Monday, January 19, 2009

Andrew Mellon's "liquidationist thesis"

Here's a little bit of economic history from the US Great Depression, a failed approach that economists do not want to repeat.

One of the most famous quotes from the depression is Andrew Mellon's advise to the president:

“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.”

Andrew Mellon was Treasury of the Secretary under then President Herbert Hoover (1929-1933). Mellon opposed government intervention and bailing out failed banks. The economy would heal itself naturally after everything had failed and been sold-off in one gigantic fire-sale, he thought, but in the end Mellon's approach failed to bring the Great Depression in the US to an end (Read paper and quote by Eichengreen and paper by Brad De Long). Here's the full quote from President Herbert Hoover on the advice given to him by Mellon:

...the “leave it alone liquidationists” headed by [my] Secretary of the Treasury Mellon, who felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” He insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. He held that even a panic was not altogether a bad thing. He said: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people”... (Source: U.C. Berkeley Economist Brad De Long).

Or more recently Fed Chairman Bernanke reflecting on the thesis:

It was in large part to improve the management of banking panics that the Federal Reserve was created in 1913. However, as Friedman and Schwartz discuss in some detail, in the early 1930s the Federal Reserve did not serve that function. The problem within the Fed was largely doctrinal: Fed officials appeared to subscribe to Treasury Secretary Andrew Mellon's infamous 'liquidationist' thesis, that weeding out "weak" banks was a harsh but necessary prerequisite to the recovery of the banking system. Moreover, most of the failing banks were small banks (as opposed to what we would now call money-center banks) and not members of the Federal Reserve System. Thus the Fed saw no particular need to try to stem the panics. At the same time, the large banks--which would have intervened before the founding of the Fed--felt that protecting their smaller brethren was no longer their responsibility. Indeed, since the large banks felt confident that the Fed would protect them if necessary, the weeding out of small competitors was a positive good, from their point of view. (Source: Fed Chairman Bernanke speech to honour Milton Friedman, November 8, 2002, link)

In some ways Andrew Mellon's failed approach resembles the IMF austerity programmes after the 1997 Asian economic crisis that economist Joseph Stiglitz criticized so vehemently in his book Globalization and its Discontents (2002). 


  1. Blaming the Great Depression on Andrew Mellon's "liquidationist thesis" is unfair. Hoover didn't take Mellon's advice - Hoover increased spending, taxes, instituted massive new trade barriers, and manipulated industry in such a way as to prevent falling prices and wages. Basically, Hoover went directly against Mellon's advice, and THAT is what started the Great Depression. When Mellon's advice was followed by Warren Harding during the Depression of 1920-21, a downturn that was initially more severe than the Great Depression was quickly turned around into robust economic growth. For more information on how Mellon's advice actually worked, read the following article by historian Tom Woods:

  2. @AJ. That's wishful political propaganda. The fed's did stay out during the Great Depression and the U.S. suffered the worse deflation in history. By 1932 the debt/GDP increased to 300% and by the mid 30's we'd suffered the worse deflation in history at almost 30%, all without any additional government spending. True, Mellon was a hero in the early 20's by revising the tax code and increasing revenue. But that was post WWI and an entirely different situation.