How Premature Austerity Caused A Recession And The Market Crash Of 1937

fireside chat roosevelt

Photo: Wikimedia

Now that sequestration has hit, people are wondering whether we’re going to see another 1937.That’s the year that brought America a 12-month-long “recession-within-a-depression.”

The Dow also fell 47 per cent.

But there remains disagreement about what caused this event.

Keynesians like Paul Krugman argue it was indeed the result of Roosevelt’s decision to curb New Deal spending.

Monetarists, meanwhile, believe fears of inflation choked off business spending.

And still a third prominent economist, Dartmouth’s Douglas Irwin, has recently written it was the result of gold sterilization — that is, federal gold reserves out of the monetary supply.

Before we determine who’s right, we wanted to go back and see what contemporary accounts were saying.

By April of 1937, many had grown fearful about excessive New Deal Spending. This editorial compared it to Santa's bag of gifts. But it's also worth noting it says it was inevitable.

By August, there were signs the economy was faltering.

But the government was convinced it was time to leave business to its own devices — lest the U.S. risk bankruptcy, as writer David Lawrence put it.

No one believed the spending pullback had led to the recession. Other, more arcane factors, like a corporate surplus tax, were blamed.

Some thought it was the fault of the National labour Relations Board

You also might recognise some of the remedies espoused: cutting taxes and balancing the budget.

It's true that Roosevelt ended up denying there was a problem — he was doing so as late as December.

But eventually the government wised up, and Roosevelt planned a series of spending measures.

Technically, GDP had already turned around by the new year. But the NBER says the actual recession last well into spring.

And stocks did not bounce back 'til June.

But the same front page also explains what helped finally restart the economy.

As Prof. Irwin says, the Treasury did commence a massive desterilization program to reinstate gold as collateral.

Once that passed — and as Roosevelt attacked superfluous pork — stocks recovered. This Times story is from June 2, 1938.

Ultimately, contemporary observers weren't sure which of the measures was directly responsible for turning the economy around.

But if you argue that the cure reflects on the cause, clearly the spending was needed.

More financial history...

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