Review of Austrian Economics

White’s Free-Banking Thesis A Case of Mistaken Identity

Larry J. Sechrest

Lawrence H. White’s fascinating work entitled Tree Banking in Britain: Theory, Experience, and Debate, 1800–1845 has had a not inconsiderable impact upon monetary economists. Everyone seems now to be, at the very least, aware of the issues relevant to the free banking versus central banking controversy. (Of course, White is not alone in his endeavors. See also the recent work of Rolnick and Weber,1, 2, 3, 4 Rockoff,5 and Rothbard6.) Furthermore, White’s depiction of the Scottish system between the years 1695 and 1845 appears to have gone unchallenged as to its historical accuracy. This article examines several of White’s key assertions, as well as several tangential ones, in light of the available historical documentation. Wherever possible, sources are quoted rather than paraphrased so as to reduce to a minimum any interpretive bias.

What emerges from the process is the realization that—rather than White’s model of a laissez-faire system devoid of a central bank, solidly based upon the unquestioned convertibility of notes into specie, with each bank bearing its full liquidity costs by holding its own specie reserves—the Scottish system was de facto a central bank system in which individual private banks pyramided their note issues upon the reserves of the three chartered banks, which, in turn, pyramided their issues upon the reserves of the ultimate source of liquidity for the entire British Isles: the Bank of England. In short, White’s thesis that the Scots enjoyed free banking fails to be supported by the evidence.

Parenthetically, I would like to point out that I draw these conclusions despite the fact that I am myself an advocate of free banking. White’s theoretical model is elegantly stated and, furthermore, workable in the real world. It is simply in trying to fit the Scottish experience to that model that White goes astray.

Convertibility of Notes

First of all, it behooves me to clarify just what is necessary if one is to have “free banking.” White defines it as “the unrestricted competitive issue of specie-convertible money by unprivileged private banks” (p. ix). Vera C. Smith adds that (1) notes issued by such banks must be redeemable upon demand for gold and (2) such banks should not be able to “call upon the Government or any other such institution for special help in time of need.”7 It should be, in other words, a “system of ‘each tub on its own bottom’,” to quote White himself (p. 43).

There must be neither—if a given system is to be categorized as free banking—frequent refusals to redeem notes for specie nor regular recourse to a central bank in order to fulfill the bank’s liquidity needs. Those needs should be met via “interbank lending of existing reserves” within the system.8 Furthermore, notes should (if truly convertible on demand) trade at par with gold coin. Finally, as White claims for the Scottish banks, a free banking system should be conducive to stable economic growth rather than to successions of crises.9

Of the numerous citations that follow, the lion’s share goes to the man who has written the definitive history of Scottish banking, Professor S.G. Checkland of the University of Glasgow.10 Please notice that my reliance upon Checkland is fully consistent with White’s own statements: in Free Banking in Britain, White refers to “S.G. Checkland’s authoritative chronicle of the industry” (p. 33), while in personal correspondence, White declares that Checkland “is, of course, the authority on the facts.”11 Other citations will be from Vera C. Smith, Adam Smith, Frank W. Fetter, Ludwig von Mises, and Henry Meulen—all mentioned in White’s book.

Certainly a cornerstone of the Scottish system as White portrays it is the absolute convertibility of bank notes into specie upon demand. Admittedly, before 1765, Scottish banks sometimes failed to redeem on demand because they utilized the “option clause,” which allowed the bankers (at their discretion, not that of the note holder) to delay redemption for six months in exchange for the payment of interest—usually 4–5 percent—on the notes held.12, 13 But what of after 1765, the year in which both the option clause and notes smaller than £1 were declared illegal?

Frank W. Fetter states that: “To a large degree there was a tradition, almost with the force of law, that banks should not be required to redeem their notes in coin. Redemption in London drafts was the usual form of paying noteholders.”14 Checkland confirms this:

The Scottish system was one of continuous partial suspension of payments. No one really expected to be able to enter a Scots bank, perhaps especially a public bank [the Bank of Scotland, the Royal Bank and the British Linen Bank were publicly chartered institutions], with a large holding of notes and receive the equivalent immediately in gold or silver. At best they would get a little specie and perhaps bills on London.15

Checkland adds that: “Much emphasis was laid on the loyalty of the banks’ customers—requests for specie met with disapproval and almost with charges of disloyalty.”16

Henry Meulen—himself no friend to the gold standard—alleges that the typical Scottish banker “paid notes instead of gold to any depositor who might call, and was thus able to operate with a smaller reserve of gold than would otherwise have been necessary.”17

Nor are these quotations the only such comments on the issue of convertibility. Meulen18 and Checkland19 both make additional comments that do not depart significantly from the statements already cited and that, therefore, will not be quoted here. The unambiguous nature of the foregoing compels one to question seriously White’s claim that Scottish bank notes were redeemable in gold upon demand.

