Don't Count On the Fed to Engineer a V-Shaped Recovery

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It was a pandemic, of sorts, a diseasing infestation that demanded the strictest economic curtailment. The consequences of the resulting quarantine and shutdown were extreme, so severe that they triggered a financial and monetary crisis. In response, central bank authorities were pressed into unprecedented action.

An official from Florida’s State Board of Agriculture had been engaged in a routine inspection of the state’s citrus crops. Horrified, the man uncovered larvae in some grapefruit inventory on its way out to other markets inside the United States. Worse, these bugs belonged to the Mediterranean fruit fly species, a particularly verminous danger to the region’s bread and butter citrus industry.

Not just citrus, either, this particular fruit fly could consume all manner of agricultural produce growing in the fields of pastoral farms all over the land. It was a dire threat which demanded strong human intervention. With rapid life and breeding cycles, and no natural predators, once the fly gained its foothold in an area near total losses could be expected.

Emergency inspections ordered up in the wake of the shocking discovery found infestation in three Florida counties already. Within three months of the initial warning, the US Department of Agriculture would estimate a third of the state’s land area, containing three-quarters of its citrus growth, had been affected.

The government’s reply was severe. Anything within one mile surrounding an orchard found containing the pests was destroyed; all crops, all wild plants, even the orchards themselves. USDA scientists and laborers then used arsenic and mercury to further decontaminate.

Another nine miles further out, any fruit or produce still growing was immediately razed. Crops, of any kind, that had already been harvested were subject to instant ban. Only rigorous inspection would allow any produce to leave.

Florida’s governor mobilized the state’s contingent of the National Guard. The troops set up roadblocks and checkpoints throughout the state, searching private American citizens who might intentionally or unintentionally smuggle contraband citrus in their vehicles.

A broader quarantine imposed by the federal government, along with bans enacted by surrounding states, meant that all trains leaving Florida were subjected to warrantless searches and seizures. Domestic embargoes were quickly followed by those imposed across neighboring regions, including even Canada.

While the citrus shutdown was being enforced, Congress debated bailing out the affected farm companies; just compensation, it was claimed, for a non-economic imposition creating massive losses for a key industry which was the backbone of the regional labor market. No agreement could be found, however, as politics took center stage and the US Lower House adjourned without finding a common ground resolution.

Given the unceasing run of bad news, Florida depositors began to run to their local banks who were obviously heavily exposed to paper and debts owed by a single key economic sector with little immediate hope. A wave of bank failures and suspensions was unleashed to amplify the great economic damage the Mediterranean fruit fly was already accomplishing.

From discovery to bank panic, a mere three months. The year was 1929.

By June 1929, two months into the disaster, Citizens Bank in Tampa, hit with largescale customer withdrawals, pleaded with the Federal Reserve’s Atlanta branch (the regional central bank branch which covered Florida banks) to rediscount more eligible paper on an emergency basis; that is, accept loan and other debt collateral from the bank in exchange for Atlanta Fed reserves on account. Governor Eugene Black endorsed the proposal and obtained further approval from Washington.

By July 12, 1929, the Atlanta Bank’s Board of Directors voted two “revolving currency funds”, one for Miami and the other for Tampa. These were emergency stores of physical currency that would be shipped, placed at strategic custodian depositories, and made available to other banks “as urgent need therefore may arise.”

Even this program, which amounted to correspondent system aid rather than a local hard currency Discount Window, took an additional five days for System approval in DC. On July 17, the day after the Federal Reserve Board endorsed the currency funds, Citizens Bank in Tampa was forced to close.

Not merely one of Tampa Bay’s largest, it was also an important member of a complex consortium of funding mechanisms throughout Florida’s wider bank system. Such an important monetary cog, the one failure unleashed runs throughout the state, especially in Gainesville and Orlando.

Eugene Black, as legend has it, loaded up a suitcase with $6 million of the Fed branch’s cash, an enormous sum in those days, and drove from Atlanta to Tampa to distribute “liquidity” personally. Trying to stem the destructive run, the Governor was experimenting in heavy monetary intervention of the sort unheard of prior.

After all, Citizens Bank had begun the year with $13.7 million in total deposits, considered a behemoth at the time and in that place. “We are watching this drastic measure with these banks in an effort to learn whether such a step can be successful with a commercial bank,” Black said. To come to town with a cash liquidity fund at half the size of Citizens entire deposit base was monumental.

Whether Governor Black was successful or not remains a matter for debate, even today. There are those who argue it was a tremendous success, keeping Florida from suffering an even worse fate than it would have otherwise. Others aren’t so sure, pointing to the rigid and at-times unnecessarily bureaucratic structure of the Fed in the way it operates and even doles out “emergency” liquidity.

