Mistake of 1937

Maybe, someday
Saved by zero
I'll be more together
--The Fixx

On the heels of his re-election in 1936, FDR wanted to lean back and smell the roses. He considered his New Deal a resounding success. Unemployment was coming down, share prices were higher. However, commodity prices were also marching higher, and this was trickling over into goods and services prices.

Washington was ready to ease off the gas a bit. The Fed was already working to dial back on monetary stimulus. In the summer of 1936, the central bank began raising bank reserve requirements, and reduced the rate at which gold piling up in Fed bank vaults was converted into dollars. The net effect was that money began leveling off.

Like the drug addict deprived of his next fix, markets went into convulsions as the stimulus was withdrawn. Industrial production sank by 1/3. Stocks fell 50%. Unemployment, which had been falling thru the low teens, reversed higher back toward 20%.

Keynesians call this The Mistake of 1937. The lesson to be learned was to keep the stimulative pedal to the metal. Better to stimulate too much than too little. Being an 'expert' of the Great Depression, this lesson is seared into current Fed chair Ben Bernanke's brain.

Facing an episode of withdrawal, drug addicts arrive at similar conclusions.