If notes were often not readily redeemable in gold coin, then one may fairly ask: why would bank customers be so willing to accept them? Why, in other words, was most Scottish business conducted entirely in terms of bank notes? (That this latter state of affairs was indeed the case is confirmed by Checkland,20 Vera Smith,21 and Adam Smith.22) The answer is of two levels. (1) The banks, in their quest for profits, sought the greatest possible circulation for their respective notes. To accomplish such circulation, they offered very easy repayment terms to those who had discounted bills of exchange and were willing to accept notes rather than specie.23 (2) It became accepted practice for merchants who had received said bank notes to either require their employees to accept their wages in those notes rather than coin or to offer higher wages to those employees who were willing to do so.24

Notice what is implicit in the preceding: if notes were truly convertible on demand and, therefore, traded at par with specie—as White claims was the case—why were such inducements necessary? This suggests that notes perhaps did not trade at par. And, indeed, there is evidence that they did not. Adam Smith records that, in regard to transactions involving bills of exchange in the towns of Carlisle and Dumfries, notes traded at 4 percent below par because “at Carlisle, bills were paid in gold and silver; whereas at Dumfries they were paid in Scotch bank notes.”25 Meulen certainly concurs: “There were frequent instances of notes circulating at a discount for months on account of diminution of public confidence in the bank of issue and inability to apply for immediate redemption of the paper in coin.”26 As Mises has stated with characteristic clarity, the only way to prevent money-substitutes such as notes from trading at a discount against money (gold coin in the British case) is to guarantee their prompt and unconditional conversion into money on demand.27 Conversely, if one witnesses notes trading below par, one can safely conclude that the reason is the failure to redeem them for specie.

Privileged Banks

Recall White’s definition of free banking as involving “unprivileged private banks” (emphasis is mine). At least one other commentator disagrees with White’s claim that such a characteristic was present in the Scottish system. Checkland states categorically that “the three public institutions (Bank of Scotland, Royal Bank, and British Linen Bank) enjoyed limited liability [the private banks and the joint-stock banking companies were all subject to unlimited shareholder liability] and so were in a preferred position relative to all others.”28 Later he notes that “the State had created two public banks [and later added the third] and continued to confirm their preferred position, through their limited liability and through their public identity and perpetual succession.”29 To this can be added the observation that “there was a longstanding government instruction to the officers of the customs to accept only the notes of the chartered banks in payment of duties, and to ‘refuse the Notes of every other bank without exception’.”30 Clearly, there were privileges held by the chartered banks that were denied to all others.

Along with these privileges, however, there apparently were attendant responsibilities. The three chartered banks were expected to function somewhat like local reserve banks for the private bankers and the joint-stock banking companies. Notice, for example, that during the 1797–1821 suspension of specie payments, the large private firm of William Forbes and Co. paid its depositors not with its own notes but with the notes of the public banks.31 Indeed, “it became the custom of other banks, both private bankers and provincial banking companies, to hold part of their cash in the notes of the public banks, rather than hold cumbersome gold. When there was a demand for coin at crisis times, such banks would pay out such notes, telling their clients to go to the public banks for specie.”32 Fetter clearly confirms this when he states that “Scottish private banks held most of their reserves in the notes and deposits of the chartered banks of Scotland.”33 This practice would, of course, compel the chartered banks to maintain large liquid reserves on behalf of the other banks, this being a key manifestation of the “traditional responsibility of the older chartered banks of Scotland to keep the system in order.”34

Furthermore, it should be pointed out that the few existing records of the public and private banks do seem to bear out the previously mentioned relationships. The average reserve ratio of specie to demand liabilities for six provincial banking companies was 10 to 20 percent in the late eighteenth century, but dropped to 0.5 to 3.2 percent in the early nineteenth century.35 By comparison, the average ratio of investments and liquid assets to total assets for the Royal Bank and the Bank of Scotland for the years 1814, 1817, 1819, 1822, 1823, 1825, 1833, and 1838 was 48.4 percent as opposed to 35 percent for the three public banks together in 1802.36 In other words, as the private banks and provincial banking companies continued to economize on specie by redeeming notes less and less often, the public banks held ever more liquid assets to serve as a cushion for the others. I want to emphasize here that the extant data are quite sketchy, so only the most general of conclusions can be justified; nevertheless, the data do not seem to contradict what one might expect given the foregoing quotes from Checkland and Fetter.

