Theory that the Federal Reserve was the primary cause of the 1930s Great Depression

Monday, Jun 29, 2009

SEIB: So, the central bankers [in the late 1920s] essentially adopted this strategy of trying to defend, at all costs, a monetary system that really had become an anachronism at that point.

AHAMED: Exactly.

SEIB: And the policy mistakes were in defense of something that they should have just let go.

AHAMED: Exactly.

SEIB: And in the U.S., that policy mistake took the effect of very low interest rates, designed to help the Europeans by keeping the interest rates low, so that they could handle these massive bills that they had to pay [from World War I].

AHAMED: Yeah, and the signature moment was in the middle of 1927, and the pound was coming under increasing pressure, and the central bankers organized a secret meeting. In an unusual place... Long Island [NY]... It was actually at the estate of Ogden Mills in Westbury, Long Island. And they sort of tried to stitch together a deal to keep the structure going. And the deal was that the U.S. would ease interest rates. And you can almost date the beginning of the stock market bubble from the day The Fed eased in July 1927. Within three months, the stock market was up 20% and it never looked backed thereafter.

SEIB: That has a familiar ring to it, doesn't it? Very low interest rates produce an inflated stock market. Is that the same scenario that we just saw over the last say five years in the United States today?

AHAMED: Yeah, I mean I think less so the stock market and more the real estate this time. But yeah, the similarity is, that then and now, we had a bubble. Then it was in the stock market, this time it was in real estate. Both bubbles were caused by a mistake in Fed policy. Interestingly enough, both bubbles were exasperbated, and some would say even caused, by a malfunctioning international financial system. Then, it was the decision to ease to prop up the pound. This time it was the consequences, or the effects, of massive accumulation of dollars in the hands of Asian central banks. And both bubbles, as they always do, eventually burst.

C-SPAN Book TV, After Words: Lords of Finance: The Bankers Who Broke the World, Gerald Seif from the Wall Street Journal interviews Liaquat Ahamed author of Lords of Finance: The Bankers Who Broke the World, 12:40, May 2, 2009,


Drawing on a wide range of recent empirical research, we find the following: (1) The Fed’s full history (1914 to present) has been characterized by more rather than fewer symptoms of monetary and macroeconomic instability than the decades leading to the Fed’s establishment. (2) While the Fed’s performance has undoubtedly improved since World War II, even its postwar performance has not clearly surpassed that of its undoubtedly flawed predecessor, the National Banking system, before World War I. (3) Some proposed alternative arrangements might plausibly do better than the Fed as presently constituted. We conclude that the need for a systematic exploration of alternatives to the established monetary system is as pressing today as it was a century ago.