America's Great Depression is often cited as the
primary example of the failure of free market economics. According to
the official liberal interpretation of the Depression, both the economic
collapse that began in 1929 and the nation's eventual recovery prove
that the American government must never again allow its economy to
operate in a free market mode. The common view is that the 1920s in
America was a period of unbridled free enterprise. In order to restore
stability to the nation's economy and bring the nation out of the depths
of the Depression, the government had to step in and do what businessmen
could not or would not do to correct the weaknesses of the free market
system. The decade of the 1930s proves the importance of governmental
control over the economy and justifies continuing interventionist or
statist measures.
It would be difficult to imagine an explanation that is
more in conflict with the evidence. This essay will examine four myths
that ground this mistaken explanation of the Depression. Once the myths
are recognized for what they are-an intentional distortion of the
truth-one of the major ploys used by academicians and politicians to
deceive the American people into supporting bigger government will be
exposed.
Myth Number One: The Case of Business Cycles
The first myth can be summarized as follows: A free
market is notoriously unstable and leads inevitably to economic cycles
in which periods of prosperity are followed by recessions and
depressions. These irregularities in a nation's economy can be either
eliminated or made less severe by proper government intervention.
The recurrence of business cycles is one of the most
frequently cited reasons for the need of governmental intervention with
the economy. The often unstated and always unproven assumption behind
this claim is that business cycles and, more specifically, economic
depressions are caused by free market economics. This assumption is
clearly false.
Business cycles in general and depressions in
particular are caused not by free markets, but by governmental
intervention with a nation's economy, specifically with its money
supply. As nations expand credit and the money supply, a pattern becomes
apparent. First, there is a governmentally induced period of economic
expansion as easy credit and a larger money supply mislead businessmen
into making bad investments. Markets unhampered by governmental
intervention keep sending signals to astute investors and entrepreneurs.
The rise or decline in prices along with the cost of borrowing money
(interest rates) can tell a wise investor whether a particular
opportunity is a good risk at that particular time. But governmental
intervention in the form of monetary and credit expansion affects the
reliability of normal market signals. Interest rates may be artificially
(and temporarily) reduced while inflation causes many prices to rise.
The rise in prices eventually affects the prices of capital goods
required for business expansion. This increase in business costs finally
affects the profitability of many businesses, leading them to find ways
to cut costs. In the later stages of the boom, interest rates begin to
rise, which also increases the cost of doing business and often affects
loans incurred when money was much cheaper.
Because governmental intervention with the economy
sends the wrong signals to businessmen and investors, their subsequent
investment in the wrong things at the wrong time makes a day of
reckoning inevitable. While that day can be postponed by even more
expansion of credit, it cannot be postponed forever. When the quantity
and degree of bad investments in any economy passes a certain point, the
economy can no longer absorb them. Ventures must be terminated;
businesses must be closed; bills must be left unpaid; workers must be
laid off; unemployment will increase; savings will be depleted.
A recession or depression therefore is a necessary step
in an economy's return to normal after the misinformation and
distortions caused by monetary inflation during the boom have produced a
large amount of malinvestment. The recession or depression that follows
periods of governmentally induced booms is a necessary time of
readjustment. Prices must be readjusted to new consumer preferences.
Interest rates must be readjusted to reflect the new demand for savings
along with the actual supply of savings. Bad investments must be reduced
through such means as greater managerial efficiency or lower labor
costs. These lower costs may be reached through greater productivity;
often they result from a business employing fewer workers. There must be
a general cutting back across the board until businesses can once more
be profitable, until investments can earn a proper return, and until the
economy once more functions efficiently. What people call a recession or
depression, therefore, is actually an adjustment of the economy to the
wasteful and mistaken errors made during the boom. The process of
adjustment is a return to a more sane set of economic arrangements which
means, among other things, that many of the bad investments are
liquidated.
There is a common thread that runs through every period
of economic decline in American history, namely, governmental
manipulation of the money supply. The obvious culprit in these economic
downturns was not the free market but the government-indeed, the very
government responsible for the downturns in the first place. What then
should one think of economists and politicians who appeal to such
periods of economic decline as justification for increased amounts of
the very types of economic interventionism that produced the
depressions?
