A note on the financial crisis of 1929

There was no financial crisis in 1929.

Mark Thoma links to a very interesting series of graphs, which show how quickly countries recovered from various financial crises.  A few caveats:

1.  Countries like Korea and Hong Kong were seeing their trend rates of RGDP growth slow at about the time of the 1997 crisis, as they were quickly approaching rich country levels of RGDP per capita.  This makes it look like they failed to recover, when in fact they recovered just fine.  This is probably true in many other cases as well.   I hope Rogoff and Reinhart took that into account.

2.  One of the graphs has two serious mistakes:

The blue line needs to be shifted one year to the left, as the pre-Depression RGDP peak occurred in 1929, not 1930.  More seriously, the financial crisis occurred in 1931, not 1929.  So relative to the blue line, the vertical “start crisis” line needs to be shifted three years to the right.  That makes a big difference.  The US economy had fully recovered from the 1931 financial crisis by 1936, even though it didn’t recover from the Depression itself until 1941.

Oddly, Robert Hall made a similar mistake in the opening sentences of an important JEP paper published in 2010:

The worst financial crisis in the history of the United States and many other countries started in 1929. The Great Depression followed. The second-worst struck in the fall of 2008 and the Great Recession followed.

Three mistakes in three sentences.  How does stuff like that get past the editor?


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35 Responses to “A note on the financial crisis of 1929”

  1. Gravatar of Majorajam Majorajam
    23. March 2012 at 18:18

    Good question there at the end. One possibility is the editor was on his lunch break during twelve alarm agnotological fire that consumed the monetarists.

  2. Gravatar of marcus nunes marcus nunes
    23. March 2012 at 19:01

    Scott
    In a recently released WP Robert Hall has this in the abstract:
    The financial crisis of late 2008 shifted household expenditure downward, as financial institutions tightened lending standards and required repayment of outstanding consumer loans. The crisis also raised financial frictions by depleting the equity capital of financial institutions. The result was a severe reduction in business and residential investment expenditure. The zero bound on the interest rate worsened the adverse effects of these developments by limiting the corrective response of monetary policy. In a straightforward and comprehensible macro model, I measure the two financial driving forces by matching the actual and forecasted movements of two key variables, the unemployment rate and the investment/GDP ratio. I then use the model to describe a counterfactual economy over the period 2009 through 2020 in which the same increase in financial frictions occurred but no household deleveraging took place. The comparison of the counterfactual and actual economies reveals the separate effects of the two financial driving forces. Deleveraging had an important but transitory role immediately after the crisis, while high financial frictions account for the long period of high unemployment, depressed GDP, and subnormal investment.
    He separates 2 strains of bacteria and says one is important, the other not so. He forgets to examine the “knife” that contained both bacteria so he misses the ultimate “cause of death”.
    In this post I have the correct graph (for NGDP and trend)covering the Great Depression.
    http://thefaintofheart.wordpress.com/2012/03/20/another-bitch-potential-output/

  3. Gravatar of Bill Woolsey Bill Woolsey
    24. March 2012 at 03:11

    I think most of us would read “finaincial crisis,” to mean the stock market crash in October 1929. I agree the cyclical peak was in in August of 1929.

  4. Gravatar of Nick Rowe Nick Rowe
    24. March 2012 at 03:27

    Tell us more Scott (or anyone, if Scott is busy). Tell us about the difference(s) between the stock market crash of 1929 and the financial crisis of 1931. Most of us know about 1929. Fewer of us know about 1931. Bank failures, right? Were there no (or few) bank failures etc. in 1929 and 1930? Was 1929 like 1987?

  5. Gravatar of ssumner ssumner
    24. March 2012 at 05:04

    Marcus, Thanks, I can’t imagine why he would seem to give the Fed a pass on monetary policy. Hall pointed out that the IOR program effectively tightened monetary policy in late 2008.

    In addition, almost the entire crash in RGDP occurred BEFORE we had reached the zero bound.

    Bill, I can’t imagine any serious economist equating “stock market crash” and “financial crisis.”

    Nick, Yes, 1929 was exactly like 1987, the stock crashes were almost identical, and in both years there was no financial crisis. I’ve never once heard anyone claim the US had a financial crisis in 1987, “and no recession followed.” That would be a truly bizarre claim.