Stability of the System

What of the cyclical stability of the Scottish system? White refers to the “relative mildness of Scottish cycles”37 and produces a table of bank failures (1809–30) in the English and Scottish systems, respectively, which demonstrates that the percentage of bank failures during that period was greater in England (1.81 percent to 0.40 percent).38 First of all, I must comment that that percent difference does not seem tremendously large intuitively even though statistically the percentages are significantly different at the 1 percent confidence level. More importantly, if one reviews the entire “free-banking” period (1765–1845, according to White), the picture changes somewhat dramatically.

White depicts the Ayr Bank failure of 1772 as relatively minor in import, having brought about an increase in money demand in Edinburgh for less than a day, and as an incident that “did not imperil the Scottish banking system as a whole.”39 Checkland sees it a little differently. He maintains that “no less than thirteen Edinburgh private bankers fell with the Ayr Bank, never to rise again.”40 However, Checkland does agree with White that little permanent damage was done to the system as a whole.41

The point is that if one looks at the period 1772–1830 in regard to Scottish bank failures, one finds that the inclusion of the 1772 closures as well as the seven failures that occurred between 1773 and 1808 changes White’s ratio noticeably.42 The mean average of the annual Scottish bank failures per thousand banks becomes 13.28, whereas the comparable figure for English banks (1809–30) is 14.1 or 18.1—depending on whether one uses Gilbart’s or Pressnell’s data.43 But in either case, the failure rates of Scottish and English banks are now not statistically different at the 1 percent confidence level.

It also may be noted that financial crises seemed to hit Scotland very frequently—specifically, in 1762–64, 1772, 1778, 1787, 1793, 1797, 1802–03, 1809–10, 1818–19, 1825–26, 1836–37, and 1839.44 Further, Checkland’s description of the expansionary phases that preceded each “crisis” sounds much like the scenario of credit-induced malinvestment that lies at the heart of the classic Misesian business cycle. Checkland sums it up well when he states: “In principle, it [the Scottish system] should have been capable of stability or, at least, of fairly easy contraction. In reality, it was not.”45 Due, perhaps, to its being established upon the wrong principle?

And how, one may ask, did the Scottish banks extricate themselves from these frequent liquidity crises? Did they, as White claims, solve the problem among themselves via interbank loans?46 Although such interbank loans do seem to have occurred, the largest and most frequent loans were from that paradigm of central banking, the Bank of England. I will cite but a few of the many examples of such loans. (1) In the crisis of 1793, a total of £404,000 was granted to several Scottish banks. (2) When the Ayr Bank failed in 1772, the first place it sought a loan—for £300,000—was the Bank of England. (After rejecting the Bank of England’s terms, the Ayr Bank asked for £50,000 each from the Royal Bank and the Bank of Scotland—and was turned down.) (3) In November 1830, the “Royal Bank negotiated a credit with the Bank of England of £500,000; the Bank of Scotland, one of £200,000.”47

To confirm that the foregoing were not isolated incidents, please observe the following summary declaration by Checkland: “By 1810, the Bank of England, short of the state itself, was the effective final arbiter of the supply of liquidity, both for England and Scotland.”48 Fetter adds that “it [the Bank of England] was also the holder of the nation’s gold reserve. The country and joint-stock banks, and the Scottish and Irish banks, either directly or through the London money market, turned to it in time of crisis.”49 This certainly seems to establish the Bank of England as the lender of last resort for the whole British Isles rather than just for England, as White tends to argue. Furthermore, those who might object that recourse to the London money market does not necessarily imply recourse to a central bank need to refute Checkland’s statement that the Bank of England directly controlled both interest rates and the supply of credit in London.50

In addressing the issue of how to gain monetary autonomy for Scotland (something White apparently thinks the Scots had throughout the period under consideration), Checkland, who clearly thinks no such autonomy existed, asserts that:

most important of all, it would be necessary for Scottish banking to hold its own gold reserve . . . conversely, Scottish banking, by placing itself outside the London system, would relieve the Bank of England of the need to hold bullion reserves against Scottish demands for liquidity . . . [yet] a willing Scottish dependence upon London had been apparent from the founding of the Bank of Scotland in 1695 . . . The Scots in expelling their gold by the vigour of their note issue, basing their banking system on the latter, had made themselves ultimately dependent upon London liquidity.51

How such circumstances can fail to contradict any “free banking” hypothesis I do not understand.