But what about the Great Depression? As everyone thinks
they know, the decade prior to the economic collapse of 1929 was a
period of unbridled economic freedom. It was, so the official doctrine
goes, the extent of America's experiment with free enterprise in the
1920s that led to the greatest depression in our history. But this
belief is also a myth that must now be unmasked.
Myth Number Two: The Unbridled Capitalism of the Twenties
According to the official liberal dogma, the
seriousness of the Great Depression was in direct proportion to
America's reliance upon a noninterventionist economy during the decade
of the twenties. The unparalleled economic freedom of the twenties did
more than make the Great Depression inevitable; it also made it the
worst depression in the nation's history.
Even a brief survey of the evidence, however, will
reveal how mistaken the com-mon wisdom about the twenties is. The decade
that preceded the Crash of 1929 was anything but a period of unbridled
capital-ism. It was actually a time of continued governmental
intervention with the money supply. The foundations for the Depression
can indeed be found throughout the preced-ing decade. But the causes of
the Depression were a string of governmental actions that resulted in an
expansion of credit and the money supply that was similar to the
inter-ventionism that led to earlier economic downturns.
lishment of the Federal Reserve System in 1914. The
Federal Reserve was given the power to increase the nation's money
sup-ply in response to what it regarded as justifiable circumstances.
For most of the sixteen years following the creation of the Fed, the
nation's money supply was sub-jected to an almost steady increase.
Be-tween 1914 and 1917, this took the form of massive amounts of credit
extended to na-tions like England and France for their purchase of war
materiel. Following Amer-ica's own entry into World War I, the money
supply was expanded even more as a way of paying for our own war effort.
When the war was finally over, the now greatly expanded money supply
produced the inevitable in-flation.
The higher postwar prices led in turn to an increase in
cheaper imports. But this hurt American businesses, which led
business-men, farmers, and labor unions to pressure Congress to do
something about foreign competition. This pressure led to two
un-fortunate tariff acts (tariffs are clearly anti-thetical to
capitalism). The Emergency Tar-iff Act of 1921 increased duties on such
commodities as wool, sugar, and wheat.
Another tariff act passed in 1922 imposed the highest
duties to that time in the history of the nation. It also gave the
President the power to change tariffs as he thought nec-essary. These
high tariffs produced a serious instability in agriculture, other export
indus-tries, and the rest of the American economy.
All of this intervention with the economy had the
effect of reducing foreign trade. Prospective foreign customers could
not buy American products until they accumu-lated credits; but such
credits could be accumulated only after they first sold their products
to us, something the increased tariffs made much more difficult. In an
effort to offset some of this harm, the government adopted cheap money
policies. To make it easier for foreign buyers to purchase Amer-ican
goods (while still making it difficult for them to sell their goods in
the United States), bankers floated enormous loans and bond issues in
this country. Between the end of World War I and 1929, American lenders
provided more than $9 billion in foreign loans, done largely to shore up
America's sagging export markets which had been hurt as a result of
earlier interventionist mea-sures (the tariffs) to reduce imports. While
the cheap money policy of the twenties produced temporary increases in
exports, it was accompanied by a huge burden of internal and
international debt.
The Federal Reserve System continued to follow an easy
money policy during the second half of the twenties. Between July 1924
and 1929, the money supply increased more than 20 percent. Farm and
urban mortgages increased more than $10 billion between 1921 and 1929.
Because much of the new money created by the system was channeled into
speculation in real estate and the stock market, rapid price rises
occurred in the stock market and in real estate. (Other significant
forms of statist intervention with America's economy that helped lay the
foundation for the Depression must be dis-cussed elsewhere, due to a
lack of space.)
Often overlooked as a major contributing cause of the
Depression was what became known as the Smoot-Hawley Tariff Acts. Even
though Smoot-Hawley was not passed until June of 1930, it makes sense to
view the measure as a significant cause of the Crash. The bill had been
widely discussed and debated in Congress throughout much of 1929. By the
autumn of 1929, Wall Street had begun to realize that passage of the
tariff bill was inevitable. It also realized that President Hoover would
not veto the damaging measure. Hence, it seems clear, the damage from
Smoot-Hawley was not confined to the period of time following its
passage, as bad as that was. It also had a major effect on events prior
to its passage, including the October Crash of the Stock Market.
