Great Myths of the Great Depression

Universidad Autónoma de Centro América ^ | 1998 | Lawrence W. Reed

[AdamSelene235]

Great Myths of the Great Depression

Lawrence W. Reed

Many volumes have been written about the Great Depression and its impact on the lives of millions of Americans. Historians, economists, and politicians have all combed the wreckage searching for the "black box" that will reveal the cause of this legendary tragedy. Sadly, all too many of them decide to abandon their search, finding it easier perhaps to circulate a host of false and harmful conclusions about the events of seven decades ago.

How bad was the Great Depression? Over the four years from 1929 to 1933, production at the nation?s factories, mines, and utilities fell by more than half. People?s real disposable incomes dropped 28 percent. Stock prices collapsed to one-tenth of their precrash height. The number of unemployed Americans rose from 1.6 million in 1929 to 12.8 million in 1933. One of every four workers was out of a job at the Depression?s nadir, and ugly rumors of revolt simmered for the first time since the Civil War.

Old myths never die; they just keep showing up in college economics and political science textbooks. Students today are frequently taught that unfettered free enterprise collapsed of its own weight in 1929, paving the way for a decade-long economic depression full of hardship and misery. President Herbert Hoover is presented as an advocate of "hands-off", or laissez-faire, economic policy, while his successor, Franklin Roosevelt, is the economic savior whose policies brought us recovery. This popular account of the Depression belongs in a book of fairy tales and not in a serious discussion of economic history, as a review of the facts demonstrates.

The Great, Great, Great, Great Depression

To properly understand the events of the time, it is appropriate to view the Great Depression as not one, but four consecutive depressions rolled into one. Professor Hans Sennholz has labeled these four "phases" as follows: the business cycle; the disintegration of the world economy; the New Deal; and the Wagner Act.[1]

The first phase explains why the crash of 1929 happened in the first place; the other three show how government intervention kept the economy in a stupor for over a decade.

Phase I: The Business Cycle

The Great Depression was not the country's first depression, though it proved to be the longest. The common thread woven through the several earlier debacles was disastrous manipulation of the money supply by government. For various reasons, government policies were adopted that ballooned the quantity of money and credit A boom resulted, followed later by a painful day of reckoning. None of America?s depressions prior to 1929, however, lasted more than four years and most of them were over in two. The Great Depression lasted for a dozen years because the government compounded its monetary errors with a series of harmful interventions.

Most monetary economists, particularly those of the "Austrian school", have observed the close relationship between money supply and economic activity. When government inflates the money and credit supply, interest rates at first fall. Businesses invest this "easy money" in new production projects and a boom takes place in capital goods. As the boom matures, business costs rise, interest rates readjust upward, and profits are squeezed. The easy-money effects thus wear off and the monetary authorities, fearing price inflation, slow the growth of or even contract the money supply. In either case, the manipulation is enough to knock out the shaky supports from underneath the economic house of cards.

One of the most thorough and meticulously documented accounts of the Fed?s inflationary actions prior to 1929 is America?s Great Depression by the late Murray Rothbard. Using a broad measure that includes currency, demand and time deposits, and other ingredients, Rothbard estimated that the Federal Reserve expanded the money supply by more than 60 percent from mid-1921 to mid-1929.[2] The flood of easy money drove interest rates down, pushed the stock market to dizzy heights, and gave birth to the "Roaring Twenties".

By early 1929, the Federal Reserve was taking the punch away from the party. It choked off the money supply, raised interest rates, and for the next three years presided over a money supply that shrank by 30 percent. This deflation following the inflation wrenched the economy from tremendous boom to colossal bust.

The "smart" money ?the Bernard Baruchs and the Joseph Kennedys who watched things like money supply? saw that the party was coming to an end before most other Americans did. Baruch actually began selling stocks and buying bonds and gold as early as 1928; Kennedy did likewise, commenting, "only a fool holds out for the top dollar".[3]

When the masses of investors eventually sensed the change in Fed policy, the stampede was underway. The stock market, after nearly two months of moderate decline, plunged on "Black Thursday" ?october 24, 1929? as the pessimistic view of large and knowledgeable investors spread.