Further Difficulties

The institutional link between the individual private banks and joint-stock banking companies, on the one hand, and the Bank of England as lender of last resort, on the other hand, seems to have been the three chartered “public” banks—the Royal Bank, the Bank of Scotland, and the British Linen Bank. I have already noted that the nonpublic banks often redeemed their notes and deposits in the notes of the public banks, rather than in specie (i.e., much of the reserves of the nonpublic banks were held in the form of public bank notes). Similarly, “the three chartered banks of Scotland kept their reserves largely in deposits with the Bank of England.”52 And apparently the chartered banks had a ready source of liquidity in the Bank of England, for Checkland says that “the Royal Bank had access to and credits from the Bank of England from 1728, whereas the Bank of Scotland did not gain such facilities until 1791.”53

This suggests the potential for the pyramiding of an excessive note issue upon inadequate reserves, but it does not establish that such monetary expansion actually took place. Indeed, in the absence of any reliable economic data for Scotland separate from the rest of the kingdom, one could probably never demonstrate either the truth or falsity of such a proposition in a modern quantitative way. Nevertheless, one does have some qualitative evidence: “The Scottish banks had developed so compelling a set of means for getting and keeping their paper in circulation that, in non-crisis times at least, they could provide an extraordinarily high level of liquidity, with accompanying danger.”54 No less an authority than Adam Smith went so far as to say that “the circulation (in Scotland) has frequently been over-stocked with paper money . . . The Bank of England paid very dearly, not only for its own imprudence, but for the much greater imprudence of almost all the Scotch banks.”55

Meulen asserts that “it transpired that at times when gold was being drained both from Scottish and English banks the Scottish bankers had not restricted their note issue, but had withdrawn gold from the Bank of England to support their credit system.”56 Notice that this directly contradicts the fact that in a true free-banking system, even when a number of banks expand and contract their note issues together, a loss of specie from the system necessitates, ceteris paribus, a decrease in the total note issue.57 Meulen’s assertion seems much more in keeping with a central banking system in which there is a single lender of last resort, but a multiplicity of issuers of notes and demand deposits. This latter is what I believe the Scottish system actually to have been.

Two important means by which “free banks” allegedly compete are the discounting of commercial bills and the payment of interest on deposits. If it were the case that these operations were seriously constrained by law, then one might conclude that a significant characteristic of free banking was absent. That appears to be applicable to Scotland. In 1714, a Usury Law was passed which set an upper limit on interest paid of 5 percent. This law was not changed until nearly the end of “free banking”—1833—at which time, bills of exchange and promissory notes were exempted from its provisions.58 Checkland declares that “the Usury Law limited competition for deposits”59 and, indeed, its effect on “any form of advance was seriously prohibitive,”60 which conclusion is also expressed by Meulen.61

Three additional inconsistencies should be noted. Admittedly, they involve tangential issues which are, by themselves, trivial; yet they are perhaps instructive in that they may reveal inadequate research on White’s part. White claims that Britain’s first bank to ever make public its annual report was the joint-stock Union Bank of Glasgow in 1836.62 Yet Checkland, in his chapter on banking practices from 1810 to 1850, states that the officers of the public banks and the joint-stock banks were very secretive and that “none of the joint-stock banks printed and circulated their annual reports.”63

Also, according to White’s list of Scottish bank failures (1809–30), there were no failures in 1821.64 However, Checkland states that in 1821, both the Galloway Bank and the Kilmarnock Banking Company went under.65

Finally, White declares that “private bankers in Edinburgh did not issue notes, whereas provincial banks typically were banks of issue.”66 In contrast, Checkland remarks that Edinburgh private bankers did indeed issue notes—although not before the 1760s and not in any great quantity.67

Conclusion

This article has examined in some detail the historical evidence regarding Scottish banking in the eighteenth and early nineteenth centuries. The focus has been upon the following question: is Lawrence White’s contention that this period was one of free banking supported by other commentators? The unavoidable answer—and one that I accept with regret—is that the evidence does not support White on several key points.

First and foremost, the Scottish banks do not seem to have actually practiced note convertibility (into specie). They also had frequent recourse to the Bank of England as their primary source of liquidity in time of crisis. The three chartered banks possessed both privileges and responsibilities that were not possessed by the private banks and the joint-stock banking companies. Overall, the system does not appear to have been very productive of stable economic conditions: expansionary, inflationary periods were followed with rapidity by contractionary, deflationary periods. The source of such fluctuations seems to have been largely the Bank of England, an observation consistent with the 1810 Bullion Committee’s report that “the circulation of the Bank of England had an important influence on the circulation of the country banks and of the Scottish banks.”68 (As evidence of this, one may notice that, for example, in 1818, the Bank of England restricted both money and credit, and prices in Glasgow plummeted—sugar, grain and timber by about 33 percent, cotton by 50 percent—while commercial bankruptcies in Glasgow and Aberdeen hit new highs.69)

But was this a straightforward central-bank system with one issuer of notes? Clearly not. There was indeed competition in note issuance as well as some competition (limited due to the Usury Law) in advances and deposit issuance. Yet there was, unmistakably, a single lender of last resort—a single ultimate source of liquidity. Thus, there also was some pyramiding of notes upon inadequate specie reserves. This was a hybrid system: part free banking, part central banking, possessing both the virtues of the former and the vices of the latter.

