The specter of 1937 hangs over the economy and the stock market.
That's the year when overconfidence that the Roosevelt administration had whipped the Great Depression and that it was time to balance the federal budget led to another deep recession that wiped out three years of growth and sent the economy reeling back to the Depression depths of 1934.
The Dow Jones Industrial Average ($INDU), which had climbed 127% from a low of 85.51 in July 1934 to a high of 194.40 in March 1937, fell 49% to 98.95 by the end of March 1938 -- not far above its '34 low. (Remember, it takes only a 50% loss to wipe out a 100% gain.)
After that collapse and another one in 1942, stocks didn't match that 1937 peak until 1945.
I wrote on my blog a few days ago that "most of the time," after big rallies like the one going on now, the stock market has remained higher a year later.
Almost always. The one big exception, the one that delivered a loss big enough to wipe out portfolios, came in 1937.
A self-inflicted swoon
It's that "almost" that gives me pause as I look not so much at the stock market but at the economy and at what passes for our national discussion of economic policy these days.The comforting thing about looking back at that economic and investment disaster of 1937 is that we did it to ourselves. Bad policy decisions, not accident or fate, led us over the cliff. So all we have to do to avoid a repeat of the results is to avoid the policy mistakes, right?
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1937 was the year, students of the Great Depression know, that everyone from the president on down got so confident that the bad times were over that they tipped the country back from recovery to depression.
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Unemployment, which had marched down from its Depression high of 25% to a low of 14.3% in 1937, climbed again, hitting 19% in 1938. Personal income dropped 15% from its 1937 peak. And manufacturing output fell 40% from its 1937 peak, all the way back to the levels of 1934.
In other words, 1937 was the year that the V-shaped recovery from the depths of the Depression turned into a W-shaped one. The economic growth of 1934 (17%), 1935 (11%), 1936 (14%) and 1937 (10%) that had succeeded the economic collapse of 1930-33 came to a grinding halt. In 1938, the U.S. economy actually returned to negative growth, shrinking 6.2%.
What happened? Buoyed by the economic numbers and a landslide in the 1936 election -- Franklin D. Roosevelt had defeated Republican Alf Landon of Kansas by an Electoral College vote of 523 to 8 -- the Roosevelt administration declared victory over the Great Depression.
The declaration was a bit premature. Yes, unemployment was down from the horrifying 25% levels of the worst of the Depression, but it was still horrendous at more than 14%. The economy had begun to grow again, but 1937's gross domestic product of $88 billion was still lower than it had been in 1930 ($97 billion).
The emergency seemed to be over, however, and many in the New Deal, including Roosevelt's Treasury secretary, Henry Morgenthau, were deeply uncomfortable with the idea of running what looked very much like a permanent budget deficit. The annual deficit had peaked at $5.9 billion (yes, I know how quaint these numbers are in the days of trillion-dollar deficits), but it was still a shockingly high $5.5 billion in 1936.
You have to do a bit of number crunching to realize exactly how high a $5.5 billion annual deficit seemed then. It represented 7.7% of GDP and a huge 110% of the federal government's total annual revenue.
Erasing the deficit -- and the recovery
In 1937, the Roosevelt administration and the Federal Reserve moved to reverse many of the extraordinary measures they'd taken to fight the Depression. In 1937, the federal deficit was cut to $2.5 billion from the previous year's $5.5 billion as Roosevelt and Congress slashed spending by 18%. In 1938, spending dropped still further, 10% down from the level of 1937.And the annual deficit just about vanished. The government ran an almost-balanced budget that year with a deficit of a mere $100 million.
The Federal Reserve moved in the same direction. After pursuing policies that had resulted in an average 11% annual increase in the money supply in the previous four years, the Fed reversed course at the beginning of 1937 and began to contract the money supply, raising reserve requirements twice, the second time in the spring.
Continued: Could it happen again?
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