    The was no banking crisis in 1929.

    Everyone, Does anyone know if Rogoff and Reinhart took the slowdown in trend rates of growth into account in their claim that countries usually recover slowly from financial crises?

  6. Gravatar of Majorajam Majorajam
    24. March 2012 at 05:07

    Quite simple really, Nick. The two sets of things happened in different calendar years, and therefore were unrelated. Like the Bear Stearns and Lehman collapse, or the popping of the TMT bubble and the surge in corporate bankruptcies in 2001 and 2002. Hey, plausible deniability worked for Ollie North, why not here?

  7. Gravatar of Majorajam Majorajam
    24. March 2012 at 05:40

    Indeed Scott, very similar events. The 1929 was a top fifteen worst equity markets of the past century, while the 1987 portfolio insurance crash, a single event whose exclusion causes the kurtosis of a near century long daily return series to plummet by a factor of three, knocked that years returns all the way down to… a slight gain. Mirror images, the two.

  8. Gravatar of dwb dwb
    24. March 2012 at 05:51

    12 recessions since WWII, and one has involved a financial crisis.

    ok well, here goes with a bizarre claim: following the recession of 82 there was a post-depression high number of bank failures (google Continental Illinois for example). There were a lot of S&L failures throughout the 80s, culminating in resolution trust in the 90s.

    I would say a lot of these banks were weak, the recession just hastened their demise. But no one says the S&L crisis caused the 82 recession, rather we say the reverse (Volker caused the recession to tamp inflation).

    If you track “recessions” and bank failures they track pretty closely.

    the only differece it seems to me is the degree of the recession (which, impacts the “size” of the “crisis” or panic(the recession of 2007 was a whopper.

  9. Gravatar of John John
    24. March 2012 at 06:01

    To say the financial crisis happened in 1931 is pretty arbitrary. There’s certainly no mistake saying it started in 1929. You could argue it either way. The fact is that hours worked and began around the same time as the “financial crisis” of the stock market crash. On the other hand, 1931 was “the disastrous year” where large scale bank failures crippled the nation’s monetary system. You could very well argue that 1931 was a consequence of 1929 as well. In any case, it’s a bit strange to say that the other guy was wrong for saying it was in 1929.

  10. Gravatar of dwb dwb
    24. March 2012 at 06:09

    i googled this. Funny: substitute “housing” for “energy” and “Lehman” or “Bear Stearns” for “Continental Illinois” and “subprime” in a few places, change the dates… and viola!

    To fully understand the demise of Continental, it is first necessary to review the history of Penn Square Bank’s involvement with Continental. Penn Square was one of the most aggressive lenders in one of the hottest … areas of the country. Because its loan generating ability exceeded its legal lending limit as well as funding ability, Penn Square would originate loans and then sell them to other banks, including Continental and First National Bank.

    OCC’s 1982 examination determined that many of the loans purchased from Penn Square, particularly in the months just prior to Penn Square’s failure, had failed to meet Continental’s typical energy lending standards. Many were also poorly documented and were, therefore, not being internally rated in a timely manner.

    lol… just proves there is nothing new under the sun! poor lending standards and low documentation in one of the hottest areas of the country, the moral hazard of the originate-to-distribute model rears its head. and when the recession hits…

    http://fic.wharton.upenn.edu/fic/case%20studies/continental%20full.pdf

  11. Gravatar of dwb dwb
    24. March 2012 at 06:32

    … and heres the FDIC summary too.

    http://www.fdic.gov/bank/historical/managing/history2-04.pdf

    anyone who claims “subprime” was invented in the 2000s… nope, not so much. “subprime” ala poor lending standards has been around since we invented loans.

  12. Gravatar of W. Peden W. Peden
    24. March 2012 at 06:56

    dwb,

    I think that the tendency is for recessions to cause financial crises (the converse is possible, of course). 1982 was a particularly severe recession. So was the 2008 recession that preceded the Lehman Brothers phase of the most recent financial crisis. The current problems in Europe are due to an existing NGDP shortfall etc.

