themovement of factors in the first globalization) between 1909/14 and1924/29 the cultivated area increases by c. 1/3 in US, Canada, Australiaand Argentina. Once European agriculture recovers excess demandbecomes excess supply
Deflationary pressures from the Gold Standard and the more restrictivecentral bank regulations
Instead of helping the banks to survive with cheap money(low interest
rates, helping national credit supply), many countries did the contrary:They raised interest rates to save their gold reserves and exchange rate
To make this possible they also cut government budgets to meet fallingtax revenues instead ofexpansive fiscal policy(credit-financedgovernment investments in infrastructure, etc.)
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Gold standard and wholesale prices 1929=100)
No gold standard in Spain in this period
Source: Bernanke, Ben / James, Harold: The Gold Standard, deflation, and financial crises in the GreatDepression: an international comparison, S. 3368 in Robert G. Hubbard (ed.), Financial markets andfinancial crises, Chicago: Chicago University Press, 1991, p. 43. From a presentation by Ulrich Pfister(Mnster)
0
20
40
60
80
100
120
1929 1930 1931 1932 1933 1934 1935 1936
Spain
Countries that abandoned the GoldStandard in 1931 (average)
Countries that abandoned the GoldStandard in 1936 (average)
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Industrial production index (1929=100)
Source: Bernanke, Ben / James, Harold: The Gold Standard, deflation, and financial crises in the GreatDepression: an international comparison, S. 3368 in Robert G. Hubbard (ed.), Financial markets andfinancial crises, Chicago: Chicago University Press, 1991, p. 45. From a presentation by Ulrich Pfister(Mnster)
0
20
40
60
80
100
120
1929 1930 1931 1932 1933 1934 1935 1936
Germany
France
UK
SpainUS
Gold standard, unemployment and discontent
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Source: Persson (2010), p. 189
This does notimply apologiesfor the voters!
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Readings Cameron and Neal (text book), cap. 14.
Persson, Karl Gunnar (2010),An Economic History of Europe,Cambridge UP, chs. 9.3 and 10.2
Eichengreen, Barry (2008 and others), Globalizing Capital: A Historyof the International Monetary System, Princeton University Press.
Kindleberger, Charles P. (1973): The World in Depression. 19291939, Berkeley: University of California Press.
Bernanke, Ben / James, Harold (1991): The Gold Standard, deflation,and financial crises in the Great Depression: an internationalcomparison, en Robert G. Hubbard (ed.), Financial markets andfinancial crises, Chicago: Chicago University Press, 1991, pp. 33-68.
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