I. The Great Inequality of the 1920s mirrored our own time
A Statistical Portrait of the 1920s shows a vibrant and expanding continent-wide economy, that represented the largest creditor nation on the planet, but marred by a very unequal distribution of wealth:
While productivity surged over 30% in that period, worker's incomes increased only 11%.
Moreover, over 70% of American families lived in relatively strapped conditions according to the statistical abstract. The financial gains of the 1920s were vaccuumed by the very top strata:
Minimum income deemed necessary for a decent family standard of living: $2500
Percentage of American families with incomes under $2500 in 1929: 71%
Distribution of Wealth
Rise in per capita income for nation as a whole: 9%
Rise in per capita income for top 1% of population, 1920-1929: 75%
Percentage of savings held by top .1% of Americans: 34%
Percentage of savings held by top 2.3% of Americans: 67%
Percentage of American Families with no savings: 80%
[Today, the top .1% once again owns 34% of the wealth; the top 5% owns 60%.]
Or, as more fully set forth in Main Causes of the Great Depression
the rewards of the "Coolidge Prosperity" of the 1920's were not shared evenly among all Americans. According to a study done by the Brookings Institute, in 1929 the top 0.1% of Americans had a combined income equal to the bottom 42%. That same top 0.1% of Americans in 1929 controlled 34% of all savings, while 80% of Americans had no savings at all.... This maldistribution of income between the rich and the middle class grew throughout the 1920's. While the disposable income per capita rose 9% from 1920 to 1929, those with income within the top 1% enjoyed a stupendous 75% increase in per capita disposable income.
A major reason for this large and growing gap between the rich and the working-class people was the increased manufacturing output throughout this period. From 1923-1929 the average output per worker increased 32% in manufacturing. During that same period of time average wages for manufacturing jobs increased only 8%. Thus wages increased at a rate one fourth as fast as productivity increased. As production costs fell quickly, wages rose slowly, and prices remained constant, the bulk benefit of the increased productivity went into corporate profits. In fact, from 1923-1929 corporate profits rose 62% and dividends rose 65%.
Three quarters of the U.S. population would spend essentially all of their yearly incomes to purchase consumer goods such as food, clothes, radios, and cars. These were the poor and middle class: families with incomes around, or usually less than, $2,500 a year. The bottom three quarters of the population had an aggregate income of less than 45% of the combined national income; the top 25% of the population took in more than 55% of the national income.
If, exactly like today, the middle and working classes were not sharing in the huge expansion of overall wealth in the 1920s, from a truly robust and growing national economy, there was another innovation which allowed them to at least think -- again, just like today -- for a while that they were on their way to riches: installment consumer credit.
II. The 1920s Credit Bubble spawned 3 asset bubbles
In a major paper by the Bank for International Settlements, "The Great Depression as a Credit Boom gone Wrong" Barry Eichengreen and Kris Michener (2003) set forth how the dramatic expansion of credit in the 1920s set the stage first for overconsumption, and then the drastic decline of the great depression:
The 1920s was a decade of expansion, reflecting recovery from World War I, new information and communications technologies like radio, and new processes like motor vehicle production using assembly-line methods. Accounts of the twenties in the United States ... emphasize the ready availability of credit, reflecting the ample gold reserves accumulated by the country during World War I, the stance of Federal Reserve policies, and financial innovations ranging from the development of the modern investment trust [i.e., mutual fund] to consumer credit tied to purchases of durable goods like automobiles. Credit fueled a real estate boom in 1925, a Wall Street boom in 1928-9, and a consumer durables spending spree spanning the second half of the 1920s. That these booms developed under the fixed exchange rates of the gold standard meant that they generated little inflationary pressure at home and that their effects were transmitted to the rest of the world. Absent overt signs of inflation, the Fed had no reason to raise the official short-term rate.
Graphically shown, we can see that the 1920s featured a property boom that peaked in 1925 (just as our own peaked in 2005-2006) but wages continued to climb until 1929:
Let's examine these bubbles one at a time.