The author is indebted to Murray N. Rothbard for the suggestion that this line of inquiry might prove productive.

Review of Lawrence H. White, Free Banking in Britain: Theory, Experience, and Debate, 1800–1845 (Cambridge, Eng.: Cambridge University Press, 1984).

• 1Historical Statistics of the United States, part 1 (Washington, D.C.: 1975), series D-86 for unemployment rates and series F-32 for gross national product. Throughout this article, the standard data series for unemployment rates are used, with recognition that there has been a challenge to the validity of those data during the Great Depression years. See Michael R. Darby, “Three-and-a-Half Million U.S. Employees Have been Mislaid: Or An Explanation of Unemployment, 1934–1941,” Journal of Political Economy 84, 1976.
• 2A.C. Pigou, Industrial Fluctuations, 1st ed. (London: Macmillan, 1927), p. 176.
• 3A.C. Pigou, Theory of Unemployment (London: Macmillan, 1933), p. 252. Pigou makes his arguments in a variety of other places. For example, see his “Real and Money Wage Rates in Relation to Unemployment,” Economic Journal 47, 1937, and “Money Wages in Relation to Unemployment,” Economic Journal 48, 1938.
• 4It is perhaps something of an exaggeration to ascribe this position entirely to Pigou. A number of other economists espoused similar views. Recognizing that the list is incomplete, we cite a few, beginning with Jacob Viner, Balanced Deflation, Inflation, or more Depression (Minneapolis, Minn.: University of Minnesota Press, 1933), especially pp. 12–13. See also W.H. Beveridge, Causes and Cures of Unemployment (London: Longmans, Green and Co., 1931), p. 25, and Unemployment, A Problem of Industry (London: Longmans, Green and Co., 1930), chapter 16; Wilford I. King, The Causes of Economic Fluctuations (New York: Ronald Press Co., 1938), chapter 8; and Lionel Robbins, The Great Depression (New York: Macmillan, 1934).
• 5John A. Hobson, The Economics of Unemployment (New York: Macmillan, 1923), p. 84.
• 6W.T. Foster and W. Catchings, Profits (Boston: Houghton Mifflin, 1925) and Business Without a Buyer (Boston: Houghton Mifflin, 1927); and C.H. Douglas, Credit-Power and Democracy (London: C. Palmer, 1920) and Warning Democracy (London: C.M. Grieve, 1931). A more recent interpretation of the Great Depression with underconsumptionist overtones in John Kenneth Galbraith, The Great Crash, 1929 (Boston: Houghton Mifflin, 1976).
• 7Murray N. Rothbard, America’s Great Depression (Princeton, N.J.: Van Nostrand, 1963), p. 45.
• 8Henry Ford, The New York Times, November 22, 1929, p. 2.
• 9The New York Times, November 22, 1929, p. 1. It is interesting to note that Hoover’s inclinations toward underconsumptionism were recognized and, of course, approved, by trade unionists. Witness a statement by the AFL’s John P. Frey in 1929 relating to a public works scheme of Hoover’s. In effect, Frey argued that the president was in agreement with the AFL’s position that depressions were the result of underconsumption and low wages. See Joseph Dorfman, The Economic Mind in American Civilization (New York: Viking Press, 1959), vol. 4, pp. 349–50. See also Ronald Radosh, “The Development of the Corporate Ideology of American Labor Leaders, 1914–1933” (doctoral dissertation in history, University of Wisconsin, 1967).
• 10Rothbard, America’s Great Depression, chapter 8. Not to be ignored is the fact that ideas such as those that enamored Hoover were not as unorthodox among professional economists as sometimes claimed. See J. Ronnie Davis, The New Economists and the Old Economists (Ames, Iowa: Iowa State University Press, 1971). Davis presents an interesting array of statements by economists and other academics relating to the issue of the impact of wage reductions on the economy (pp. 94–99).
• 11John M. Keynes, The General Theory of Employment, Interest and Money (London: Macmillan, 1936).
• 12Abba P. Lerner, “Mr. Keynes’ ‘General Theory of Employment, Interest and Money,’” International Labor Review 34, 1936. See also W.B. Reddaway, “The General Theory of Employment, Interest and Money,” Economic Record 12, 1936. A systematic description of the thought of this time is contained in Lawrence R. Klein, The Keynesian Revolution (New York: Macmillan, 1947). For a taxonomic description of the various views of the aggregate demand schedule for labor, see Sidney Weintraub, “A Macroeconomic Approach to the Theory of Wages,” American Economic Review 46, 1956.
• 13Paul M. Sweezy, personal letter to John B. Shelley, dated February 11, 1977, cited in Dana C. Hewins and John B. Shelley, “Sweezy’s Kink: Macro Foundations of a Micro Theory,” Economic Inquiry 17, 1979.
