Although the Great Depression engulfed the world
economy some 40 years ago, it lives on as a nightmare for individuals
old enough to remember and as a frightening specter in the textbooks of
our youth. Some 13 million Americans were unemployed, "not wanted" in
the production process. One worker out of every four was walking the
streets in want and despair. Thousands of banks, hundreds of thousands
of businesses, and millions of farmers fell into bankruptcy or ceased
operations entirely. Nearly everyone suffered painful losses of wealth
and income.
Many Americans are convinced that the Great Depression
reflected the breakdown of an old economic order built on unhampered
markets, unbridled competition, speculation, property rights, and the
profit motive. According to them, the Great Depression proved the
inevitability of a new order built on government intervention, political
and bureaucratic control, human rights, and government welfare. Such
persons, under the influence of Keynes, blame businessmen for
precipitating depressions by their selfish refusal to spend enough money
to maintain or improve the people's purchasing power. This is why they
advocate vast governmental expenditures and deficit spending - resulting
in an age of money inflation and credit expansion.
Classical economists learned a different lesson. In
their view, the Great Depression consisted of four consecutive
depressions rolled into one. The causes of each phase differed, but the
consequences were all the same: business stagnation and unemployment.
The Business Cycle
The first phase was a period of boom and bust, like the
business cycles that had plagued the American economy in 1819-20,
1839-43, 1857-60, 1873-78, 1893-97, and 1920-21. In each case,
government had generated a boom through easy money and credit, which was
soon followed by the inevitable bust.
The spectacular crash of 1929 followed five years of
reckless credit expansion by the Federal Reserve System under the
Coolidge Administration. In 1924, after a sharp decline in business, the
Reserve banks suddenly created some $500 million in new credit, which
led to a bank credit expansion of over $4 billion in less than one year.
While the immediate effects of this new powerful expansion of the
nation's money and credit were seemingly beneficial, initiating a new
economic boom and effacing the 1924 decline, the ultimate outcome was
most disastrous. It was the beginning of a monetary policy that led to
the stock market crash in 1929 and the following depression. In fact,
the expansion of Federal Reserve credit in 1924 constituted what
Benjamin Anderson in his great treatise on recent economic history
(Economics and the Public Welfare, D. Van Nostrand, 1949) called "the
beginning of the New Deal."
The Federal Reserve credit expansion in 1924 also was
designed to assist the Bank of England in its professed desire to
maintain prewar exchange rates. The strong U.S. dollar and the weak
British pound were to be readjusted to prewar conditions through a
policy of inflation in the U.S. and deflation in Great Britain.
The Federal Reserve System launched a further burst of
inflation in 1927, the result being that total currency outside banks
plus demand and time deposits in the United States increased from $44.51
billion at the end of June, 1924, to $55.17 billion in 1929. The volume
of farm and urban mortgages expanded from $16.8 billion in 1921 to $27.1
billion in 1929. Similar increases occurred in industrial, financial,
and state and local government indebtedness. This expansion of money and
credit was accompanied by rapidly rising real estate and stock prices.
Prices for industrial securities, according to Standard & Poor's
common stock index, rose from 59.4 in June of 1922 to 195.2 in September
of 1929. Railroad stock climbed from 189.2 to 446.0, while public
utilities rose from 82.0 to 375.1.
A Series of False Signals
The vast money and credit expansion by the Coolidge
Administration made 1929 inevitable. Inflation and credit expansion
always precipitate business maladjustments and malinvestments that must
later be liquidated. The expansion artificially reduces and thus
falsifies interest rates, and thereby misguides businessmen in their
investment decisions. In the belief that declining rates indicate
growing supplies of capital savings, they embark upon new production
projects. The creation of money gives rise to an economic boom. It
causes prices to rise, especially prices of capital goods used for
business expansion. But these prices constitute business costs. They
soar until business is no longer profitable, at which time the decline
begins. In order to prolong the boom, the monetary authorities may
continue to inject new money until finally frightened by the prospects
of a run-away inflation. The boom that was built on the quicksand of
inflation then comes to a sudden end.
The ensuing recession is a period of repair and
readjustment. Prices and costs adjust anew to consumer choices and
preferences.
And above all, interest rates readjust to reflect once
more the actual supply of and demand for genuine savings. Poor business
investments are abandoned or written down. Business costs, especially
labor costs, are reduced through greater labor productivity and
managerial efficiency, until business can once more be profitably
conducted, capital investments earn interest, and the market economy
function smoothly again.
