The Myth of Pent-up Demand and the Successful Reconversion after World War II

The orthodox story of U.S. reconversion after World War II places heavy weight on the drawing down of accumulated liquid assets to finance consumers’ satisfaction of their so-called pent-up demands. In the words of economic historians Gary Walton and Hugh Rockoff, “During the war, people had accumulated large stores of financial assets, especially money and government bonds. . . . Once the war was over, these savings were released and created a surge in demand” (emphasis added). No doubt many people did urgently desire to purchase new cars, household appliances, houses, and other goods that had been unavailable or in tightly limited supply during the war. But the idea that postwar consumers paid for such goods by drawing down their liquid-asset holdings conflicts with the evidence.

The most serious flaw in the orthodoxy is that individuals did not in fact reduce their holdings of liquid assets after the war. Let us define liquid assets as currency held by the public, demand and time deposits in commercial banks, deposits in mutual savings banks, and deposits in the postal savings system. In November 1945 liquid assets so defined reached an all-time high of $151.1 billion. By December 1946 they had risen to $161.6 billion and by December 1947 to $168.5 billion. Every component of liquid assets so defined increased during that two-year period. Of course, so long as the total amount of money was increasing, the public as a whole could not “draw down” its holdings: What one member of the public gave up, another acquired.

If people did not—indeed, could not—reduce their holdings of liquid assets, perhaps they tried to do so, thereby driving up the velocity of monetary circulation. Not so. Neither the velocity of money defined as M1 nor the velocity of money defined as M2 rose in those years. For the four years from 1945 through 1948, the velocity of M1 took the values 1.75, 1.52, 1.62, and 1.73; the velocity of M2 took the values 1.37, 1.16, 1.23, and 1.31.

Perhaps consumers were liquidating their war-bloated holdings of government bonds? No. At the end of 1945 individuals held $64.0 billion of the public debt; at the end of 1946, $64.1 billion; and at the end of 1947, $65.7 billion.

How then did consumers finance their surge of spending during the postwar recovery of the private economy? In nominal terms, by a combination of increased personal income and a reduced rate of saving; in real terms, simply by reducing the rate of personal saving.

Between 1945 and 1946, when personal consumption spending increased by $23.7 billion, annual personal savings dropped by $14.4 billion and personal taxes fell by $2.2 billion; increased (nominal) personal income financed the balance of the increased consumption. Between 1946 and 1947, when personal consumption spending increased by $17.3 billion, annual personal savings dropped by $5.2 billion and personal taxes rose by $2.7 billion; increased (nominal) income financed the balance of the increased consumption. Between 1947 and 1948, when personal consumption spending increased
by $12.9 billion, increased (nominal) personal income accounted for more than the entire increase, as personal taxes fell by just $0.2 billion and annual personal savings actually increased by $6.1 billion.

Clearly, during the critical first two years after the war, the ability of consumers to spend more nominal dollars ($41.0 billion) for consumer goods depended overwhelmingly on just two sources: increased personal income ($20.5 billion) and reduced annual saving ($19.7 billion).

Untapped Potential

The potential for reduction of the personal saving rate (personal saving relative to disposable personal income) was huge after V-J Day. During the war the personal saving rate had risen to extraordinary levels: 23.6 percent in 1942, 25.0 percent in 1943, 25.5 percent in 1944, and 19.7 percent in 1945. After the war the personal saving rate fell to 9.5 percent in 1946 and 4.3 percent in 1947 before rebounding to the 5–7 percent range characteristic of the next two decades. After having saved at much higher rates than they would have chosen in the absence of the wartime restrictions, households quickly reduced their rate of saving when the war ended. Note, however, that they did not dissave. Even at the low point in 1947, the savings rate was 4.3 percent, not much below the prewar norm for relatively prosperous years.

The postwar resurgence of the private economy rested on an investment boom as well as a consumer spending surge. In current dollars, gross private domestic investment leaped from $10.6 billion in 1945 to $30.6 billion in 1946, $34.0 billion in 1947, and $46.0 billion in 1948. Relative to gross national product (GNP), that surge pushed the private investment rate from 5 percent in 1945 (it had been even lower in the previous two years) to 14.7 percent in 1946 and 1947 and 17.9 percent in 1948.

Firms could finance their increased investment spending in part because, unlike individuals, they did unload some of the government securities they had acquired during the war. Between 1945 and 1946, holdings of public debt by corporations (exclusive of banks and insurance companies) fell by $6.9 billion. They fell further, by $1.2 billion, in 1947 before rising by $0.7 billion in 1948.

Moreover, owing to reduced tax liability—the Revenue Act of 1945 lowered the top corporate income tax rate and repealed the excess-profits tax—corporations enjoyed rising after-tax profits from 1946 through 1948. During the years from 1941 through 1944, after-tax corporate profits had held steady in the range of $10–$11 billion annually. After-tax profits dropped to $9.0 billion in 1945, as the government canceled procurement contracts and many firms incurred extraordinary expenses to reconvert their production facilities. Then after-tax profits rose to $15.5 billion in 1946, $20.2 billion in 1947, and $22.7 billion in 1948.

With greater after-tax profits to draw on, businesses increased their retained earnings. Gross business savings increased from $15.1 billion in 1945 and $14.5 billion in 1946 to $20.2 billion in 1947 and $28.0 billion in 1948. The additional retained earnings provided an important source of financing for the higher business investment after the war.

Corporations also returned to capital markets in a big way. Stock and bond offerings, which only once had exceeded $3.2 billion in the years from 1935 to 1944 (the exception being $4.6 billion in 1936), jumped to $6.0 billion in 1945, $6.9 billion in 1946, $6.6 billion in 1947, and $7.1 billion in 1948.

In sum, the corporate investment boom of the postwar transition years received its financing from a combination of the proceeds from sales of previously acquired government bonds, increased current retained earnings (attributable in part to reduced corporate-tax liabilities), and the proceeds of corporate securities offerings.

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