• 14For a description of the various dimensions of the Keynesian critique of classical economics, see Alvin H. Hansen, A Guide to Keynes (New York: McGraw-Hill, 1953). More recent appraisals and restatements of the total thrust of Keynesianism are Abba P. Lerner, “From ‘The Treatise on Money’ to ‘The General Theory,’” Journal of Economic Literature 12, 1974; and Hyman P. Minsky, John Maynard Keynes (New York: Columbia University Press, 1975).
• 15Peter Temin, Did Monetary Forces Cause the Great Depression? (New York: Norton, 1976), p. 140. Temin also attempts to demonstrate that the Great Depression was brought on by an autonomous shift in the consumption function. That view has been challenged (successfully, we think) by Thomas Mayer, “Consumption in the Great Depression,” Journal of Political Economy 86, 1978.
• 16Keynes, The General Theory. In chapter 2, Keynes is very explicit. In reference to the principle that real wages and employment are systematically related, he says, “I am not disputing this vital fact which the classical economists have (rightly) asserted as indefeasible.”
• 17Ludwig von Mises, The Theory of Money and Credit (New Haven, Conn.: Yale University Press, 1953). Permission granted by Mrs. Margit von Mises. Quotes from 1981 Liberty Classics, Indianapolis, edition.
• 18Milton Friedman, “The Role of Monetary Policy,” American Economic Review 58, 1968.
• 19In particular, see Jerome Stein, Monetarist, Keynesian, and New Classical Economics (Cambridge, United Kingdom: B. Blackwell, 1982).
• 20The key assumptions are constant returns to scale and neutral disembodied technical progress.
• 21The underlying statistical models are moderately complex. They are described briefly in the statistical appendix. The logic and structure of the models are more fully developed in Lowell Gallaway and Richard Vedder, The “Natural” Rate of Unemployment, staff study, Subcommittee on Monetary and Fiscal Policy, Joint Economic Committee, Congress of the United States (Washington, D.C.: 1982).
• 22Federal Reserve Bulletin, various issues.
• 23Historical Statistics, series D-86.
• 24The productivity-adjusted real wage rate on a quarterly basis is calculated by dividing the manufacturing wage bill by the product of Federal Reserve Board (not the wage bill) and the index of average labor productivity (not total output) should be used. However, converting the wage bill and the index of industrial production to wage rate and productivity measures involves dividing both of them by the same quantity of labor (L). Since L appears in both the numerator and denominator of the expression for the adjusted real wage rate, it cancels out and can be ignored.
• 25As calculated from Historical Statistics, series D-688.
• 26Ibid,, series D-683 and D-688.
• 27Ibid., series D-724 and Paul A. David and Peter Solar, “A Bicentenary Contribution to the History of the Cost of Living in America” in Paul Uselding, ed., Research in Economic History, vol. 2 (Greenwich, Conn.: JAI Press, 1977), pp. 59–60.
• 28Broadus Mitchell, Depression Decade, vol. 9, The Economic History of the United States (New York: Rinehart, 1947), p. 84; and Arthur Schlesinger, Jr., The Age of Roosevelt: The Crisis of the Old Order, 1919–1933 (Boston: Houghton Mifflin, 1957), p. 249. Interestingly, though, some observers of the period disagree with this assessment. For example, Leo Wolman, Wages in Relation to Economic Recovery (Chicago: 1931) notes, “[I]t is indeed impossible to recall any past depression of similar intensity and duration in which the wages of prosperity were maintained as long as they have been during the depression of 1930–1931.” Similarly, Don Lescohier, “Working Conditions,” vol. 3, History of Labor in the United States, 1896–1932, John R. Commons and Associates, eds. (New York: Macmillan, 1935) states:
• 29Historic Statistics, series D-802, D-813, D-818, and D-824, respectively.
• 30Robbins, The Great Depression, p. 224.
• 31Geoffrey H. Moore, ed., Business Cycle Indicators, vol. 2, Basic Data on Cyclical Indicators (Princeton: Princeton University Press, 1961), p. 129.
• 32Benjamin M. Anderson, Economics and the Public Welfare (New York: Van Nostrand, 1949), p. 72.
• 33Historical Statistics, series D-839.
• 34Anderson, Economics, p. 220.
• 35Without the productivity adjustment, real wages in manufacturing (in 1923 prices) rose from 58.9 cents an hour in December 1929 to 62.5 cents an hour in December 1930. After that, they continued to rise to 66.3 cents an hour in January 1932. Wilford I. King, Causes of Fluctuations, pp. 182–83. See also Sol Shaviro, “Wages and Payroll in the Depression, 1929–1933” (unpublished M.A. essay, Columbia University, 1947).
• 36Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, N.J.: Princeton University Press, 1963).
• 37U.S. Bureau of the Census, National Income and Product Accounts of the United States, 1929–1976 (Washington, D.C., Department of Commerce, Bureau of Economic Analysis, 1981), p. 308.
• 38Moore, Business Cycle Indicators, p. 106.