As important as the Stock Market Crash of October 1929
was, it did not mark the beginning of the Depression. The economy
actually began to recede during the summer of 1929. Economic troubles
had been brewing long before the Crash. What the collapse of the stock
market did was make those troubles visible and mark the end of an
incredible period of speculation that had to end sometime.
The October Crash is often exaggerated with regard to
its supposed effects on the Great Depression. While the Crash was
clearly very bad for the many unwise investors and speculators who had
been wiped out, America was still far from anything resembling what we
now think of as the Great Depression. That was still to come; and like
previous depressions, it would result from further governmental
mismanagement. The collapse of the stock market provided clear evidence
that badly mistaken policies had been followed. The time for necessary
readjustments had finally come.
Even with the crash of the stock market, the economy
was strong enough so that the nation should have entered a normal period
of readjustment. 1Even during 1930, unemployment averaged
less than 8 percent of the work force. Barring mistakes on the part of
the government, 1931 should have been the start of a recovery. Obviously
it was not, and the reason can be found in the mistaken, often foolish
policies of the federal government.
The economic decline that began at the end of 1929
could and should have been of short duration, if only Hoover and the
Congress had acted in an economically responsible way. Unfortunately,
they did not. Hoover and his administration were in no mood to admit
their mistakes. Had they taken their medicine, paid their dues, and
suffered through the severe but limited depression that would have
followed, the economy soon would have made the proper adjustments.
Instead, the Hoover administration piled error on top of error. Its
mistakes plus the blunders of Congress plus the economic malfeasance of
the Roosevelt Administration turned what would have been an economic
downturn like every other one in the previous history of the country
into an economic nightmare that lasted eleven years.
Myth Number Three: Hoover's Commitment to Free Market Economics
Deepened the Recession
As we have seen, liberals want to lay all of the blame
for the Depression at the feet of the free market. With such a
convenient scapegoat available, they can then use the Depression to
justify statist measures they wish to impose upon the economy in the
future. Their rewriting of history requires, however, that they turn
Herbert Hoover into a flaming advocate of free market economics whose
stubborn refusal to adopt interventionist measures made the Depression
worse until Franklin Roosevelt's courageous adoption of wise statist
policies finally turned things around. Nothing could be farther from the
truth.
In late 1929, the nation's economy was in need of a
number of major readjustments. But these necessary readjustments all
took the form of decreasing or terminating various interventionist
measures of the twenties that had produced the Depression. What Hoover
and his administration did however was reject the adjustments that
should have been made and opt instead for a course of more governmental
control over the economy.
Herbert Hoover was not a champion of a free market
economics whose conservative principles helped first to produce the
Depression and then caused it to worsen. In truth, Hoover was a proven
interventionist whose interventionist policies helped bring about the
start of the Depression and whose succeeding interventionist actions
helped to make it worse.
Following the 1929 Crash, the Hoover Administration and
Congress committed three major blunders that were to deepen and prolong
the Depression. Each blunder was a typically interventionist measure.
(1) Hoover did everything he could to keep wages and
prices high during 1930. For one thing, his administration took action
designed to keep the prices of wheat, cotton, and other agricultural
products up. The unfortunate result of these farm policies was to
encourage larger crops and greater farm surpluses for which no markets
could be found. This had the effect of depressing farm prices even more.
Also in 1930, Hoover attempted to persuade business
leaders to keep wages and prices high. In place of cutting wages and
prices-the normal practice in a time of recession-Hoover urged
businessmen to increase their spending on wages and capital outlay in
the belief that this would preserve the purchasing power of consumers.
The Hoover Administration pursued a policy of deficit spending and
public works projects. Local and state governments were asked to borrow
money to support their own public works projects.
