vol. 59, no. 3 (January), 1993,
The Great Myths of 1929 and Lessons to be Learned
by Harold Bierman, Jr.
Westport, CT: Greenwood Press, 1991, pp. 202
With a background in managerial accounting and capital budgeting and
inspriation from a 1961 article by Jørgen Pedersen , Harold Bierman
tells a story substantially at odds with most macroeconomic theories of
boom and bust. Although he lists seven great myths about 1929 in the opening
pages of this volume, his views on the stock-market crash of that year
stand or fall with the "first and most important" one—so identified in
the closing pages. It is a myth, according to Bierman, that "Stocks were
obviously overpriced" before the crash [p. 14]. At issue here is not the
obviousness of the overpricing (obvious when? obvious to whom?) but the
notion that there was a general overpricing at all. Closely related is
the second-listed alleged myth that "The crash was inevitable."
So, why did the market crash?
According to the book's major thesis, an effective but ill-conceived war
against stock-market speculators was being waged by the Federal Reserve,
Congress, and the President. With the market highly leveraged and under
siege, any negative news could trigger a self-reinforcing decline [p. 16].
Bierman eventually fills in the blanks with a rhetorical and metaphorical
question: "Was the Hatry affair a match thrown on the floor of a forest
which had been dried out by the Federal Reserve tight-money policy combined
with low margin requriements?" [p. 161]. English financier Clarence Hatry
was ruined and disgraced in September of 1929 when some of his loan collateral
was revealed to be forged securities.
The claim that stocks were
not overpriced in the third quarter of 1929 is based upon conventional
present-value calculations in which a stock's price-to-earnings ratio varies
inversely with the difference between the expected growth rate (g)
in earnings and the relevant discount rate (k). A low k-g
can justify a high P/E [pp. 43-44]. Alternatively—but more tellingly—restated,
easy money and rosy expectations imply stock prices that are no lower than
the ones actually observed in the summer of 1929.
Bierman's calculations are
less than persuasive for two reasons. First, the plausibility of assumed
growth and discount rates is a weak justification for the implied price-to-earnings
ratio. P/E is very sensitive to growth- and discount-rate assumptions,
as acknowledged by Bierman [p. 44], all the more sensitive if it is easy
money (low k) that underlies the rosy expectations (high g).
Almost-as-plausible assumptions could justify stock prices twice as high
as they actually were. Second, the widely held belief that stock prices
were too high is largely a reflection of the belief, also widely held,
that money was too easy, expectations too rosy.
Readers who have learned
their interest-rate dynamics from Knut Wicksell and their business-cycle
theory from F. A. Hayek will not be satisfied that Bierman has effectively
dealt with the question of the bust's inevitability. He picked up the story
after the most significant events had already occurred. Although the Federal
Reserve's tight-money policy just before the crash is subjected to sustained
criticism, its loose-money policy throughout most of the decade is treated
as a non-issue. Bierman acknowledges neither a policy-induced discrepancy
between the bank rate of interest and the natural rate, as identified by
Wicksell, nor the consequent artificial boom involving the misallocation
of capital, as illuminated by Hayek. According to Hayek's capital-theoretic
account of the cycle, booms driven by credit expansion contain the seeds
of their own undoing. It is in this sense that busts are inevitable. Had
the interest rate throughout the 1920s been governed by saving and investment
without the influence of the Federal Reserve's credit expansion, the interwar
period would have been characterized by neither boom nor bust but by sustainable
growth. Rather than fault easy money for derailing both the interest rate
and stock prices from their natural paths, Bierman sees the high stock
prices as natural largely becuse of the low discount. [p. 34].
Most readers will agree
with the author that speculation is a healthy aspect of the market process.
Contrary to Bierman, however, widespread speculation in the final throes
of a credit-induced boom is not a sign of good health and cannot be fully
explained in terms of discounted income streams. While debate within the
Federal Reserve was colored with the rhetoric of war on speculation, the
alternative was not peace with speculation but rather an escalation of
the speculative boom. In 1929 the Federal Reserve had a tiger by the tail.
Both bulls and bears were speculating on how long it could hold on and
just when it would let go.
Frequently citing Irving
Fisher and sometimes Friedman and Schwartz, Bierman argues that all was
well until the Federal Reserve began bungling monetary policy in 1929.
Typically, macroeconomists who theorize in terms of capital and interest,
e.g., Hayek, believe that things had gone awry long before the crash, while
macroeconomists who believe the trouble started in 1929, e.g., Fisher and
Friedman, theorize in terms of monetary aggregates and the price level.
Bierman's perspective on 1929, then, does not neatly fit into either school
of thought. In summary terms, Bierman uses capital accounting methods to
arrive at monetarist conclusions.
The most engaging parts
of the book consist of testimony before Congressional committees by Federal
Reserve officials and investment-pool operators as well as speeches by
public officials and communiqués between the Federal Reserve Board
and the New York Federal Reserve Bank. Adolph Miller of the Board favored
selective credit controls aimed at speculators; George Harrison of the
New York Federal Reserve Bank favored a general tightening of credit as
a means to reduce speculation. Amidst the uncertainty about what the Federal
Reserve would actually do, speculation proceeded apace while Harrison tried
to convince Miller that there was no mechanism with which to implement
selective controls [p. 83]. Adding to the confusion, Roy Young, another
Board member unattuned to implementation problems, announced publically
that "It seems to me that it would be the [better] part of prudence for
all who are lenders to see first that business gets credit at reasonable
rates and let the others get what is left" [p.89].
The penultimate chapter
on the "Crash of 1987" is short and mostly descriptive. This and the final
chapter on "Lessons" contain heavy doses of We Don't Know; Experts Can
Be Wrong; and Hindsight Is Better Than Foresight.
Roger W. Garrison
1. Pedersen, Jørgen. "Some Notes on the Economic
Policy of the United States during the Period 1919-1932," in Money,
Growth, and Methodology, edited by Hugo Hegeland. Lund, Sweden: CWK
Gleerup, 1961, pp. 473-94.