The Accounting System #11: The Great Unraveling of 1930

previous: #10, The Federal Reserve and Accounting Money

In short, in 1930 the economic system unraveled because of the way it was built. The previous upward spiral of increasing economic activity was enabled by the ability of the banking system to expand both deposits and loans. Over time, however, many people had withdrawn deposits from banks to buy stocks, while others took loans from banks that were used to buy stocks. When stock prices started dropping (because enough people had realized it was a fool's game), people could no longer easily take money out of the market like they could take it out of a bank deposit. For loans to be repaid more stocks needed to be sold, and when stocks became relatively worthless, deposits had to be drained to make loan payments or for ordinary expenses. Loans and deposits, accounting money, disappeared rapidly, even when there was plenty of cash to facilitate cash transactions.

At the end stage banks could not collect on loans (because so many people had lost their jobs), and so had to use reserves to pay depositors who wanted to make withdrawals. When reserves were gone, the accounting rules said the banks had to close. There was no deposit insurance, so accounting money in the form of deposits, simply disappeared. Suddenly self-accounting with cash seemed like a better idea than bank accounting with numbers in ledgers.

We are largely trained to forget that there was one large, industrialized nation whose economy did not collapse in the 1930s. In the U.S.S.R. (essentially Russia) there was no stock market to collapse, and state banks and most of the economy were all government-owned. The government had total control of the accounting system. Despite the other defects (even atrocities) of the Communist system, there was a realization that money, the economy, and accounting were all human creations, and it was possible to run a command economy with some success (although command economies also have very high failure rates. It mostly depends on the commanders).

The New Deal can be fairly said to replace the free market economy of the United States by a command economy supervised by the government. In the end it took the increased demand created by World War II to get the American economy on its feet, and the legacy of the New Deal was not a command economy but a re-engineered free market economy.  Some of the changes had little to do with the accounting system, but two made noteworthy changes.

While most of the bubble in stock market prices was simple human folly, there was also fraudulent accounting at some corporations that was used to jack up stock prices. The SEC (Securities and Exchange Commission) was created in 1934 to attempt to insure that investments traded in public markets were neither fraudulent or manipulated. Among other reforms, the accounting of individual listed corporations now had to be audited by a (hopefully) independent auditor, and reported to all investors at least quarterly in a standardized format. Their accountants and their auditors were giving accounting rules they had to follow, Generally Accepted Accounting Principles (GAAP). This standardization of the accounting system meant that any person, not just accountants, could learn to read and understand any American business accounting statement.

The creation of the Social Security system would have long-term repercussions far beyond what was originally envisioned. Because many Americans were alive who had the same name, each person who paid into or received money from the system was given a Social Security Number.  Later this number would come to be used as a national, individual identity number, thus vastly enlarging the domain of The Accounting System.

Next: #12 Electronic Money Takes Over

[The Accounting System, Your Fate is in the Cloud, is a work in progress by William P. Meyers, ©2013]