(2) The Hoover Administration instituted large tariff
increases that had a disastrous effect on international exchange. With
tariffs already higher than they should have been and a huge burden of
international debt hanging over the world's economy, Hoover went along
with Congress's passage of a huge tariff increase. Already high tariffs
made it almost impossible for foreign goods to reach our markets.
Hoover's acceptance of a new round of even higher tariffs was the major
blunder that turned the recession of 1930 into the Great Depression. The
Smoot-Hawley Tariff Act of June 1930 was the most protection is law in
the history of the nation. America's borders were effectively closed to
foreign goods. The government's intentions with regard to the new tariff
act no doubt seemed good at the time. It wanted to raise farmers' low
incomes that resulted from the low prices they were getting for their
products. But in economics, good intentions often produce disastrous
results.
Other nations responded to the increase in our tariffs
by raising their own. This had the effect of cutting off international
markets and narrowing lines of trade. The new protectionist policies
created enormous problems for countries that owed money and needed to
pay off their debts with goods. Since so much of this mountain of debt
was unsound to begin with, creditors could not collect. In the two years
that followed passage of Smoot-Hawley, American exports declined by
almost two-thirds. The politicians had ignored a fundamental principle
of international exchange; exports pay for imports. If people in other
nations cannot sell their goods to us, they cannot earn the money they
need to buy our products. Closing the door to imports will result
eventually in closing the door to exports.
While farm prices dropped precipitously throughout
1930, the sharpest decline followed passage of the Smoot-Hawley Act in
June. While American exports had totaled $5.5 billion in 1929, they had
by 1932 fallen to just $1.7 billion. All of this led to a collapse of
American farming. Hundreds of thousands of American farmers lost their
farms. America's recession was being turned into a world depression.
(3) The government proceeded to raise taxes, an
incredible move under the circumstances. In fairness to Hoover, it
should be noted that much of the blame for the tax increase belonged to
the Congress. After the midterm elections of 1930, there was a
Democratic majority in the House of Representatives.
The tax increase of 1932 was the largest increase in
federal taxes in the history of the nation to that point. The income tax
was doubled. Estate taxes were raised, corporation tax rates were
increased, exemptions were lowered, and postal rates were raised. There
was also a 2 cent tax on checks, a 3 percent automobile tax, a tax on
telephones and telegraph messages, and a 1 cent a gallon gasoline tax.
Faced by declining revenues, state and local governments followed
Washington's lead and imposed new taxes of their own. The total tax
burden of the nation almost doubled in the period after 1932. If the
politicians had been seeking a way to bring the nation's economy to its
knees, they could not have found a better strategy. The huge tax
increases guaranteed that the Depression would not end soon. Real Gross
National Product fell by 14.8 percent in 1932, the year the tax increase
went into effect. An unemployment rate that had averaged 3.2 percent in
1929 and 7.8 percent in 1930 jumped to almost 25 percent in 1932.
By the end of Hoover's term, unemployment had reached
25 percent of the work force or more than twelve million workers. The
Depression had spread beyond the borders of the United States and had
become a worldwide depression. Nations like Germany and Austria stopped
making foreign payments and froze American credits. England ended gold
payments in September 1931. Foreign bond values fell drastically, which
led to a collapse of the bond market in America. This proved to be an
additional blow at American banks, in this case, a blow at their own
investments.
The collapse of so many American farmers put their
major creditors-the rural banks-in jeopardy. Many of them were forced to
close. Between August 1931 and February 1932, approximately 2,000 banks
closed, still owing depositors more than $1.5 billion. Banks that did
not close were often forced to take extreme measures. New loans were
often refused, and old loans were pressured to make payment. This
banking panic led to even greater pressures on the market as many banks
dumped many of their own stock holdings.
Bank runs and other banking difficulties did not occur
to any great degree until the fall of 1930. But once a number of Midwest
and Southern banks failed, confidence in banks was undermined and many
people rushed to withdraw their funds. In mid-1929, America had almost
25,000 commercial banks. By the time of Roosevelt's inauguration in
1933, this number had fallen to about 18,000. Another 3,000 were
eliminated by the end of 1933.