The stock market crash was only a symptom ?not the cause? of the Great Depression: the market rose and fell in near synchronization with what the Fed was doing.

Phase II: Disintegration of the World Economy

If this crash had been like previous ones, the subsequent hard times might have ended in a year or two. But unprecedented political bungling instead prolonged the misery for twelve long years.

Unemployment in 1930 averaged a mildly recessionary 8.9 percent, up from 3.2 percent in 1929. It shot up rapidly until peaking out at more than 25 percent in 1933. Until March 1933, these were the years of President Herbert Hoover-the man that anti-capitalists depict as a champion of noninterventionist, laissez-faire economics.

Did Hoover really subscribe to a "hands off the economy", free-market philosophy? His opponent in the 1932 elections, Franklin Roosevelt, didn?t think so. During the campaign, Roosevelt blasted Hoover for spending and taxing too much, boosting the national debt, choking off trade, and putting millions of people on the dole. He accused the president of "reckless and extravagant" spending, of thinking "that we ought to center control of everything in Washington as rapidly as possible", and of presiding over "the greatest spending administration in peacetime in all of history". Roosevelt?s running mate, John Nance Garner, charged that Hoover was "leading the country down the path of socialism".[4] Contrary to the modern myth about Hoover, Roosevelt and Garner were absolutely right.

The crowning folly of the Hoover administration was the Smoot-Hawley Tariff, passed in june 1930. It came on top of the Fordney-McCumber Tariff of 1922, which had already put American agriculture in a tailspin during the preceding decade. The most protectionist legislation in U.S. history, Smoot-Hawley virtually closed the borders to foreign goods and ignited a vicious international trade war. Professor Barry Poulson notes that not only were 887 tariffs sharply increased, but the act broadened the list of dutiable commodities to 3,218 items as well.[5]

Officials in the administration and in Congress believed that raising trade barriers would force Americans to buy more goods made at home, which would solve the nagging unemployment problem. They ignored an important principle of international commerce: trade is ultimately a two-way street; if foreigners cannot sell their goods here, then they cannot earn the dollars they need to buy here.

Foreign companies and their workers were flattened by Smoot-Hawley?s steep tariff rates, and foreign governments soon retaliated with trade barriers of their own. With their ability to sell in the American market severely hampered, they curtailed their purchases of American goods. American agriculture was particularly hard hit. With a stroke of the presidential pen, farmers in this country lost nearly a third of their markets. Farm prices plummeted and tens of thousands of farmers went bankrupt. With the collapse of agriculture, rural banks failed in record numbers, dragging down hundreds of thousands of their customers.

Hoover dramatically increased government spending for subsidy and relief schemes. In the space of one year alone, from 1930 to 1931, the federal government's share of GNP increased by about one-third.

Hoover's agricultural bureaucracy doled out hundreds of millions of dollars to wheat and cotton farmers even as the new tariffs wiped out their markets. His Reconstruction Finance Corporation ladled out billions more in business subsidies. Commenting decades later on Hoover's administration, Rexford Guy Tugwell, one of the architects of Franklin Roosevelt?s policies of the 1930s, explained, "We didn?t admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover started".[6]

To compound the folly of high tariffs and huge subsidies, Congress then passed and Hoover signed the Revenue Act of 1932. It doubled the income tax for most Americans; the top bracket more than doubled, going from 24 percent to 63 percent. Exemptions were lowered; the earned income credit was abolished; corporate and estate taxes were raised; new gift, gasoline, and auto taxes were imposed; and postal rates were sharply hiked.

Can any serious scholar observe the Hoover administration?s massive economic intervention and, with a straight face, pronounce the inevitably deleterious effects as the fault of free markets?

Phase III: The New Deal

Franklin Delano Roosevelt won the 1932 presidential election in a landslide, collecting 472 electoral votes to just 59 for the incumbent Herbert Hoover. The platform of the Democratic Party whose ticket Roosevelt headed declared, "We believe that a party platform is a covenant with the people to be faithfully kept by the party entrusted with power". It called for a 25 percent reduction in federal spending, a balanced federal budget, a sound gold currency "to be preserved at all hazards", the removal of government from areas that belonged more appropriately to private enterprise, and an end to the "extravagance" of Hoover?s farm programs. This is what candidate Roosevelt promised, but it bears no resemblance to what President Roosevelt actually delivered.