After an abortive attempt at stabilization in the first
half of 1928, the Federal Reserve System finally abandoned its easy
money policy at the beginning of 1929. It sold government securities and
thereby halted the bank credit expansion. It raised its discount rate to
6 per cent in August, 1929. Time-money rates rose to 8 per cent,
commercial paper rates to 6 per cent, and call rates to the panic
figures of 15 per cent and 20 per cent. The American economy was
beginning to readjust. In June, 1929, business activity began to recede.
Commodity prices began their retreat in July.
The security market reached its high on September 19
and then, under the pressure of early selling, slowly began to decline.
For five more weeks the public nevertheless bought heavily on the way
down. More than 100 million shares were traded at the New York Stock
Exchange in September. Finally it dawned upon more and more stockholders
that the trend had changed. Beginning with October 24, 1929, thousands
stampeded to sell their holdings immediately and at any price.
Avalanches of selling by the public swamped the ticker tape. Prices
broke spectacularly.
Liquidation and Adjustment
The stock market break signaled the beginning of a
readjustment long overdue. It should have been an orderly liquidation
and adjustment followed by a normal revival. After all, the financial
structure of business was very strong. Fixed costs were low as business
had refunded a good many bond issues and had reduced debts to banks with
the proceeds of the sale of stock. In the following months, most
business earnings made a reasonable showing. Unemployment in 1930
averaged under 4 million, or 7.8 per cent of labor force.
In modern terminology, the American economy of 1930 had
fallen into a mild recession. In the absence of any new causes for
depression, the following year should have brought recovery as in
previous depressions. In 1921-22 the American economy recovered fully in
less than a year. What, then, precipitated the abysmal collapse after
1929? What prevented the price and cost adjustments and thus led to the
second phase of the Great Depression?
Disintegration of the World Economy
The Hoover Administration opposed any readjustment.
Under the influence of "the new economics" of government planning, the
President urged businessmen not to cut prices and reduce wages, but
rather to increase capital outlay, wages, and other spending in order to
maintain purchasing power. He embarked upon deficit spending and called
upon municipalities to increase their borrowing for more public works.
Through the Farm Board which Hoover had organized in the autumn of 1929,
the Federal government tried strenuously to uphold the prices of wheat,
cotton, and other farm products. The GOP tradition was further invoked
to curtail foreign imports.
The Hawley-Smoot Tariff Act of June, 1930, raised
American tariffs to unprecedented levels, which practically closed our
borders to foreign goods. According to most economic historians, this
was the crowning folly of the whole period from 1920 to 1933 and the
beginning of the real depression. "Once we raised our tariffs," wrote
Benjamin Anderson, "an irresistible movement all over the world to raise
tariffs and to erect other trade barriers, including quotas, began.
Protectionism ran wild over the world. Markets were cut off. Trade lines
were narrowed. Unemployment in the export industries all over the world
grew with great rapidity. Farm prices in the United States dropped
sharply through the whole of 1930, but the most rapid rate of decline
came following the passage of the tariff bill."When President Hoover
announced he would sign the bill into law, industrial stocks broke 20
points in one day. The stock market correctly anticipated the
depression.
The protectionists have never learned that curtailment
of imports inevitably hampers exports. Even if foreign countries do not
immediately retaliate for trade restrictions injuring them, their
foreign purchases are circumscribed by their ability to sell abroad.
This is why the Hawley-Smoot Tariff Act which closed our borders to
foreign products also closed foreign markets to our products. American
exports fell from $5.5 billion in 1929 to $1.7 billion in 1932. American
agriculture customarily had exported over 20 per cent of its wheat, 55
per cent of its cotton, 40 per cent of its tobacco and lard, and many
other products. When international trade and commerce were disrupted,
American farming collapsed. In fact, the rapidly growing trade
restrictions, including tariffs, quotas, foreign exchange controls, and
other devices were generating a world-wide depression.
Agricultural commodity prices, which had been well
above the 1926 base before the crisis, dropped to a low of 47 in the
summer of 1932. Such prices as $2.50 a hundredweight for hogs, $3.28 for
beef cattle, and 320 a bushel for wheat, plunged hundreds of thousands
of farmers into bankruptcy. Farm mortgages were foreclosed until various
states passed moratoria laws, thus shifting the bankruptcy to countless
creditors.