There is no way to exaggerate the tragic desperation of
the nation at the end of Hoover's Presidency. But Hoover and his
administration refused to admit that the disaster was a result of their
interventionist policies; they continued to blame businessmen and
speculators. But the truth is that Hoover's economic interventionism had
only made things far worse.
Myth Number Four: Roosevelt's Interventionism Ended the
Depression
If anyone was an interventionist, Franklin Roosevelt
was. The mythical component in our fourth claim concerns the mistaken
belief that the ultimate end of the Depression resulted from any of
Roosevelt's economic policies. The evidence makes it clear that late
into the 1930s, Roosevelt's interventionist measures were only making
things worse!
During his first one hundred days in office, Roosevelt
and his administration refused to remove the barriers to prosperity
raised during the Hoover years. Instead, he erected dozens of new ones.
Roosevelt's first significant action with regard to the economy was to
undercut the quality of the dollar by seizing people's private gold
holdings. In 1933 and early 1934, private holders of gold were forced to
turn over their gold to the government at a price well below the market
price, but equal to the official price of gold. By this act of
confiscation, the federal government gained legal and physical control
of the nation's gold, which it replaced with certificates. The
government's action was legalized theft. Later, in 1934, the government
raised the official price of gold to $35 an ounce, which was above the
market price. This devaluation produced a de facto profit for the
government of $2.8 billion. A dollar thus became worth whatever the
government said it was worth.
Then Roosevelt's advisers proposed the National
Industrial Recovery Act (NRA), instituted in 1933 as a way of increasing
the purchasing power of American workers. The Act established minimum
wages, prices, and rates for specific industries. Its purpose was to
raise prices at the same time that it increased purchasing power. The
government did this by forcing employers to increase their payrolls by
means of shorter work weeks and a minimum wage. It also banned jobs for
youth. This government mandated increase in business costs acted as a
further brake on economic recovery. Unemployment increased still more,
to almost thirteen million. The minimum wage provisions of the law
caused enormous suffering in the South, where approximately a half
million blacks were forced out of work. In 1935, the Supreme Court
declared that the NRA was unconstitutional. But the policies of the Act
had given the economy another severe jolt which had the effect of
postponing any recovery.
Roosevelt's results with American agriculture were just
as bad. Congress passed the Farm Relief and Inflation Act, also known as
the Agricultural Adjustment Act (AAA). It was supposed to increase the
income of farmers by reducing the number of acres under cultivation and
by destroying crops already in the field. Farmers were paid not to
plant. The program spread rapidly from its original coverage of cotton
to all basic cereals and meat and then to all cash crops. This expensive
program was supposed to be paid for by a so-called "processing tax." The
new tax that the AAA placed on the agricultural industry provided money
that was used to destroy crops and livestock. Healthy animals were
slaughtered, and fields of cotton, wheat, and corn were plowed under.
Farmers were paid not to plant crops. Like all interventionist acts, the
government thought it was aiding one group of people in the market. But
of course this "aid" would have to come at the expense of the many
others who were forced to pay for it. Even if the program had helped the
farmers - which it did not - it would have done so at enormous cost to
the millions who had to pay higher prices or had less to eat.
When the Roosevelt interventionists saw that things
were not going as they had planned, they proclaimed that the ensuing
disaster was not the result of their efforts. It was a result rather of
their measures not going far enough. What the nation needed was more
priming of the economy by the federal government. Roosevelt's budget
message in January 1934 promised a $7 billion deficit in a total budget
of $ 10 billion. This attempt to prime the economic pump failed to
revive the economy. A slight recovery in the first half of 1934 was
followed by a decline to an even lower economic level by September of
1934.
Roosevelt's Administration raised taxes in 1933, in
1934, and again in 1935. Federal estate taxes became the highest in the
world. By now, it was clear that the increased taxation was aimed not at
the production of more revenue but at the redistribution of wealth.
When the Supreme Court judged that both the NRA (in
1935) and the AAA (in 1936) were unconstitutional, two awesome burdens
were removed from the American economy. The end of NRA helped to
increase productivity and reduce labor costs. The end of AAA lowered
taxes on agriculture and ended the destruction of crops and livestock.