In the first year of the New Deal, Roosevelt proposed spending $10 billion while revenues were only $3 billion. Between 1933 and 1936, government expenditures rose by more than 83 percent. Federal debt skyrocketed by 73 percent.

Roosevelt secured passage of the Agricultural Adjustment Act (AAA), which levied a new tax on agricultural processors and used the revenue to supervise the wholesale destruction of valuable crops and cattle. Federal agents oversaw the ugly spectacle of perfectly good fields of cotton, wheat, and corn being plowed under. Healthy cattle, sheep, and pigs by the millions were slaughtered and buried in mass graves.

Even if the AAA had helped farmers by curtailing supplies and raising prices, it could have done so only by hurting millions of others who had to pay those prices or make do with less to eat.

Perhaps the most radical aspect of the New Deal was the National Industrial Recovery Act (NIRA), passed in June 1933, which set up the National Recovery Administration (NRA). Under the NIRA, most manufacturing industries were suddenly forced into government-mandated cartels. Codes that regulated prices and terms of sale briefly transformed much of the American economy into a fascist-style arrangement, while the NRA was financed by new taxes on the very industries it controlled. Some economists have estimated that the NRA boosted the cost of doing business by an average of 40 percent?not something a depressed economy needed for recovery.

Like Hoover before him, Roosevelt signed into law steep income tax rate increases for the high brackets and introduced a 5 percent withholding tax on corporate dividends. In fact, tax hikes became a favorite policy of the president?s for the next ten years, culminating in a top income tax rate of 94 percent during the last year of World War II. His alphabet agency commissars spent the public's tax money like it was so much bilge.

For example, Roosevelt?s public relief programs hired actors to give free shows and librarians to catalogue archives. The New Deal even paid researchers to study the history of the safety pin, hired 100 Washington workers to patrol the streets with balloons to frighten starlings away from public buildings, and put men on the public payroll to chase tumbleweeds on windy days.

Roosevelt created the Civil Works Administration in November 1933 and ended it in March 1934, though the unfinished projects were transferred to the Federal Emergency Relief Administration. Roosevelt had assured Congress in his State of the Union message that any new such program would be abolished within a year. "The federal government", said the President, "must and shall quit this business of relief. I am not willing that the vitality of our people be further stopped by the giving of cash, of market baskets, of a few bits of weekly work cutting grass, raking leaves, or picking up papers in the public parks".

But in 1935 the Works Progress Administration came along. It is known today as the very government program that gave rise to the new term, "boondoggle" because it "produced" a lot more than the 77,000 bridges and 116,000 buildings to which its advocates loved to point as evidence of its efficacy.[7] The stupefying roster of wasteful spending generated by these jobs programs represented a diversion of valuable resources to politically motivated and economically counterproductive purposes

The American economy was soon relieved of the burden of some of the New Deal?s excesses when the Supreme Court outlawed the NRA in 1935 and the AAA in 1936, earning Roosevelt?s eternal wrath and derision. Recognizing much of what Roosevelt did as unconstitutional, the "nine old men" of the Court also threw out other, more minor acts and programs which hindered recovery.

Freed from the worst of the New Deal, the economy showed some signs of life. Unemployment dropped to 18 percent in 1935, 14 percent in 1936, and even lower in 1937. But by 1938, it was back up to 20 percent as the economy slumped again. The stock market crashed nearly 50 percent between August 1937 and March 1938. The "economic stimulus" of Franklin Roosevelt?s New Deal had achieved a real "first": a depression within a depression!

Phase IV: The Wagner Act

The stage was set for the 1937-38 collapse with the passage of the National Labor Relations Act in 1935?better known as the Wagner Act and organized labor's "Magna Carta". To quote Hans Sennholz again:

This law revolutionized American labor relations. It took labor disputes out of the courts of law and brought them under a newly created Federal agency, the National Labor Relations Board, which became prosecutor, judge, and jury, all in one. Labor union sympathizers on the Board further perverted this law, which already afforded legal immunities and privileges to labor unions. The U.S. thereby abandoned a great achievement of Western civilization, equality under the law.[8]

Armed with these sweeping new powers, labor unions went on a militant organizing frenzy. Threats, boycotts, strikes, seizures of plants, and widespread violence pushed productivity down sharply and unemployment up dramatically. Membership in the nation's labor unions soared; by 1941 there were two and a half times as many Americans in unions as in 1935.