Rural Banks in Trouble
The main creditors of American farmers were, of course,
the rural banks. When agriculture collapsed, the banks closed their
doors. Some 2,000 banks, with deposit liabilities of over $1.5 billion,
suspended between August, 1931, and February, 1932. Those banks that
remained open were forced to curtail their operations sharply, They
liquidated customers' loans on securities, contracted real estate loans,
pressed for the payment of old loans, and refused to make new ones.
Finally, they dumped their most marketable bond holdings on an already
depressed market. The panic that had engulfed American agriculture also
gripped the banking system and its millions of customers.
The American banking crisis was aggravated by a series
of events involving Europe. When the world ecoriomy began to
disintegrate and economic nationalism ran rampant, European debtor
countries were cast in precarious payment situations. Austria and
Germany ceased to make foreign payments and froze large English and
American credits; when England finally suspended gold payments in
September, 1931, the crisis spread to the U.S. The fall in foreign bond
values set off a collapse of the general bon-d market, which hit
American banks at their weakest point-their investment porifolios.
Depression Compounded
1931 was a tragic year. The whole nation, in fact, the
whole world, fell into the cataclysm of despair and depression. American
unemployment jumped to more than 8 million and continued to rise. The
Hoover Administration, summarily rejecting the thought that it had
caused the disaster, labored diligently to place the blame on American
businessmen and speculators. President Hoover called together the
nation's industrial leaders and pledged them to adopt his program to
maintain wage rates and expand construction. He sent a telegram to all
the governors, urging cooperative expansion of all public works
programs. He expanded Federal public works and granted subsidies to ship
construction. And for the benefit of the suffering farmers, a host of
Federal agencies embarked upon price stabilization policies that
generated ever larger crops and surpluses which in turn depressed
product prices even further. Economic conditions went from bad to worse
and unemployment in 1932 averaged 12.4 million.
In this dark hour of human want and suffering, the
Federal government struck a final blow. The Revenue Act of 1932 doubled
the income tax, the sharpest increase in the Federal tax burden in
American history. Exemptions were lowered, "earned income credit" was
eliminated. Normal tax rates were raised from a range of 11/2 to 5 per
cent to a range of 4 to 8 per cent, surtax rates from 20 per cent to a
maximum of 55 per cent. Corporation tax rates were boosted from 12 per
cent to 1V/4 and 141/2 per cent. Estate taxes were raised. Gift taxes
were imposed with rates from 3/4 to 331/2 per cent. A 10 gasoline tax
was imposed, a 3 per cent automobile tax, a telegraph and telephone tax,
a 20 check tax, and many other excise taxes. And finally, postal rates
were increased substantially.
When state and local governments faced shrinking
revenues, they, too, joined the Federal government in imposing new
levies. The rate schedules of existing taxes on income and business were
increased and new taxes imposed on business income, property, sales,
tobacco, liquor, and other products.
Murray Rothbard, in his authoritative work on America's
Great Depression (Van Nostrand, 1963), estimates that the fiscal burden
of Federal, state, and local governments nearly doubled during the
period, rising from 16 per cent of net private product to 29 per cent.
This blow, alone, would bring any economy to its knees, and shatters the
silly contention that the Great Depression was a consequence of economic
freedom.
The New Deal of NRA and AAA
One of the great attributes of the private-property
market system is its inherent ability to overcome almost any obstacle.
Through price and cost readjustment, managerial efficiency and labor
productivity, new savings and investments, the market economy tends to
regain its equilibrium and resume its service to consumers. It doubtless
would have recovered in short order from the Hoover interventions had
there been no further tampering.
However, when President Franklin Delano Roosevelt
assumed the Presidency, he, too, fought the economy all the way. In his
first 100 days, he swung hard at the profit order. Instead of clearing
away the prosperity barriers erected by his predecessor, he built new
ones of his own. He struck in every known way at the integrity of the
U.S. dollar through quantitative increases and qualitative
deterioration. He seized the people's gold holdings and subsequently
devalued the dollar by 40 per cent.
With some third of industrial workers unemployed,
President Roosevelt embarked upon sweeping industrial reorganization. He
persuaded Congress to pass the National Industrial Recovery Act (NIRA),
which set up the National Recovery Administration (NRA). Its purpose was
to get business to regulate itself, ignoring the antitrust laws and
developing fair codes of prices, wages, hours, and working conditions.
