-Caveat Lector-
~~for educational purposes only~~
Great Myths of the Great Depression
by 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 "handsoff" 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 election, 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 America'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.
1. Hans F. Sennholz. "The Great Depression,"
The Freeman, April 1975. p. 205.
2. Murray Rothbard, America's Great Depression
(Kansas City: Sheed and Ward, Inc., 1975), p. 89
3. Lindley H. Clark. Jr.. "After the Fall," Wall
Street Journal, October 26, 1979, p. 18.
4. "FDR's Disputed Legacy," Time, February 1,
1982, p. 23.
5. Barry W. Poulson, Economic History of the
United States (New York: Macmillan Publishing
Co., Inc., 1981), p. 508.
6. Paul Johnson. A History of the American People
(New York: HarperCollins Publishers. 1997), p. 741.
7. Martin Morse Wooster. "Bring Back the WPA?
It Also Had A Seamy Side." Wall Street Journal.
September 3, 1986, p. A26.
8. Sennholz, pp. 212-13.
9. Robert Higgs, "Regime Uncertainty: Why the Great
Depression Lasted So Long and Why Prosperity
Resumed After the War," The Independent Review.
Spring 1997, p. 573.
10. Ibid., p. 564.
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