From the White House on the heels of the Wagner Act came a thunderous barrage of insults against business. Businessmen, Roosevelt fumed, were obstacles on the road to recovery. New strictures on the stock market were imposed. A tax on corporate retained earnings, called the "undistributed profits tax", was levied. "These soak-the-rich efforts", writes economist Robert Higgs, "left little doubt that the president and his administration intended to push through Congress everything they could to extract wealth from the high-income earners responsible for making the bulk of the nation?s decisions about private investment".[9]

Higgs draws a close connection between the level of private investment and the course of the American economy in the 1930s. The relentless assaults of the Roosevelt administration ?in both word and deed? against business, property, and free enterprise guaranteed that the capital needed to jumpstart the economy was either taxed away or forced into hiding. When Roosevelt took America to war in 1941, he eased up on his antibusiness agenda, but a great deal of the nation's capital was diverted into the war effort instead of into plant expansion or consumer goods. Not until both Roosevelt and the war were gone did investors feel confident enough to "set in motion the postwar investment boom that powered the economy?s return to sustained prosperity".[10]

Whither Free Enterprise?

On the eve of America?s entry into World War II and twelve years after the stock market crash of Black Thursday, ten million Americans were jobless. Roosevelt had pledged in 1932 to end the crisis, but it persisted two presidential terms and countless interventions later.

Along with the horror of World War II came a revival of trade with American?s allies. The war?s destruction of people and resources did not help the U.S. economy, but this renewed trade did. More important, the Truman administration that followed Roosevelt was decidedly less eager to berate and bludgeon private investors, and as a result, those investors came back into the economy to fuel a powerful postwar boom.

The genesis of the Great Depression lay in the inflationary monetary policies of the U.S. government in the 1920s. It was prolonged and exacerbated by a litany of political missteps: trade-crushing tariffs, incentive ?sapping taxes, mind? numbing controls on production and competition, senseless destruction of crops and cattle, and coercive labor laws, to recount just a few. It was not the free market that produced twelve years of agony; rather, it was political bungling on a scale as grand as there ever was.

[andy_card]

You're right. FDR was responsible for far more boondoggles than the author mentions. But the piece was already running a bit long, don't you think?

No, I don't think the piece was anywhere near long enough. If the author wanted to attack FDR programs as boondoggles (which many if not most were, imho), he should have argued such. Instead, he just pulls out a few issues and adds some circumstantial evidence without really making a compelling case one way or the other. This article has all of the depth of a high-school textbook, without any substance behind the claims.

[tcostell]

Old myths never die; they just keep showing up in college economics and political science textbooks.

Actually, this hasn't been true of the great depression for 20 years. It's the english department that has kept socialism alive. The Economics department moved on a quarter century ago when it became apparent that Hayek was right instead of Keynes.

[Libertarianize the GOP]

good post

[AdamSelene235]

Good point. What institutional changes would you make?

It will be politically impossible to make serious changes in absence of a major crisis. Personally, I believe the very internal economic logic of the GSE's could produce such a crisis. A Fannie Mae crisis prompted by deflation or derivatives trading would simulataneously take out the bond, stock and real estate markets, for example.

The problem of money is a tricky one. I'm not a gold bug but I have been pleased at the recent emergence of electronic gold. The fiat system is lunacy. The government is the largest and most irresponsible debtor in the room, so their bias will always be towards debasing the currency. Until it is impossible, that is. Then you've really got your tit caught in the wringer.

My best guess is that a deflationary environment will be the endgame for Keynesian economics. Afterwards, I'd like to see corporate taxes (in reality a regressive consumer tax), capital gain, and income taxes abolished. A National Sales tax should suffice. Restoring the nation to a Constitutional Republic from its current status as a Socialist Democracy would also be nice.

As far as currency is concerned? Since capital gains taxes would no longer punish you for not participating in the inflation, you could use any thing you please, a tri-metalic currency or one backed by a basket of equities.

