Liveblogging the Great Depression: Lords of Finance

By Bob Bruner-

This post begins some commentaries on readings about the Great Depression.  Richard A. Mayo and I are conducting a year-long seminar to look at this complicated and overshadowing episode in economic history.  We will drill into readings that are classic and/or new.  I have decided to liveblog about these readings in order to give to our students some added perspective and criticism on the slant that writers take on the Great Depression—and on comments made in our seminar discussion.  This is not a Cliff’s Notes summary of what we read and discussed, but collects, rather, some ideas that rattle around in my mind.  I hope that our students (and any other readers) will find these reflections helpful.


The Great Depression vastly influences the way we think about business cycles (especially troughs), financial crises, and government intervention in markets.  And it represents a massive pivot in American politics as well, away from laissez-faire and toward socialization of risks and returns, centralization of economic policy-making, and the regulation of economic life.  Thus, mastery of the Great Depression is a very worthy goal for the development of MBA students.   As the generation with any personal memory of the Great Depression passes away, and as we approach the 10th anniversary of the Panic of 2008, now seems like the right time to help the rising generation make some meaning about it.   


On August 25th, the seminar commenced with a discussion of Lords of Finance: The Bankers Who Broke the World by Liaquat Ahamed.  Few books about central banking have gained the plaudits of this one.  It has figured among the “must-read” recommendations of prominent executives and critics.  And the book has taken some stiff criticism from Stephen Schuker (historian at UVA) for Ahamed’s neglect of important source material, or “of fiscal politics, evolving industrial structure, or the prerequisites for a growth-oriented entrepreneurial culture.”  Ahamed (a hedge-fund manager) might fairly be indicted for practicing history without a license.  Yet Lords of Finance remains a valuable portal into a multi-disciplinary study of the Great Depression for raising a number of important themes and stimulating critical thinking about that period of time.  Here are six such points:


1.      Financial and economic crises have long ancestry.   How far back in time must one go to tell the story of the Great Depression?  The popular view is that the story begins with the stock market crash of October, 1929: “greedy speculators created a bubble, which burst, and imposed economic hardship on everyone for ten years.”  But it’s not that simple.  Ahamed advances the view that the Great Depression had its origins in the First World War and especially the Versailles Treaty of 1919.  The developed economies exhausted themselves fighting and financing the war.  Reparations and the payment of war debts, combined with an ill-advised return to the gold standard created a brittle and unsustainable economic system.  This repeats an argument made by luminaries such as John Maynard Keynes and Herbert Hoover.  Therefore, if one is interested in getting to root causes of a financial crisis, one must look farther back in time than the obvious onset. 

2.      The cycle of debt-deflation is the foundational economic phenomenon of the Great Depression.  Debt-deflation entails a pernicious feedback spiral in which the pressure for repayment of debts triggers the effort to sell assets by debtors.  The effort to liquidate assets drives asset prices downward.  Declining prices (deflation) worsen the adequacy of collateral underpinning other credits in the economy, which triggers more pressure for repayment of debt and/or for demanding more collateral for loans—in other words, “the more the debtors pay, the more they owe.” [1]  The increased pressure triggers more liquidation of assets.  As the debt-deflation spiral worsens, economic output plummets, workers are laid off, and bankruptcies (corporate and personal) and social distress rise.  This stimulates hoarding of money, which worsens liquidity in the economy and threatens the stability of the financial system.  The debt-deflation spiral ends either with the return of confidence from some powerful surprise (such as government intervention through debtor relief or fiscal spending) or when no assets remain to be sold in the effort to liquidate debt obligations.  The theory of debt deflation was originally formulated by Irving Fisher in 1933, in response to the onset of the Great Depression.  Significantly, Fisher rejected the view that markets were generally and always in equilibrium.  In response, mainstream economists argued that deflation wasn’t so dangerous, since in Fisher’s model, value was merely transferred from debtors to creditors, with no impact on the overall economy.  But in 1995, Ben Bernanke (another student of deflation) counter-argued that a sufficiently severe debt deflation cycle would produce adverse effects on output and employment, both of which could produce depressions.  The deflationary process that caused so much hardship, especially in 1930-1934, spanned most sectors of the economy and appeared sporadically early in the 1920s, notably in agriculture.  Orthodox thinking held that deflation was a temporary adjustment following a period of inflation.  Yet economic history suggests that the US has sustained some extended periods of deflation.  Some sectors, such as agriculture, experienced deflation for much of the 1920s and 1930s.  Why might this be?  Maladroit monetary and fiscal policies are standard explanations.  An added candidate would be technological innovation.  Technological change is generally deflationary.  Alexander Field, in his book Great Leap Forward offers some evidence to suggest that the displacement of steam-based power by electro-motive power in American manufacturing during the 1920s had a depressing effect on prices.  Deflation is much in the minds of central bankers today: what are the parallels between the twenty-teens and the 1920s?    