    In the UK, the secondary banking crisis of the mid-1970s was… Well, secondary, to the recession that began in early 1974 after Anthony Barber belated tightened monetary policy. An example demonstrating that the tendency of recessions to cause financial crises is only a tendency is that the 1980-1981 recession in the UK, which was more severe than the 1982 US recession, didn’t result in a financial crisis. It wasn’t caused by one either; it was as pure a case as you’ll find of a recession born out of a deliberately disinflationary monetary policy (though the Conservative government of the day certainly didn’t intend to be as harsh as they were in 1980).

  13. Gravatar of W. Peden W. Peden
    24. March 2012 at 07:02

    Here’s some historic UK NGDP and inflation data to back up my point. Note how (1) the 1974 recession begins with a very sharp slowdown in NGDP growth; the failure of incomes policies and the subsequent 1974 Miners’ Strike forced the Conservatives into a sharp contraction in monetary policy; (2) the 1980-1981 recession was caused by a very sharp and sustained slowing down of NGDP growth; and (3) UK NGDP growth began to seriously slow down in mid-2008, very soon after non-bank M4 holdings shift from strong growth to stagnation-

    http://timetric.com/index/gdp-at-market-prices-quarterly-nsa-m-uk/

    http://timetric.com/topic/cpi-rpi-comparison-of-indexes/

    http://www.bankofengland.co.uk/statistics/PublishingImages/fm4/2012/jan/CHART1.GIF

  14. Gravatar of W. Peden W. Peden
    24. March 2012 at 07:05

    dwb,

    Continuing on the finance and recessions thought, as far as I know the S&L crisis wasn’t a systemic crisis and was on a considerably smaller scale than the Great Recession, let alone the Great Depression. Of course, the severity of the financial problems in all three is matched to some extent by the preceding recession.

  15. Gravatar of Majorajam Majorajam
    24. March 2012 at 07:35

    After some digging, 100 years of daily US equity returns excluding Monday October 19, 1987:

    Skewness -.24
    Excess Kurtosis 7.53

    100 years of daily US equity returns including Monday October 19, 1987:

    Skewness -3.30
    Excess Kurtosis 79.67

    Pay no attention to the man behind the curtain

  16. Gravatar of dwb dwb
    24. March 2012 at 07:54

    The S&L crisis cost quite a bit of money. RTC liquidated on the order of 400 billion dollars of assets (Wikipedia says $394). Thats comparable to TARP and Maiden Lane 15 years later.

    you’re right, poor lending standards and poor capital cause bank failures, not recessions per se (they merely accelerate the process). The degree of bank failures will not just reflect the depth of the recession, but the stupidity of capital and lending standards before the recession.

    The S&L crisis was slow moving and considered less of a crisis … maybe I dunno, cause the Fed steered nominal income and only allowed recessions in order to disinflate.

  17. Gravatar of W. Peden W. Peden
    24. March 2012 at 09:12

    dwb,

    “The S&L crisis was slow moving and considered less of a crisis … maybe I dunno, cause the Fed steered nominal income and only allowed recessions in order to disinflate.”

    I find it hard to explain US economic history in the late 1980s any other way. Lots of things that were supposed to cause recessions happened, but the recessions didn’t follow. What did happen was that NGDP growth was kept at around 5-8% from 1985-1990.

    It’s worth while noting that the UK, despite having a very financially developed and financially focused economy (and it’s been ahead on these scores for a long time) has had ONE significant financial crisis in over 100 years (the secondary banking crisis was dealt with quickly and tidily with no notable macroeconomic effects). I suspect that’s due to a number of factors, not least the informal* regulatory role played by the Bank of England. Sadly, that very successful system was dismantled in the late 1990s as part of a characteristically transatlantic reform of financial regulation towards agencies and explicit rules. At a first glance, versions of the financial instability hypothesis which I’ve heard don’t match the UK data, though I could have only come across oversimplifications.

    I find that most economic theories and hypotheses supported by a very casual empiricist analysis of apparent phenomena in US economic data (e.g. the multitude of theories who consider it a bonus that they can explain real wage stagnation in the US) break down when applied to most other economies, not least the UK. Sometimes you get entire books supported only by almost totally uncontrolled bivariate regressions where often the US creates almost the entirety of the slope (e.g. The Spirit Level).

    * With stress on “informal”. We’re talking lunchtime conversations between the governor and banking executives. Bankers vs. bankers.