If the Fed wasn’t so much of a bureaucracy, the emergency fund set up and operating maybe a day or two before, would Citizens have even failed in July 1929?

There’s no real way to settle the argument because by the time Eugene Black stocked his luggage with cash rather than clothes, heading south toward Tampa, the month was October.

Yes, October 1929. Florida’s fruit fly-inspired bank panic quickly subsumed by the national and international one triggered on Wall Street late in that month; rendering this one precursor event a minor historical footnote.

What cannot be argued is that the monetary damage greatly magnified the economic injury suffered originally due to non-economic concerns. Florida’s economy was already devastated on the cusp of the national economy falling off a cliff.

But that term is misleading if appropriate when looking back from a distant post far away in the future; condensing history into long chunks which seem from the perspective of the future’s inhabitants unfolding all at once when in real time it seems like forever for those living through them. From ten or even five years forward, it does appear like the economy fell off a cliff when in truth it wasn’t so simple.

Even in the hot Florida summer of 1929 there were twists and turns in the way the tragedy unfolded. Days, even weeks of optimism punctuated by bouts of more extreme negativity; wild rumors of terrible bank losses leading to deposit runs, followed by even wilder speculation that the whole thing was a huge nothing, uncorking a rush to speculate on the cheap.

Nothing ever goes in a straight line. Thus explains some lack of haste often exhibited in the official sector; one day it looks dire as if the whole thing will collapse without official aid, but then the next like it’s all over and no need for any intervention at all.

And on those days when the world seems to be turning upright again, do we credit the action of those officials on the narrowest terms? Or, do we take the longer view and follow the whole thing to where it ultimately leads? If the final destination is off a cliff, even falling off of it in slow motion, that’s powerful and meaningful commentary on the lacking nature of the systemic response as well as thefrailty of the system.

Tampa 1929 was in many ways a model for the Great Collapse which came shortly after. Again, Great Collapse wasn’t really a single motion though at first it sounds like it must’ve been; no one snowball sent careening down the snowy slope and progressively picking up mass so as to become an unstoppable force of destruction. From October 1929 to April 1933, there were so many twists and turns.

For much of 1930, for example, it looked quite a lot like the worst of it had passed. The growing depression was already serious, but not at all out of line with those which almost regularly appeared before – including the Depression of 1920 which was itself enormous but ultimately short-lived. A long way down, but very quickly all the way back up again.

In July 1930, Henry Ford said the contraction was “of minor moment in onward sweep of industry” while Thomas Edison called it largely psychological. The following month, August 1930, Harvey Firestone, President of Firestone Tire & Rubber, built further on Ford’s assumption, telling the Wall Street Journal that America was on the verge of greater prosperity over the coming decade than it had experienced during the prior one of the Roaring Twenties.

Alfred Sloan, President of GM, said in September 1930, “Business has turned a corner and is now on a slow but sure return to normal conditions” and further added how he believed this was true for all industry not just the auto business. The same month, Dr. Julius Klein, Assistant Secretary of Commerce, noted that the average duration of depression during the half century before then was a mere 13 months, and given that the world should expect a determined upswing no later than the last few months of 1930.

Not to be outdone, the Federal Reserve Bulletin in the same month declared that US banks were in the best shape they had been since 1917. The banking system was, at that point, busy extending a record amount of aggregate credit and doing so - you really have to laugh here – having borrowed theleast amount from the Federal Reserve going back to almost when the system began.

An October 1930 issue of Bankers Monthly also found the banking system to be in terrific shape – largely due to the many bank failures, including those in Florida, which had preceded the 1929-30 depression. With such “dead wood” having been cleared out beforehand, the magazine declared from it “one of the reassuring aspects of the situation today is the stable banking position.”

Caldwell and Company was by the middle of 1930 the largest financial holding company in the entire Old South. A conglomeration of what we call today financial services, on November 7, 1930, the Bank of Tennessee was closed. A primary subsidiary of Caldwell, this would trigger a run on other affiliates in Tennessee as well as Kentucky.

Being under the Fed’s Sixth District jurisdiction, the Atlanta branch, Eugene Black instantly sprang into action. He believed, and his Board agreed, that the Fed was responsible for systemic liquidity in a crisis – just as he had acted, on their authority, during the fruit fly episode a year earlier.

Atlanta went into overdrive, expediting loan discounts of liquidity-thirsty members while encouraging those with excess reserves to relend on their own initiative to non-member banks (particularly to save their own respondents from dragging correspondents under) equally in dire straits. Cash was often rushed, as Tampa, to towns and villages under siege of bank runs.

To no avail. The rash of banking panics which were begun in Tennessee reached the streets of New York City on December 10, 1930. The Bank of the United States would famously shut its doors the very next day. An unfortunate name for a private commercial bank, one often confused with the names of the first two long ago central banks in the country, its high-profile failure would set off the second wave of eventually international panic.