• 39Harold Barger, Outlay and Income in the United States, 1921–1938 (New York: National Bureau of Economic Research, 1942), appendix B, table 28. A smaller profit decline is reported in a less comprehensive survey conducted by the Federal Reserve Bank of New York. See Irving Fisher, Booms and Depressions: Some First Principles (New York: Adelphi, 1932), p. 98.
• 40Robbins, The Great Depression, p. 205. The data were originally published in Commercial and Financial Chronicle.
• 41This is based on the Standard and Poor’s index, which fell 32.9 percent from September to November 1929. The second decline actually began in April 1930. A similar pattern is observed using the Dow-Jones index, which fell 39.7 percent from April to December 1930, compared to 37.0 percent from September to November 1929. The recovery in stock prices after November 1929 was robust; the April 1930 Dow-Jones index was the eleventh highest recorded in history, exceeded only in the first ten months of 1929. See Moore, Cyclical Indicators, pp. 108–9.
• 42Ben Bernanke, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic Review, June 1983, p. 261.
• 43Ibid., p. 262.
• 44Federal debt declined about $700 million in both 1929 and 1930, but rose more than $600 million in 1931. See Historical Statistics, series Y-493.
• 45If one uses the consumer price index to measure price changes, real interest rates on bank loans in 1929 averaged about 6 percent, rising to about 7.7 percent in 1930, and to about 13 percent in 1931. This is based solely on current year price changes. A real interest rate model using weighted averages of past price changes would show a smaller rise. Interest rate data are based on Federal Reserve System reports. See Moore, Cyclical Indicators, p. 154.
• 46Historical Statistics, series F-54.
• 47Friedman and Schwartz, A Monetary History, table A-1, pp. 712–13.
• 48Ibid., table B-3, p. 803.
• 49Ibid. The deposit/currency ratio fell from 11.57 in October 1929, to 4.44 in March 1933, a decline of 7.13 points, with 3.87 points (54 percent) of that decline occurring between October 1930 and October 1931.
• 50Ibid., pp. 308–13.
• 51The price would fall to $750 only for a consol, a bond with no maturity. Short-term bonds would sell at a small discount from face value because the owner of the bond would receive the face value at maturity.
• 52Historic Statistics, series X-581.
• 53Capital accounts were $10,372 million. Ibid., series X-587.
• 54Most nominal interest rate series show little change in the early years of the Great Depression, and, indeed, many show some decline. This masks two phenomena, however. First, declining commodity prices during the period led to rising real interest rates over time. Second, most interest rate series report actual transactions, probably ignoring a growing number of customers who were crowded out because of sharply rising risk premiums. It is possible that interest rates demanded of some average potential borrower rose, even though actual interest rates reflected in transactions did not rise.
• 55Data from U.S. Bureau of Economic Analysis, Fixed Residential Business Capital in the United States, 1929–1973 (Washington, D.C.: Department of Commerce, 1974), reported in Historical Statistics. The exact data series employed is F-484 for producers’ equipment valued at 1958 prices. This series falls from a 1929 level of $74.1 billion to $59.2 billion in 1933. Simon Kuznets, Capital in the American Economy (Princeton, N.J.: Princeton University Press, 1961), table R-5, p. 492, concludes that net capital formation was almost zero in 1931, and decidedly negative in the years 1932–34.
• 56Use of the consumer price index yields lower-bound measures of the extent of wage disequilibrium. This index fell substantially less than did the wholesale price index during the Great Depression. Consumer prices (Historical Statistics, series E-135) fell 24.3 percent, while wholesale prices (Ibid., series E-23) declined by 30.8 percent.
• 57The codes in question were the blanket codes introduced pending the development of the specific industry codes. See David A. Shannon, Between the Wars: America, 1919–1941 (Boston: Houghton Mifflin, 1965), pp. 154–55. See also Michael M. Weinstein, “Some Macroeconomic Impacts of the National Industrial Recovery Act, 1933–1935,” chapter 14, pp. 262–81, in Karl Brunner, ed., The Great Depression Revisited (Boston: Kluwer/Nijhoff, 1981) and Recovery and Redistribution under the NIRA (Amsterdam: North-Holland Publication Company, 1980).
• 58Historical Statistics, series D-802.
• 59Section 7(a) of the National Industrial Recovery Act was added to allay the fears of labor leaders that industry would act cooperatively against labor. It required that every industry code developed under the act include provisions guaranteeing the right of employees to organize and bargain collectively and that employees could not be required as a condition of employment to either join a company union or refrain from joining a union of their choice.
