Recently, I’ve been thinking about the credit contraction of the early 1930s. This generally gets far too little attention today, but people have thought about it somewhat in the past. One such person was Irving Fischer, a prominent economist of the time. He called it “debt deflation.” Here is a nice summary of his views:
In general, this theory is not so much of a “cause,” as it is a description of the events of his time. It is, in my view, more in the nature of symptoms or characteristics. For example, here is what he wrote about causes:
8. There may be equilibrium which, though stable, is so delicately poised that, after departure from it beyond certain limits, instability ensues, just as, at first, a stick may bend under strain, ready all the time to bend back, until a certain point is reached, when it breaks.
This is not an explanation at all, but is rather more in the nature of the typical Keynesian “autonomous decline in aggregate demand” (“It just happened”) version of things. An economy is “delicately poised,” such that, for some minor reason — here unidentified, despite causing a Great Depression — “instability ensues.” It is sort of like the twitch of a butterfly’s wings leading to a hurricane.
Then we may deduce the following chain of consequences in nine links: (1) Debt liquidation leads to distress setting and to (2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circula- tion. This contraction of deposits and of their velocity, precipitated by distress selling, causes (3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be (4) A still greater fall in the net worths of business, precipitating bank- ruptcies and (5) A like fall in profits, which in a ” capitalistic,” that is, a private-profit society, leads the concerns which are running at a loss to make (6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to (7) Pessimism and loss of confidence, which in turn lead to (8) Hoarding and slowing down still more the velocity of circulation.
Here is a little more on original causes:
15. While any deviation from equilibrium of any economic variable theoretically may, and doubtless in practice does, set up some sort of oscillations, the important question is: Which of them have been sufficiently great disturbers to afford any substantial explanation of the great booms and depressions of history?
16. I am not sufficiently familiar with the long detailed history of these disturbances, nor with the colossal literature concerning their al- leged explanations, to have reached any definitive conclusions as to the relative importance of all the influences at work. I am eager to learn from others.
17. According to my present opinion, which is purely tentative, there is some grain of truth in most of the alleged explanations commonly offered, but this grain is often small. Any of them may suffice to explain small disturbances, but all of them put together have probably been inadequate to explain big disturbances.
18. In particular, as explanations of the so-called business cycle, or cycles, when these are really serious, I doubt the adequacy of over- production, under-consumption, over-capacity, price-dislocation, maladjustment between agricultural and industrial prices, over-confidence, over-investment, over-saving, over-spending, and the discrepancy between saving and investment.
19. I venture the opinion, subject to correction on submission of future evidence, that, in the great booms and depressions, each of the above-named factors has played a subordinate role as compared with two dominant factors, namely over-indebtedness to start with and deflation following soon after; also that where any of the other factors do become conspicuous, they are often merely effects or symptoms of these two. In short, the big bad actors are debt disturbances and price- level disturbances.
While quite ready to change my opinion, I have, at present, a strong conviction that these two economic maladies, the debt disease and the price-level disease (or dollar disease), are, in the great booms and depressions, more important causes than all others put together.
As we can see, he really has little to say about the originating factors. There’s a floppy hypothesis regarding “overindebtedness,” which doesn’t apply in this case, because, as we saw earlier, debt levels in the 1920s were actually rather modest, and not rising particularly.
Note the total blindness here to the very great causes that were happening all around him: in particular, the global trade war set off by Smoot-Hawley in the U.S., and the drastic “austerity” domestic tax hikes that followed.
That is all for Irving Fischer today.