III. The 1920s real estate bubble
Just as Alan Greenspan and the Fed lowered interest rates to 1% in 2002 and kept them there until mid-2004, to forestall a deflationary unwinding of the dot-com bubble (and perhaps to help in the election of George Bush to the presidency in 2004), so too the Fed in the early 1920s lowered rates to forestall an unwinding of debts incurred in World War I -- with the same result: a real estate bubble, in the case of the 1920s, centered on but not exclusive to Florida . As Eichengreen and Michener explain:
This earlier credit boom may have similarly had roots in interest rate cuts taken by the Fed in 1924-5 to help Britain back onto the gold standard. Whatever the motivations for the policy, there is little reason to doubt that monetary ease lay behind the property boom. In the words of Vanderblue (1927a, p.116), " [t]he relatively low yield on high-grade investments made it possible to tempt investors into purchasing real estate bonds...secured by new structures located in the boom territory"
But the 1925 boom was relatively minor and short-lived compared to what came after .... By 1927 investment in real structures had declined by six per cent from its 1925 peak. Real investment declined from its peak because of the big decline in detached structures investment after 1925. Nevertheless, a frenzy of apartment building followed the detached dwelling boom (peaking in 1927), and a building spree in nonresidential structures continued through 1929 (Field 1992).
Several sources from the late 1920s confirm that residential real estate was declining after 1925, but the 1920s equivalent of suburban office centers and strip malls continued to boom, for example in Chicago; in Manhattan as described in a NY Times preview of real estate in 1928:
The real estate market during 1927 showed a recession as compared with 1926 and a still greater decline when the figures of 1925 are considered.
and right up until the ultimate decline in 1929 as described in the 1929 Fed report on economic conditions (warning: pdf)
The building industry, in contrast to manufacturing and agriculture, experienced a recession of constantly increasing severity throughout the year. The total of contract awarded for all types of building in the easter states was 13 percent smailler than in the preceding year. This depression in building, which began in the middle of 1928, followed four exceptionally active years. The decline in building in 1929 was confined almost wholly, however, to residentail structures, and industrial and commercial building , influenced by increased activity in industry, reached a larger total value than in any other recent year.
That commercial real estate can continue to boom after residential real estate declines, but almost always eventually follows, is something readers of Calculated Risk already know.
IV. The 1920s Consumer Installment Credit Bubble
The great financial innovation of the 1920s, akin to the mass securitisation of mortgage debt in our own time, was the tremendous growth of Installment Plans, i.e., buying on credit. Much as in our own day, in the 1920s, the "modern" consumer was the one smart enough to base financial acquisitions on "how much is the monthly payment?" The great change was started by General Motors, which discovered a way to increase sales of its vehicles dramatically by way of the auto loan:
The idea of being in debt had always been looked down upon by the American public, yet the expansion of the market for consumer durables depended upon an increase in credit transactions. The birth of the automobile instalment finance company [GMAC] in 1919 provided the foundation for this transformation, creating a successful example of instalment selling in a major industry.
The catalyst to this change, however, lay not in the mere availability of instalment credit but in the selling of the concept of debt through advertising.... By 1929, these advertisements reflected the general acceptance of instalment buying as a way to finance consumption and demonstrated that this shift in attitudes had reached its completion.
With the spread of credit between 1919 and 1929, the percentage of households buying cars on instalment more than tripled, rising from 4.9% to 15.2%.18 ....
With this dramatic increase in the instalment selling of automobiles came the expansion of this technique into the markets for other major durable goods. According to credit expert Rolf Nugent, the success of automobile instalment plans "tended to remove the stigma which instalment selling had acquired at the hands of low-grade instalment merchants in the 1890s." In fact, credit was used in the purchases of up to 90% of major durable goods by the end of the 1920s. Average purchases of major durable goods rose from 3.7% of disposable income between 1898 and 1916 to 7.2% between 1922 and 1929. Accompanying this rise in purchases of durables was a drop in the personal savings rate, from 6.4% of disposable income in the former period to 3.8% in the latter.