[Centurion2000]

bump for later review

[AdamSelene235]

What ever happened to Rural Electrification, the CCC, the SEC, TVA, Social Security, etc.?

Are you saying this ironically?

Social Security may very well wreck the country one day if FDR's GSE timebombs don't do so first.

[Lee_Atwater]

this hardly counts as a serious piece

Sure, my idea of serious economic research is something that I would find in the Journal of Political Economy. However, research always starts with small, non-empirical articles.

Economics is very complicated

It's not an exercise in quantum mechanics.

the author doesn't make a convincing case that...the Wagner Act were responsible for much of anything

One would be hard pressed to believe that artificially increased costs that trade unions create do not stifle growth. Existing firms may be able to bear the cost. However, new entrants may be discouraged. This certainly would be a subject for further, in-depth research.

Well pro wrestling is on at 9. I have to go.

[Lee_Atwater]

Certainly, Dr. Samuelson has been forced to make some revisions. Twenty revisions of his magnum opus, Economics, is quite an indication. I was fortunate enough to study under free-market (i.e. Chicago School) types, but Keynesian theory still abounds.

[beavus]

No, the article has all the depth of a forum post. If you want depth, read some of the books the author references.

[nonliberal]

Another excellent discussion of depression era economic policies can be found here:

Economics on Trial by Mark Skousen pp.102-118

[Arioch7]

No, I must have deleted it while I was inebriated. :D

Letting Nurses do some of the things Doctors do would halep the equation greatly IMHO.

Now, on to Soros. I have been somewhat of an admirer of him my entire life. The reason I say somewhat is he is something of a hypocrite.

When the South Korean currency market collapsed, he played it brilliantly and made hundreds of millions of dollars. I do not begrudge him that but he hardly helped the situation with his strategy. He rails against western capitalists who try to do the same thing though not as succesfully as he had done.

Another glimpse of Soros can be found in his supporting of the Estate Tax in the USA. He is FIRMLY for it, yet not one PENNY of his assets will ever be touched by this type of law as he has rolled all of his wealth into corporate entities and foundations upon his death.

In other words, he talks the talk but does not walk the walk. For someone to tell ME I have to submit while exemptimg themselves from the equation smacks of "elitism," or as I like to call it a "Royalist" mentality.

He is indeed a brilliant capitalist that fervantly backs Socialist causes that he DOES NOT SUPPORT himself. I guess this is where I lost respect for his moral character. Practice what you preach is what I always say. The facts are that he is really more like the Robber-Barons of the early Americas but has cloaked himself in Leftist dogma.

On a further note, the media positively ADORES Soros and people like Warren BUffet who act just like any other Capitalist but speak against Capitalism in public. I might add, although I am a small business man and not even CLOSE to thier league, I would NEVER do some of the things they have done. Yet, because I am "Right-Wing," and wear that label proudly, I am the bad guy. They of course, are the good guys because they preach the evils of Capitalism.

I would classify them both as Mercantilists... maybe not Buffet but Soros DEFINATELY!

Perhaps the right-wing philosophy is wrong. I am speaking philosophically here, you obviously know I subscribe to said philosophy. Yet, EVERY historical example of my type of thinking (American Right Wing versus Euro Right-Left Wing thinking.) has proven more beneficial to society then the Left-Wing Ideal.

The common phrase is "It has not been done correctly," to which I say, it can NOT be done correctly because it is natural. Read the Globe article and then go to the article today on China... they actually seem to support the Socialist government before the market reforms.

The liberals have practically won the debate. Now the question seems to be thus... "George Bush increased our plans by ONLY X percent when we asked for Y percent, we MUST fight for more!".

We Conservatives are pretty flummoxed by this but I take comfort in knowing that even in the most Socialist governments, people still prefer to be Capitalistic then Socialist. Let me give you an example...

When I was in the military, we all got paid the same according to our rank. there was one INdian Sikh who was earning his citizenship(Cool, aint it?), that would stand watches for money and sew things for our squadron. They teach you to sew in Boot Camp but I always sucked at it, so I always had him sew my patches and stand watches for me. He did the same for 20% of the squadron.