• 60After the National Industrial Recovery Act was declared unconstitutional by the Supreme Court, the provisions of section 7(a) were reenacted in a more detailed fashion, including the establishment of an administrative machinery to police the law, in the National Labor Relations Act of 1935.
• 61Probably the best known study of this question is H. Gregg Lewis, Unionism and Relative Wages in the United States (Chicago: University of Chicago Press, 1963). Also worth noting are John Maher, “Union, Non-Union Wage Differentials,” American Economic Review 46, 1956; and Adrian W. Throop, “The Union-Non-Union Wage Differential and Cost-Push Inflation,” American Economic Review 58, 1968.
• 62The basic data employed in these calculations are taken from Lowell E. Gallaway, “Trade Unionism, Inflation, and Unemployment” in George Horwich, ed., Monetary Process and Policy: A Symposium (Homewood, Ill.: R.D. Irwin, 1967), pp. 60–66. At first blush, the indication of a significant change in what we call the union/nonunion wage differential appears to conflict with Lewis’s findings in Unionism and Relative Wages, which suggest a stable union/nonunion differential over time. However, we have defined our differential in terms of traditionally organized industries compared to traditionally unorganized ones. Actually, there are substantial numbers of nonunion members in the work force of what we have called the unionized industries. For example, in 1920, when trade union membership peaked at over five million, only about one-fourth of the work force in our unionized industries were union members. See Leo Wolman, Ebb and Flow in Trade Unionism (New York: National Bureau of Economic Research, 1936). They made up about 90 percent of union membership, though. By contrast, on the eve of World War II, when union membership had recovered to over ten million (compared to its 1933 low of less than three million), union workers were approaching accounting for one-half the work force in our unionized industries. In fact, what our wage differential measure attempts to capture is the impact of the changing volume of unionism on the interindustry wage structure and, ultimately, on the average wage rate. Actually, we feel that we may have underestimated the union impact by employing a relative wage differential measure rather than focusing on the absolute differential (in real terms) between the unionized and nonunionized areas. For a theoretical discussion of why the relative wage criterion may not be appropriate, see Gallaway, “Trade Unionism.” If we had used the absolute differential for purposes of this evaluation, the effect of increases in union membership on the interindustry wage structure would have been even more dramatic.
• 63The detailed statistical analysis is described in the statistical appendix to this article.
• 64This is done by estimating the impact of growth in union membership on wage levels and then translating the unionization-induced wage shifts into changes in unemployment.
• 65Total supplements are from Historical Statistics, series D-893. Average annual earnings from ibid., series D-722. See also Albert Rees, New Measures of Wage-Earner Compensation in Manufacturing, 1914–1957, occasional paper 75 (Princeton, N.J.: National Bureau of Economic Research, 1960).
• 66Detailed supplement data are from Historical Statistics, series D-907 and D-908. The percent increase in the total wage bill attributable to the increase in a particular supplement is calculated and the impact of such an increase on unemployment is estimated using the statistical relationships reported in the statistical appendix to this article.
• 67The strongest proponents of a monetary explanation for the recession of 1937–38 are Friedman and Schwartz, A Monetary History.
• 68There is an abundance of literature that suggests a fiscal policy explanation for the downturn in 1938. See E. Cary Brown, “Fiscal Policy in the ‘Thirties’: A Reappraisal,” American Economic Review 46, 1956; Alvin H. Hansen, Fiscal Policy and Business Cycles (New York: W.W. Norton, 1941); Arthur Smithies, “The American Economy in the Thirties,” American Economic Review 36, 1946; and Kenneth D. Roose, “The Role of Net Government Contribution to Income in the Recession and Revival of 1937–1938 ” Journal of Finance, 6, 1951. Roose’s views are also stated in his Economics of Recession and Revival (New Haven, Conn.: Yale University Press, 1954).
• 69Interestingly, Roose, Economics of Recession, also expresses views that are consistent with our findings. He comments, “Most important of all, however, was the reduced profitability of investment, beginning in the first quarter or 1937. This resulted from increases in costs, in which labor played a prominent part.” (pp. 238–39).