The President's- Re-employment Agreement called for a minimum wage of
400 an hour ($12 to $15 a week in smaller communities), a 35-hour work
week for industrial workers and 40 hours for white collar workers, and a
ban on all youth labor.
This was a naive attempt at "increasing purchasing
power" by increasing payrolls. But, the immense increase in business
costs through shorter hours and higher wage rates worked naturally as an
antirevival measure. After passage of the Act, unemployment rose to
nearly 13 million. The South, especially, suffered severely from the
minimum wage provisions. The Act forced 500,000 Negroes out of work.
Nor did President Roosevelt ignore the disaster that
had befallen American agriculture. He attacked the problem by passage of
the Farm Relief and Inflation Act, popularly known as the First
Agricultural Adjustment Act. The objective was to raise farm income by
cutting the acreages planted or destroying the crops in the field,
paying the farmers not to plant anything, and organizing marketing
agreements to improve distribution. The program soon covered not only
cotton, but also all basic cereal and meat production as well as
principal cash crops. The expenses of the program were to be covered by
a new 41processing tax" levied on an already depressed industry.
NRA codes and AAA processing taxes came in July and
August of 1933. Again, economic production which had flurried briefly
before the deadlines, sharply turned downward. The Federal Reserve index
dropped from 100 in July to 72 in November of 1933.
Pump-Priming Measures
When the economic planners saw their plans go wrong,
they simply prescribed additional doses of Federal pump priming. In his
January 1934 Budget Message, Mr. Roosevelt promised expenditures of $10
billion while revenues were at $3 billion, Yet, the economy failed to
revive; the business index rose to 86 in May of 1934, and then turned
down again to 71 by September. Furthermore, the spending program caused
a panic in the bond market which cast new doubts on American money and
banking.
Revenue legislation in 1933 sharply raised income tax
rates in the higher brackets and imposed a 5 per cent withholding tax on
corporate dividends. Tax rates were raised again in 1934. Federal estate
taxes were brought to the highest levels in the world. in 1935, Federal
estate and income taxes were raised once more, although the additional
revenue yield was insignificant. The rates seemed clearly aimed at the
redistribution of wealth.
According to Benjamin Anderson, "the impact of all
these multitudinous measures -industrial, agricultural, financial,
monetary and other - upon a bewildered industrial and financial
community was extraordinarily heavy. We must add the effect of
continuing disquieting utterances by the President. He had castigated
the bankers in his inaugural speech. He had made a slurring comparison
of British and American bankers in a speech in the Summer of 1934. . . .
That private enterprise could survive and rally in the midst of so great
a disorder is an amazing demonstration of the vitality of private
enterprise."
Then came relief from unexpected quarters. The "nine
old men" of the Supreme Court, by unanimous decision, outlawed NRA in
1935 and AAA in 1936. The Court maintained that the Federal legislative
power had been unconstitutionally delegated and states' rights violated.
These two decisions removed some fearful handicaps
under which the economy was laboring. NRA, in particular, was a
nightmare with continuously changing rules and regulations by a host of
government bureaus. Above all, voidance of the act immediately reduced
labor costs and raised productivity as it permitted labor markets to
adjust. The death of AAA reduced the tax burden of agriculture and
halted the shocking destruction of crops. Unemployment began to decline.
In 1935 it dropped to 9.5 million, or 18.4 per cent of the labor force,
and in 1936 to only 7.6 million, or 14.5 per cent.
A New Deal for Labor
The third phase of the Great Depression was thus
drawing to a close. But there was little time to rejoice, for the scene
was being set for another collapse in 1937 and a lingering depression
that lasted until the day of Pearl Harbor. More than 10 million
Americans were unemployed in 1938, and more than 9 million in 1939.
The relief granted by the Supreme Court was merely
temporary. The Washington planners could not leave the economy alone;
they had to earn the support of organized labor, which was vital for
re-election.
The Wagner Act of July 5, 1935, earned the lasting
gratitude of labor. 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 the law that already afforded legal
immunities and privileges to labor unions. The U.S. thereby abandoned a
great achievement of Western civilization, equality under the law.
The Wagner Act, or National Labor Relations Act, was
passed in reaction to the Supreme Court's voidance of NRA and its labor
codes. It aimed at crushing all employer resistance to labor unions.
Anything an employer might do in self-defense became an "unfair labor
practice" punishable by the Board. The law not only obliged employers to
deal and bargain with the unions designated as the employees'
representative; later Board decisions also made it unlawful to resist
the demands of labor union leaders.