  18. Gravatar of W. Peden W. Peden
    24. March 2012 at 09:23

    On prognosticating without reference to markets: I read a wee book today from 1983 called “Barbarians at the Gates”, which was very much in the JK Galbraith school of economics (I can’t recall the author’s name). Anyway, there was plenty of analysis about Kondratiev waves, incomes policies and the usual Keynesian/Post-Keynesian/Disillusioned Keynesian fare of the day. The author came to very sobering conclusions.

    Then the rest of the 1980s happened. It’s as if fate was toying with the poor author. He should have looked at what was going on with the market and NGDP.

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. March 2012 at 10:22

    Scott,
    You likely know more about his period than I. However, inflation was low prior to the stock market tumble. The estimated unemployment rate was not terribly low either. Thus my intuition tells me that we were about at capacity (from a NAIRU stance) in 1929. I do not believe, nor have I ever believed, in bubbles!!! Consequently we were in deep recession by 1931.

    P.S. I’ve been wasting time on conservative/libertarian blogs because I thought I could open some minds/hearts/eyes but I’ve realized it’s a total waste of my time. Frankly you on the right and Thoma on the left are more deserving of my energy.

    Both of you listen to the logic and the numbers.

  20. Gravatar of W. Peden W. Peden
    24. March 2012 at 10:38

    Mark. A Sadowski,

    “I’ve been wasting time on conservative/libertarian blogs because I thought I could open some minds/hearts/eyes but I’ve realized it’s a total waste of my time.”

    “I do not believe, nor have I ever believed, in bubbles!!!”

    The latter statement explains the former. In times of extremity, the right seems to retreat to deflationism of a naive sort, unscientific bubble claims, moral about the Fed as an institution, and bringing back the Gold Standard. Or DUMB for short.

    The left, of course, have their own vices during extreme times, from price controls, to opening the doors to debt-financed stimulus, and to overthrowing the market order altogether. However, I can’t think of an acronym for that.

    War tends to extremes. Economic crisis tends towards DUMB. As Scott has pointed out, all the necessary tools for analysing the Great Recession existed in mainstream economics prior to 2008 and most of the analytical framework required was worked out by David Hume about 250 years ago…

  21. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. March 2012 at 10:44

    W. Peden,
    Deflationism
    Unscientific bubble claims
    Moral about Fed as an institution
    Bring back the Gold standard

    DUMB. Cute I’ll rememeber that.

    I’ll not help you with an anacronym for the left. That’s because I’m biased. But I can think of several.

  22. Gravatar of W. Peden W. Peden
    24. March 2012 at 11:07

    Mark A. Sadowski,

    I might have accidentally suggested one in my paragraph on the left, but I can’t see one myself.

    As a small qualifier, I don’t think that believing that a deflationary trend is a dumb idea at all. However, not making the distinction between good deflation and bad deflation, and endorsing bad deflation because of the goodness of good deflation, IS dumb. The smart deflationists (like Selgin and Friedman circa “The Optimum Quantity…”) avoid it.

  23. Gravatar of Negation of Ideology Negation of Ideology
    24. March 2012 at 11:13

    DUMB – very clever, I agree. The nutty left tends to go more for the bashing of business, while the nutty right goes more for the “economics as a morality play” nonsense. The idea that we lived too good during the 20’s or the Great Moderation so we “deserved” a collapse to teach us a lesson. Somehow, the prosperity wasn’t “real” – whatever that means.

  24. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. March 2012 at 11:28

    W. Pedin,
    No fear. I’m sold thanks to Beckworth on a good deflation. The whole point of a NGDP target is we don’t worry about inflation at all.

  25. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. March 2012 at 14:02

    Scott,

    Hahaha Krugman allowed the following stupid comment. But it made me so happy.:)

    “The UK is not pegged to the euro. The other option is QE.

    Print it and it shall come.”

  26. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. March 2012 at 14:08

    Hey I’m having unusual success these days. He also let through:

    “Is it worth reminding people that Trichet is a Mining Engineer? The man has never studied economics.

    Why would a monetary union embarking on the most ambitious project ever concieved choose a Mining Engineer to be in charge of its central bank?

    I guess given Bernanke’s performance what does it matter?”

