The Economist who Said 1929 Stock Prices Weren't Too High
The Depression contemporary Irving Fisher, whom Milton Friedman referred to as “the greatest economist of the twentieth century,” proclaimed in September 1929 that “stock prices are not too high and Wall Street will not experience anything in the nature of the crash.”
He continued to be optimistic through 1930 and 1931, having invested his wife’s and sister-in-law’s fortunes in stocks. But by January 1932, with the evidence mounting that something greater was at work, he developed a thesis that overindebtedness, challenged by a shock such as a stock market selloff, might set off a self-reinforcing deflationary spiral characterized by forced liquidation.
Liquidity became a focus of his attention, particularly in the mid – 1930s, after it was apparent that one third of the “ cheque – book money ” had been destroyed by the waves of bank failures culminating in the bank holiday of 1933. He advised Roosevelt to scrap the gold standard and was an advocate of reflation as a way of cleansing the debt overhang and restoring the growth of credit.
If one views the period through the explanation of Fisher’s debt deflation theory, the recovery from the Great Depression can be explained by economic actors having repaid debt or had debt extinguished through bankruptcy by 1942, making them feel freer to make use of low interest rates and exploit profitable business expansion.
In 1942 total debt including federal, state, and household had fallen to less than 160 percent of GDP from a peak of 300 percent in 1932. That low level had not been seen since 1918, well before the roaring twenties.
No econometric regression analysis could detect this sort of causation, because in the years leading up to the big turn in the economy decreasing leverage would be coincident with weakening consumer demand and increasing savings. Then all of the sudden decreasing leverage would act like a dry forest floor, ready to be ignited by the flames of rearmament.
One could argue that the brief period of federal borrowing was stimulative, but it might not have been so had it occurred in the early 1930s when the populace was highly indebted and excess capacity had not been flushed away.
True there were powerful rebounds in the 1930s, but they were neither sustainable nor did they return business to normal profitability and put people back to work in a meaningful way.
[Editor’s note: This passage is reprinted from William W. Baker’s book, Endless Money: The Moral Hazards of Socialism, with the permission of John Wiley & Sons, Inc (©2010). You can get your own copy here.]