He made about 500$ a week OVER his standard pay. Who are WE(As a society.) to say that he can not keep the money. The truth is that whatever the government says he would have earned it ANYWAY. That is why I say Capitalism is natural. Of course, the NAvy stepped in and stopped him from doing watches but he continued his other activities, making money and that would be a bad thing under most Socialist regimes. Maybe I should have done it! LOL!

My my, I posted to log so I must say adios now but I hope you see my point.

[andy_card]

Social Security may very well wreck the country one day if FDR's GSE timebombs don't do so first.

I'm not talking about today. I'm talking about the effects in the 1930s. At the very least, I think the author might address them.

[AdamSelene235]

Read the final chapter of Soro's Alchemy of Finance. He basically says he has a God complex and wants to be the next Keynes. He goes on to say that it used to be a dirty secret he was ashamed of, but now, liberated by his immense wealth, he feels he can share. He chose the phrase "Theory of Reflexivity" because it sounded similar to Einstein's theory. And so on. I'd much rather read his former partner, Jim Rogers.

[AdamSelene235]

I'm not talking about today. I'm talking about the effects in the 1930s. At the very least, I think the author might address them.

Fair enough. I find it hard to praise them for not entirely destroying the country. Not that they didn't try.

Have you ever seen the Moscow subway? It was built in the early days of the USSR. Its breathtakingly beautiful. Kinda hard to ignore the ghastly structures that surround it.

Same thing.

[liberallarry]

I think you're too pessimistic about the conservative - or capitalist cause. No one every gets to win everything - which is good. The Left is constantly making the opposite complaint - that the Right is winning too much. :)

On Soros, or Buffet, or Gates or Andrew Carnegie, or a lot of other very wealthy types. Regardless of what they say they have this in common: in their business dealings they are fierce, ruthless, viscious, brilliant. So what? I'm not holding them up as Saviors. Soros writes and thinks extensively about our system. He's not just a businessman. One of the things he questions is the stability of the market - whether it really is self-correcting. I think that he's honest in his analysis. He's not saying this because it will benefit him in any monetary way. He takes pride in his analytical powers and would like to have the facts show him to be correct. So I listen very carefully when he speaks.

[Red Jones]

all those banks failed between 1930-1932, the federal reserve allowed it, that's why the money supply shrunk like it did.

Today, our federal reserve won't allow a 30% decline in the money supply no matter what. But consider if there are more enrons and worldcoms, corporate debt today is said to be 75% of their total value whereas in 1960 it was 40%. When equity prices decline tremendously, doesn't this put the big corps in a potential financial bind? Isn't it possible that we could have a lot of big corps go bankrupt, not just a few? at least if these negative trends keep continuing, then the whole thing could snowball out of control and cause a lot of big corporate bankruptcies.

So, in my view we could be in a period similar to 1930-1932. But instead of banks going bad, it may be large corporations. After 1930-32 we learned that the money supply must not be allowed to drop dramatically. Maybe this time we will learn that the ability to produce in america is very important to us and that we must protect it from serious decline.

[AdamSelene235]

Today, our federal reserve won't allow a 30% decline in the money supply no matter what.

What are they going to do? Lower interest rates?

[AdamSelene235]

Ever wonder how you could have an economic downturn, but no decline in consumer spending?

Here's where the bubble is hiding.

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[Springman]

Bump for latter, when I can read it.

[AdamSelene235]

I think you're too pessimistic about the conservative - or capitalist cause.

The two are quite distinct. Even the Right has become intoxicated by the power of Socialism. We aren't dealing with a free market but rather a mature Socialist Mobocracy.

Soros writes and thinks extensively about our system. He's not just a businessman. One of the things he questions is the stability of the market - whether it really is self-correcting

Read it. I'll concede he writes extensively about the system.As for thought, I suppose that's what passes for deep in financial/philosophical circles. They teach that stuff in every undergrad engineering class on control theory.

And no its not stable. That's no reason to intervene. Maxim: When dealing with multi-variable nonlinear coupled systems, first do no harm. Prices communicate information, the more you mess with them, the more disinformation you feed into the system. For instance, a 900 sq. ft. condo in my area goes for 275K$. I'd say someone has really screwed up the lines of communication.