    I think the key is to keep them short and pithy.

  27. Gravatar of ssumner ssumner
    25. March 2012 at 05:51

    Majorajam. In both cases the market peaked around August or September. In both cases the market fell gradually by about 20% over 6 weeks. In both cases the market then plunged about 22% to 24% in 2 days. In the 1929 crash prices fell back to 1928 levels. In the 1987 crash prices fell back to January 1987 levels. In both cases prices then leveled off for the rest of the year.

    Is that similar enough for you?

    dwb, Yes, the 1982 recession was FOLLOWED by an unusual number of bank failures, as you’d expect after a severe recession. I don’t think any economist has ever claimed that a financial crisis occurred in the US during the 1981-82 recession. Most post-war recessions saw a trivial number of bank failures. The 2008 recession was the only one with a financial crisis.

    John, You said;

    “To say the financial crisis happened in 1931 is pretty arbitrary. There’s certainly no mistake saying it started in 1929. You could argue it either way. The fact is that hours worked and began around the same time as the “financial crisis” of the stock market crash. On the other hand, 1931 was “the disastrous year” where large scale bank failures crippled the nation’s monetary system. You could very well argue that 1931 was a consequence of 1929 as well. In any case, it’s a bit strange to say that the other guy was wrong for saying it was in 1929.”

    You can’t just make up myths out of thin air. There was no Presidential election in the US in 1929. It’s not a matter of opinion. There was no Olympics in 1929, it’s not a matter of opinion. And there was no financial crisis in the US in 1929, it’s not a matter of opinion. Obviously the Great Depression caused the 1931 financial crisis, that’s exactly my point.

    If you think there was a financial crisis in 1929, please provide the evidence.

    dwb, Yes, but home loan lending standards really did get much worse in the 2000s. Standards of business loans were low in the 1970s and 1980s, due to moral hazard created by FDIC.

    Majorajam, That kurtosis data is widely known, and has nothing to do with this post. I’ve never claimed returns were normally distributed, everyone knows they aren’t.

    dwb, Yes, the S&Ls lost lots of money, but that wasn’t a financial crisis and it mostly didn’t occur during a recession. The 1982 recession is widely blamed on tight money (not just by me, by almost everyone.) And that’s the only other post-WWII event that even comes close to being a financial crisis.

    W. Peden, I’m glad I avoided that book.

    Mark, Yes, I agree the economy was very depressed in 1931, that’s why I said recovering to 1931 levels didn’t mean recovering from the GD itself.

    Wasn’t Herbert Hoover also a mining engineer?

  28. Gravatar of dwb dwb
    25. March 2012 at 10:21

    i agree, my point is more subtler. “financial crisis” like “bubble” is not a well defined term (cluster of bank failures? over what time? what about govt bankrupcies like the mexican default and LDC crisis in the early 80s?) and seems to be a thing where “we know it when we see it”. It’s been a while since I’ve read the Reinhart Rogoff paper, but i dont recall coming away thinking their methodology was particularly objective either.

  29. Gravatar of Cantillonblog Cantillonblog
    25. March 2012 at 11:48

    Scott Sumner – the bond market in the late 20s was bigger than the stock market, and almost every sovereign issuer ended up defaulting. The private sector didn’t fare so well either. So you might want to look at credit spreads rather than equity prices. Obviously if the market is closed to new issuance and to refinancings, that starts to become a problem some time before the situation gets bad enough to reach the stage of bank runs.

    One should also consider the international aspect, since Europe was in many ways the epicentre of the crisis. The BodenKreditAnstalt had trouble financing itself as early as October 1929 when the Bank Austria (central bank) closed the discount window. The forced merger with Credit-Anstalt created the new entity that was to kick off the acute phase of the crisis in 1931.

    So I do not understand why you write with such certainty that there was no crisis until 1931. The fire ignited in 1929 but was not noticed till some time later.

  30. Gravatar of Cantillonblog Cantillonblog
    25. March 2012 at 11:54

    To say there was no crisis in the US in 1929 is like saying there was no peripheral crisis in Europe in 2007. The whole thing was one rotten episode that took its time to spread. But in 2008 it was inevitable that the recognition of trouble in the US would inevitably lead to recognition of underlying problems down the line in Europe, no matter how aggressively the ECB eased. The problem wasn’t that the ECB tightened too much, and didn’t ease enough. The problem was that trusting German Landesbankers had lent money at stupidly low interest rates to countries that didn’t make good use of the money nor have an alternative financing source when the Germans awoke. All the liquidity in the world isn’t going to make that problem go away.