It wasn't just banks and large entities like GMAC that extended credit. Just like the explosive growth of "mortgage brokers" during the early part of this decade, in the 1920s 1,500 installment credit companies sprang up, competing with one another and with banks to lend easy credit to the masses:
To be sure, rising household incomes supported the growth of consumption, but financial institutions aggressively competing to supply households with credit allowed consumer spending to rise even faster than personal income. The most prominent case is the United States, where consumer debt as a percentage of personal income doubled from 4.2 per cent in 1918-20 to more than 9 per cent in 1929.
with some predictable and familiar results:
the availability of credit was enhanced by financial innovation, which provided channels for liquidity to flow to technologically dynamic sectors. In the 1920s the innovations in question included the new techniques for marketing securities to individual investors and the spread of the investment trust. In Perez=s view, the infusion of liquidity into the markets leads to easy capital gains, which in turn encourage "ethical softening"
But the outcome of this easy credit was a spectacular increase in consumer indebtedness, together with an equally dramatic decline in consumer savings -- both situaations totally familiar to us today. As set forth in the Statistical Portrait of the 1920s there was an explosion of consumer debt:
1925: $1.38 Billion (Consumer Credit outstanding)
1927: 15% of all consumer durables bought on installment payments
60% of automobiles bought on installment payments
80% of radios bought on installment payments
1929: $3 Billion (Consumer Credit outstanding)
$7 Billion (Total Consumer Goods purchased on Credit)
In summary, consumer credit underwent explosive growth in the 1920s. This growth meant that consumers were proverbially "loaded to the gills" with debt. Remember that some 80% of American families in the 1920s had no savings to fall back on if the (usually sole) breadwinner lost his job.
To make matters worse, installment credit loans had a hair trigger: if the consumer missed even one payment, the car, radio, furniture, or other durable good purchased could be immediately repossessed, the consequence of which was to prove devastating to the economy in 1929.
V. The Stock Market Margin credit bubble
I am sure you are very well familiar with this bubble, but let cite you one fact you may not already know:
Between the end of 1927 and October 1929, loans to brokers rose 92 percent. At the start of October, loans equaled nearly a fifth of the value of all stocks....
VI. When the credit bubble burst, consumers hit the wall
Initially, the 1929 depression was no worse than the business depressions of 1923 or 1927. For example, the 1929 Fed report on economic conditions noted:
[T]his reduction in employment, severe though it was (and it involved the discharge of over 700,00 workers between the time of the seasonal peak in September and December) did not approach in magnitude the decline in the years 1923 and 1924.
But that was no matter. The over-reliance on consumer credit now wreaked havoc with the economy:
What made matters worse was a big drop in U.S. consumer spending—far more than can be explained by the stock market crash. The drop may have been a backlash to the rise of installment lending (for cars, furniture, and appliances) in the twenties. The prevailing practice allowed lenders to repossess an item if the borrower missed just one payment. People may have stopped making new purchases to reduce the risk of losing things they already had bought on credit. Whatever happened, the slump soon fed on itself. Weak spending depressed prices, which meant that many farmers, businesses, and nations couldn't repay their debts. Rising bad debts prompted banks to restrict new loans and sell financial assets, usually bonds. Scarce credit led to less borrowing, less spending, lower prices, and more bankruptcies. Trade and investment spiraled downward.
As another essayist put it:
The market crashes undermined ... confidence. The rich stopped spending on luxury items, and slowed investments. The middle-class and poor stopped buying things with installment credit for fear of loosing their jobs, and not being able to pay the interest. As a result industrial production fell by more than 9% between the market crashes in October and December 1929. As a result jobs were lost, and soon people starting defaulting on their interest payment. Radios and cars bought with installment credit had to be returned. All of the sudden warehouses were piling up with inventory. The thriving industries that had been connected with the automobile and radio industries started falling apart.
Today, it may be said, we do not have the draconian repossession practices of the consumer installment loans of the 1920s. But what we do have are payday loans, and the "universal default" provisions of most credit cards, and the ability of credit card issuers to unilaterally change the (usurious) terms of their payment plans. Consumers may not immediately stop purchasing, as they did in 1929, but the 2005 bankruptcy "reforms" ensure that they will not have the ability to make new purchases as they are forced, possibly for years, to service their old credit card debts, ensuring if not a sudden depression, then instead a long, slow motion bust.
An examination of the 1920s credit bubble is proof of Mark Twain's quip that "History may not repeat, but it does rhyme."
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