3.      Determinism versus personal agency: shall we study economic leadership?  Ahamed could have focused his book on policies and larger trends.  But by focusing on four central bankers, Ahamed seems to argue for the significance of human agency in the unfolding of great events.  Economists don’t spend much effort studying individual leaders and instead focus on aggregate flows of money and resources.  Historians, on the other hand, don’t like to attribute big outcomes to the decisions of individuals because big outcomes have many causes and theories about free will and the “Great Man” of history are out of fashion.  Determinism flourishes in much of the writing about the Great Depression: because of pre-existing conditions, the economy was bound to collapse, regardless of what individuals might choose to do.  Yet it is important for us (at a professional school) to study the relation among individuals, their decisions, and the outcomes that follow as a way to learn about leadership.  By focusing on individuals in history, we better understand their motives and consequences of their choices, thus better informing our own choices going forward.  As much of the behavioral research in economic decision-making has shown, biases and preferences of individuals matter enormously—so do ideologies, incentives, and interests; for such reasons, the study of economic leadership is valuable.

4.      Keynes, the looming presence.  Nominally, Lords of Finance is about four central bankers.  But a fifth person, John Maynard Keynes, overshadows the episode.  From the start, he decried policies that ultimately led to catastrophe (his criticism of the Versailles Treaty, The Economic Consequences of the Peace, is worth reading in 2016—and I commend Margaret McMillan’s Paris 1919: Six Months the Changed the World).  Historians of the Great Depression generally cleave to Keynesian economics in their interpretation of the awful downward spiral of 1929-1934.  Perhaps this is with benefit of hindsight: Keynes’s General Theory of Employment, Interest, and Money was published in 1936 and reflected his critique of economic orthodoxy of the day, classical economics, which held that the cure of a depression was a process of “liquidation” like a cold or a case of the flu—and the risk of such a cure was deflation (see point 2, above).  It was in this regard that Keynes wrote, “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”  The “defunct economists” and “academic scribblers” were the classical economists whom Keynes would eventually displace.  Keynes’s demand-side stimulus-oriented policy recommendations offered a provocative alternative.  Yet Keynes had less to say about possible structural barriers to economic recovery from a crisis.  The alternative narrative to Keynes, neoclassical economics, adds that supply side inflexibilities such as entrenched labor unions, “sticky wages,” heavy regulation, trade barriers, and the like can limit the speed of an economic recovery.  But as of the 1920s, the central bankers in Lords of Finance had little consciousness of either demand-side or supply-side narratives.  An important lesson of the that era is that economic and financial crises spawn new ideas.  I leave it for our students to surmise what new ideas are arising from the Global Financial Crisis and Great Recession.

5.      Author’s purpose.  The thrust of Lords of Finance is to explain why and how the axis of monetary orthodoxy shifted profoundly between 1919 and 1939.  Not a pretty process and one fraught with poor choices and inept actions.  I surmise that Ahamed wanted to offer a cautionary tale to current and future economic leaders.  Did he succeed in this?  Much as one may enjoy a good yarn, there is no thoughtful reading without criticism: Where were YOU persuaded?  Where not?

6.      History matters.  Henry Ford famously said, “History is bunk,” words that he later ate when, in penance, he established a wonderful museum of industrial history, Greenfield Village.  History matters for practical people as a way to make meaning about what is happening right now and how the future might unfold.  The Great Depression has cast a very long shadow.  At the nadir of the Global Financial Crisis, some pundits prophesied the onset of another Great Depression.  But things didn’t turn out exactly that way.  Why and how that happened will be an underlying topic in our seminar.  Suffice it to say, as Mark Twain said, “History doesn’t repeat itself, but it rhymes.” 


  1. Irving Fisher, (1933) pages 344-346. []