  31. Gravatar of Majorajam Majorajam
    25. March 2012 at 18:59

    In both cases the market peaked around August or September. In both cases the market fell gradually by about 20% over 6 weeks. In both cases the market then plunged about 22% to 24% in 2 days. In the 1929 crash prices fell back to 1928 levels. In the 1987 crash prices fell back to January 1987 levels. In both cases prices then leveled off for the rest of the year.

    how is it possible to be that wrong about something you can resolve with google? The S&P was down by more on Black Monday than the entire month of October, and it was down around 2% in September after peaking in August. Also in dramatic contrast with 1929 (and 2008), the market was actually up in 1987, as I said before, up the following year, and the year after that (in both cases, robustly). And in your mind these two events are the same because… they both happened in October?? Were you ill the day they taught the scientific method in grad school?

    You completely misunderstood the significance of the skew and kurtosis of 100 years of daily returns with and without Black Monday. If you want to know why stock markets have circuit breakers and pension funds don’t have ‘portfolio insurance’ programs (another brilliant Chicago School innovation), google “index futures dislocation criticized”.

    The degree to which that single day that basically was the entire ‘crisis’ of 1987 was the data point that didn’t belong falls out of evidence too plentiful to inventory, but certainly the degree to which it is statistically out of character for a 100 year old daily return series is relevant in that regard.

    The bottom line is that no one could put any genuine study into the fundamental causes and effect of the crash of 1929 and come away with a convincing parallel with 1987. From the amount of leverage in the two systems to the relative levels of real interest rates to the dissonant roles of idiosyncratic geopolitical developments to technical factors to more night and day apples and oranges circumstances than I can be bothered to go into, there’s simply no comparison. Asserting one so flippantly and with such threadbare and comically erroneous evidence is actually quite revealing.

  32. Gravatar of Cantillonblog Cantillonblog
    26. March 2012 at 17:57

    The 1987 equity market crash was in part a recognition of trouble that had been brewing in the bond market since the beginning of the year. This being said, the credit market stayed open. That is really the key point, and the reason why 1931 should be seen as part of the same episode that began in 1929, just as the European peripheral crisis of 2011 should be seen as having begun in 2007-2008.

    It is astonishing that somebody can speak of linkages between financial markets and the real economy without giving any evidence of understanding the tremendous importance of the credit markets.

  33. Gravatar of ssumner ssumner
    27. March 2012 at 06:06

    dwb, Still, under any reasonable definition it’s very rare for a US recession (since WWII) to be associated with a financial crisis.

    Cantillonblog. Whether the system was “rotten” (as you claim) is completely irrelevant to my argument that there was no financial crisis in 1929.

    Majorajam, All my comparisons are accurate, I defy you to present evidence contradicting them. I’d suggestion you overlay the graphs for the two crashes, and you’ll see I’m right.

    Perhaps a finance person thinks it’s significant that the 23% fall occurred in one day in 1987 and in two days in 1929, but to a macroeconomist that distinction is unimportant.

    Cantillonblog, The cause of the crises in 1931 and 2011 was tight money.

    There is no explanation for the 1987 stock crash. Any explanation would imply these sorts of crashes should occur on various occasions, and it only happened one if you use daily frequencies.

  34. Gravatar of Cantillonblog Cantillonblog
    28. March 2012 at 17:19

    Dr Sumner – why do you plot the stock market when it is the credit market that matters for assessing whether there is a fincancial crisis or not, and the credit market was larger than the stock market?

    The European credit market was where the crisis began.

    You don’t consider the inability of the BodenKreditAnstalt to finance itself the beginning of the crisis? Why not?

  35. Gravatar of Cantillonblog Cantillonblog
    28. March 2012 at 17:21

    Dr Sumner would you care to enumerate in history those instances that saw the bursting of a bubble in the credit market where the central bank acted sufficiently fast and vigorously that everything worked out fine and there was not hell to pay?

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