Even after the Bank of the United States, the Federal Reserve in lowering its Discount Rate in December 1930 declared defiantly:

“There is a general feeling that this reduction in the local bank rate may easily prove to be the turning point in the whole economic and financial situation, here and, ultimately, throughout the world.”

Dr. Klein enthusiastically agreed, the well-known Commerce Department official ending the year with the hopeful message of how “every indication” pointed to a steady upturn in business for 1931.

Fragility, dear friends, is the message as well as the lesson. It gets lost in the minutiae of bank panics and depository runs, but ultimately the issue is a fragile system that can’t bear the strain of not being set straight. In the case of the Great Contraction, there were times when it looked like the Fed and even the federal government (Hoover was no do-nothing) had successfully fortified this delicate and brittle situation.

But it would only look that way in small pieces, and only if you ignored everything else going on around you.

I’ll give you one specific example. In November 1930 it was widely reported that General Motors had raised its cash level more than threefold; from $44.5 million at the start of the year to an astonishing $145.6 million by the end of Q3. Celebrated as a mark of sound business, a prudent practice of financial strength, as well as a sign of systemic liquidity, the truth was the exact opposite.

GM was hoarding cash because it would no longer count on credit even for working capital, accumulating so much of it because business was down so far. With inventories run down to nothing, there was no need to use any cash because GM sure wasn’t about to restart heavy production volumes. Rather, the company, despite its president’s public statements of pure optimism, was going to hoard its stash – no matter what.

A tragic consequence of monetary incompetence, the transmission of economic shock into monetary shock back into amplified economic disaster. The unmistakable results of an entirely too fragile systemic state.

Like 2008, I doubt there will be a rash of bank runs, no depository panicking. Unlike the thirties, the modern system doesn’t operate that way. Good, in the sense that bank deposit holders aren’t subject to massive losses on the basics like checking accounts; bad, in that the whole global economy doesn’t really work the way we are all taught in school.

Even in 2008, the panic itself was a shadow run; the growing fault lines hidden from view. Wholesale interbank markets rather than the depository system had fallen apart while the bureaucrats at the Fed took their time scheming different ways to come into it late and with the wrong sort. Ben Bernanke’s group thought like Eugene Black, but unlike Governor Black they didn’t have the right kind of cash nor suitcases to meet the system’s dramatic needs.

Knowing nothing about any of that, repo collateral or eurodollar transmission channels, you didn’t need to know them to understand how fragile it was. You could see it right before your very eyes; failure all around, if not specifically bank failures (though there were a few) then at least something deeply fundamental.

The world doesn’t end up with tens of millions thrown out of work for a robust system and an equally if not more robust monetary backstop.  That much we learned from the thirties, confirmed again a decade ago.

Yet, here we are; the word that continues to pop up is fragile. The count of Americans put onto unemployment rolls is up to 26 million – in just five weeks. Coronavirus, sure, but that’s not all, maybe not even the most of it.

How about record low UST yields despite the government putting FDR to shame, and, at least for one shocking day, a deeply negative oil price?  Crisis level money spreads and a dollar that won’t budge, refusing to fall even an inch despite epic levels of “money printing” and “monetary” rescue.


Yesterday, IHS Markit reporting that its PMI for US manufacturing drops to 36.9 this month, the lowest since 2009. The one for the domestic services sector collapsed to just 27.0, leaving the composite at 27.4 and substantially less than every one of the worst months of that Great “Recession.”

COVID-19, yes, but…

And while all of these things are going on, as well as a great many more I haven’t the time nor ability to succinctly depict, officials and business leaders are very optimistic. Very optimistic. Once we get past the shutdown, they say, the economy will come roaring back to life at the flip of a switch. No Great Depression this time, they’ll promise, instead it will be the Great Awesome “V!”

One of the least optimistic policymakers of the Great Collapse era was…Governor Eugene Black. In October 1930, while in the midst of fighting the Sixth District’s monetary battle to keep the smoldering panic from breaking out all over again, Black, the man who maybe pioneered the techniques that echo in Jay Powell’s current mind, complained of the “load of debt around our necks.” Even before the Bank of Tennessee, he warned, before nearly everyone else, that Americans needed to start getting used to a lower standard of living.

I guess he’d seen enough close up to recognize futility in the face of crushing weakness.  

The key word isn’t “bank” or even “money.” It is “fragility.” I’m not claiming what’s coming at us today is 1931. What I’m getting at is that with these huge signs of frailty all around, are there really any reasonable means to expect a “V”-shaped recovery from here? Furthermore, to be led to believe that it is the Fed, of all things, which is going to ensure this perfect outcome.

Jay Powell would have a better shot printing suitcases. 

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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