RECESSION DURING A RECOVERY? IT HAPPENED IN 1937
A Recession After A Depression (how to avoid).
By Ben Boothe, Sr.
We all know of the stock market crash of 1929, the panic in financial markets, and the reasons. The Federal Government was shrinking the supply of money at the very time when liquidity was needed in the financial marketplace. Federal Reserve Policy is critical during times of recession or recovery.
Few study or know about the Recession of 1937-1938. It was probably America’s third worst recession of the 20th century. Ironically, it was a recession during the “recovery” from the Great Depression.
- * Real GDP fell 10 percent.
- * Unemployment rose to 20 percent.
- * Industrial production fell 32 percent.
Why? Government policy makers determined it was a good time to “soak up bank reserves.” But one reason for excess reserves was artificially low interest rates, which contributed to higher reserves. When short-term rates are low, it is less costly for banks to hold large amounts of non-interest earning funds in reserves.
So the government increased reserve requirements, and then government leaders in their wisdom created a “treasury gold sterilization program” eliminating this source of capital, and thus decreasing sources of bank reserves. (This is similar to eliminating huge cash flows of commerce with a nation like China with tariffs.).
Finally, the government changed tax policies with a new tax in 1935 and the new Social Security tax which started in 1937. (Similarly the USA revised and passed a new income tax law which came into effect in 2017-18. Like the Social Security tax in 1937, the new Income Tax Law of 2017-18 has been a source of historically high deficits.)
Solutions then? What does it mean for now?
It means that the current Federal Reserve should ignore political pressure and do what it does best, create stability and economic security. 
The recession ended after the Fed rolled back reserve requirements, allowed interest rates to increase naturally, stopped sterilizing gold inflows and reversed the “gold sterilization policy.” President Roosevelt then began pursuing expansionary fiscal policies, and the recovery from 1938-1942 was spectacular.
Economist Christina Romer said this is a “cautionary tale” we can learn from today.
The Federal Reserve Bank system has been regarded as one of the most effective regulators of our money and banking system. When it has been well-managed and run by a "balanced board of governors," it has helped the USA to achieve great growth, stability and prosperity. Many people consider it a mystery, but I have walked the halls of the Federal Reserve, have known two Federal Reserve Chairmen, and enjoyed personal conversations and exchanges with people "at the top." I have also walked the halls where our gold reserves are stored in New York, and in my work, walked by these old stone walls every day. I knew Michael Doman, head of the Comptroller of the Currency, and I knew Donald Regan, who became our Secretary of the Treasury and also chairman of Merrill Lynch. Often I passed Allan Greenspan as he walked to work in the mornings. I have had exposure to our most important financial institutions, and I highly respect the Federal Reserve Bank and our other agencies set forth to create a stable and prosperous economy.
Our thanks to an article written by Patricia Waiwood of the Federal Reserve Bank of Cleveland, which was republished on the internet, and from which we sourced some ideas.
My experience, study and exposure to the very top levels of our nation's financial regulatory workings leads me to the conclusion that our political leaders need to leave the independence of the Federal Reserve System intact and let it do its work. We need politicians to realize that they are not economists, nor should they stick their noses too deeply into the workings of economic stability. As a former bank president and a former investment consultant, I can testify: Ours is a good system. Let it work as it should.
Ben Boothe, Chairman and President: www.benboothe.com