RDP 1999-06: Two Depressions, One Banking Collapse 5. Discussion and Concluding Remarks

This paper has focused on one of the major differences between the Australian depressions of the 1890s and 1930s. During the 1890s, a substantial proportion of the financial system collapsed: many finance companies and building societies went out of business; 13 of the 23 trading banks were forced to close their doors and required reconstruction before reopening; trading bank deposits fell substantially over most of the decade; and bank credit declined dramatically, from highs of over 70 per cent of GDP to about 40 per cent by the turn of the century. In contrast, the financial problems of the 1930s were relatively mild: only three financial institutions suspended payment; the fall in the level of deposits was more moderate; and there was only a relatively small decline in bank credit.

This variation in the performance of the financial sector across the depressions occurred despite the fact that the initial macroeconomic shock was at least as large in the first year of the 1930s depression as it was in the 1890s depression. Variation in financial performance across the two depressions was primarily due to variation in the condition of the financial sector well before each depression.

Financial fragility leading up to the 1890s was evident in a range of indicators: the very rapid rise in the share of credit to GDP; relatively high levels of private investment in the form of an unprecedented building boom; the appearance of a new set of financial institutions increased competition facing banks and led to lending for speculative purposes; this led to a property price bubble and a rapid expansion of banks' balance sheets; lending was spurred in part through readily available funds from London; all the while, the level of prudence in the banking system was declining.

This trend towards greater instability through the 1880s meant that the financial system was more susceptible to the initial downturn in the macroeconomy. Further, the collapse of the financial system helped to extend the macroeconomic decline for many years.

Although there was a boom of sorts leading up to the 1930s depression, the same factors which led to financial instability during the 1880s were more muted, or operating in the opposite direction during the 1920s. For example, the rise in the share of bank credit to GDP was smaller and started from a lower base; the share of building activity in GDP was much lower, although there was still a sizeable increase in property prices; the ratio of trading bank advances to deposits was rising only slowly from a low base and capital inflows were not sustained at the same levels, nor for as long, as during the 1880s; a greater proportion of bank assets were being held in the form of government securities during the 1920s; and in contrast to the 1880s, trading banks were increasing both capital and retained earnings at a faster rate than their total assets.

Differences in external and internal real factors that did exist were not significant enough, or were working in the wrong direction, to explain the dramatic difference in the performance of the financial sector across the two depressions. The real external shock was more substantial in the 1930s depression – that is, a bigger worldwide depression and larger fall in the terms of trade. The devaluation in 1931 helped to offset this partially, but it is hard to argue that this effect can explain much of the variation in the performance of the financial sector. Aside from this devaluation, monetary and fiscal policies were not actively expansionary through the 1930s.