The Super Summary of World History - Alan Dale Daniel [162]
Economist Milton Friedman says the Fed reduced the money supply and raised interest rates after the 1929 crash, thus making the downturn worse; other economists say the Fed increased in money supply after the crash and propped up failing businesses, thus increasing the severity of the debacle. The cold facts: Between 1921 and 1927, the money supply increased 60 percent. That is a lot by historical standards, and made loans easy to obtain. Starting in 1928, the Fed began tightening the money supply by raising the discount rate (the rate paid to borrow money) from 3.5 percent to 5 percent, thus making loans harder to get. Then came the 1929 stock market crash. In 1931 the money supply was decreased 30 percent or more, and in 1936 the central bank doubled the reserve requirements (the amount of money a bank has to keep on deposit as a safety net against failure); thus, taking more money out of the financial system. Those differentials represent a large swing in the supply of money between 1927 and 1936. Note that the Fed decreased the money supply after the crash. Private business capital investment also fell to zero, creating a situation where money was almost impossible to obtain. Everyone was living hand to mouth. Sounds like Milton Friedman was right. The Federal Reserve took money out of the system before and after the crash, just when it needed money the most, thereby increasing the severity of the Great Depression. The problem in studying the Great Depression revolves around the chosen economic theory, because that determines which statistics are the most important, and how they are interpreted. One thing is certain, the crash of 1929 became a worldwide disaster throwing people out of work in great numbers and causing starvation and fear on a world wide scale.
We must now look at a few economic concepts that are central to understanding the Great Depression.
Money Supply—Money Value
Money supply and money value are esoteric economic and banking concepts of major importance to the modern world, and understanding how the Great Depression is analyzed. A nation’s money supply is the amount of money in circulation in the nation’s economy. This is important because it determines the amount of money available for bank loans. A nation’s central bank tries to control the nation’s money supply, among other things. If money is easily available to banks they will try and loan it out by dropping interest rates, because loans are how banks make money. When there is less money available banks reduce lending and borrower’s interest rates rise.
Another key factor is the value of money. Strange as it may seem, money does vary in value in relation to other currencies, especially if they are “floated” (not backed by gold or silver) which allows money to rise or fall in value with the strength of a nation’s economy. If one nation’s economy is strong its money will have more value than an economically weak nation. Note what happens during value changes. As the value of a nation’s money increases, its merchants can buy more goods from other nations because the outside products cost relatively less, however, it makes it harder to sell goods because the cost of its products rise with the value of its money. When the value of money shifts then buying power shifts. When a nation just prints money without backing it up with gold the value of its money decreases because there is more of it. If the supply of money decreases, the value of money will normally increase because there is less of it.[196] All this can be very obscure, as everything from cash flow to emotion impacts the increase or decrease in the value of money, and often in ways not fully agreed upon