Unemployment began to come down in the mid-1930s. But the planners in
the Roosevelt Administration had not yet learned anything from their
past mistakes. Anxious to earn the support of organized labor for
Roosevelt's re-election bid in 1936, Roosevelt and the Democratic
majority in Congress gave them the Wagner Act of 1936, a price that Big
Labor never forgot.
The Wagner Act or the National Labor Relations Act was
a response to the Supreme Court's decisions with regard to NRA and AAA.
The Act totally revolutionized labor relations in the country. No longer
could labor disputes be settled in the courts; they were now under the
jurisdiction of the National Labor Relations Board, a new federal agency
which served as judge, jury, and prosecutor. Following Roosevelt's
re-election in 1936, the big unions began to consolidate the massive new
powers granted them under the Wagner Act. Millions of workers were
forced to join unions. While wages were forced up, worker productivity
declined. Strikes idled many plants. The ensuing jump in labor costs
produced another decline in economic activity. Unemployment once again
passed the ten million mark. At the end of 1937, the American economy
collapsed once more. The Roosevelt Administration had accomplished
something never before achieved in history. It actually managed to
produce a depression within a depression.
While it is true that Roosevelt inherited an
unemployment problem, he certainly did not fix it. Unemployment in 1933
(25 percent) was higher than the year before. During three years of
Roosevelt's Presidency, unemployment topped ten million. In only two of
the seven years between 1933 and 1939 did unemployment drop below eight
million. In 1938, unemployment jumped more than it did during the first
year of the Depression, reaching 18.8 percent of the labor force or more
than ten million workers. Viewed as an economic experiment to put people
back to work, the New Deal was a fraud and a farce. The massive
unemployment that still characterized the nation's economy after years
of New Deal intervention with the economy was ended only by the nation's
need to draft more than ten million men into the military.
The Depression did not result from some defect inherent
within capitalism. It did not result from this nation's love affair with
unbridled free enterprise during the twenties. The first two myths about
the Depression that we examined are clearly untrue. As Lawrence Reed
explains, "The genesis of the Great Depression lay in the inflationary
monetary policies of government in the 1920s. It was prolonged and
exacerbated by a litany of political follies: tariffs, taxes, controls
on production and competition, destruction of crops and cattle, and
coercive union legislation, to recall just a few. It was not the free
market which produced twelve years of agony; rather, it was political
bungling on a scale as grand as there ever was." 2
According to Benjamin Anderson, the nation's failure
"to get out of the depression in the years 1933 to 1939 [was] due to the
great multiplicity of New Deal 'remedies,' all tending to impair the
freedom and efficiency of the markets, to frighten venture capital, and
to create frictions and uncertainties, and impediments to individual and
corporate initiative." 3 Murray Rothbard ends his long study
of the Depression by stating: "The guilt for the Great Depression must,
at long last, be lifted from the shoulders of the free market economy,
and placed where it properly belongs: at the doors of politicians,
bureaucrats, and the mass of 'enlightened' economists." 4
Our study of economic events during the 1930s has
revealed more than the mythical character of Hoover's alleged commitment
to free market economics and the supposed success of Roosevelt's
interventionism. It has unmasked the extent to which the enormous
suffering of the thirties was a conse quence of bad economics - to be
more specific, interventionist policies that were proposed and enacted
with good intentions and horrific results.
Dr. Nash, Professor of Philosophy at Reformed
Theological Seminary-Orlando, and a Contributing Editor to The
Freeman. He has published more than 25 books including Poverty and
Wealth (Probe Books), Social Justice and the Christian Church and
Freedom, Justice and The State (both published by University Press of
America).
1. See Benjamin M. Anderson, Economics and the Public
Welfare (Indianapolis, Ind.: Liberty Press, 1979 [19491), p. 224.
2. Lawrence W. Reed, Unraveling the Great Depression
(Caldwell, Idaho: The Center for the Study of Market Alternatives,
1985), p. 13.
3. Anderson, p. 483.
4. Murray N. Rothbard, America's Great Depression, 3rd
ed. (Kansas City: Sheed and Ward, 1975), p. 295.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
November 1994, Vol. 44, No. 11.
Yourname@libertyhaven.com