Following the election of 1936, the labor unions began
to make ample use of their new powers. Through threats, boycotts,
strikes, seizures of plants, and outright violence committed in legal
sanctity, they forced millions of workers into membership. Consequently,
labor productivity declined and wages were forced upward. Labor strife
and disturbance ran wild. 'Ugly sitdown strikes idled hundreds of
plants. In the ensuing months economic activity began to decline and
unemployment again rose above the ten million mark.
But the Wagner Act was not the only source of crisis in
1937. President Roosevelt's attempt at packing the Supreme Court, had it
been successful, would have subordinated the Judiciary to the Executive.
In the U.S. Congress the President's power was unchallenged. Heavy
Democratic majorities in both houses, perplexed and frightened by the
Great Depression, blindly followed their leader. But when the President
strove to assume control over the Judiciary, the American nation rallied
against him, and he lost his first political fight in the halls of
Congress.
There was also his attempt at controlling the stock
market through an ever-increasing number of regulations and
investigations by the Securities and Exchange Commission. "Insider"
trading was barred, high and inflexible margin requirements imposed and
short selling restricted, mainly to prevent repetition of the 1929 stock
market crash. Nevertheless the market f ell nearly 50 per cent from
August of 1937 to March of 1938. The American economy again underwent
dreadful punishment.
Other Taxes and Controls
Yet other factors contributed to this new and fastest
slump in U.S. history. The Undistributed Profits Tax of 1936 struck a
heavy blow at profits retained for use in business. Not content with
destroying the wealth of the rich through confiscatory income and estate
taxation, the administration meant to force the distribution of
corporate savings as dividends subject to the high income tax rates.
Though the top rate finally imposed on undistributed profits was "only"
27 per cent, the new tax succeeded in diverting corporate savings from
employment and production to dividend income.
Amidst the new stagnation and unemployment, the
President and Congress adopted yet another dangerous piece of New Deal
legislation: the Wages and Hours Act or Fair Labor Standards Act of
1938. The law raised minimum wages and reduced the work week in stages
to 44, 42, and 40 hours. It provided for time-and-a-half pay for all
work over 40 hours per week and regulated other labor conditions. Again,
the Federal government thus reduced labor productivity and increased
labor costs-ample grounds for further depression and unemployment.
Throughout this period, the Federal government, through
its monetary arm, the Federal Reserve System, endeavored to reinflate
the economy. Monetary expansion from 1934 to 1941 reached astonishing
proportions. The monetary gold of Europe sought refuge from the
gathering clouds of political upheaval, boosting American bank reserves
to unaccustomed levels. Reserve balances rose from $2.9 billion in
January, 1934, to $14.4 billion in January of 1941. And with this growth
of member bank reserves, interest rates declined to fantastically low
levels. Commercial paper often yielded less than 1 per cent, bankers'
acceptances from 1/8 per cent to 1/4 per cent. Treasury bill rates fell
to 1 / 10 of 1 per cent and Treasury bonds to some 2 per cent. Call
loans were pegged at 1 percent and prime customers' loans at 1 1/2 per
cent. The money market was flooded and interest rates could hardly go
lower.
Deep-Rooted Causes
The American economy simply could not recover from
these successive onslaughts by first the Republican and then the
Democratic Administrations. Individual enterprise, the mainspring of
unprecedented income and wealth, didn't have a chance.
The calamity of the Great Depression finally gave way
to the holocaust of World War 11. When more than 10 million able-bodied
men had been drafted into the armed services, unemployment ceased to be
an economic problem. And when the purchasing power of the dollar had
been cut in half through vast budget deficits and currency inflation,
American business managed to adjust to the oppressive costs of the
Hoover-Roosevelt Deals. The radical inflation in fact reduced the real
costs of labor and thus generated new employment in the postwar period.
Nothing would be more foolish than to single out the
men who led us in those baleful years and condemn them for all the evil
that befell us. The ultimate roots of the Great Depression were growing
in the hearts and minds of the American people. It is true, they abhored
the painful symptoms of the great dilemma. But the large majority
favored and voted for the very policies that made the disaster
inevitable: inflation and credit expansion, protective tariffs, labor
laws that raised wages and farm laws that raised prices, ever higher
taxes on the rich and distribution of their wealth. The seeds for the
Great Depression were sown by scholars and teachers during the 1920's
and earlier when social and economic ideologies that were hostile toward
our traditional order of private property and individual enterprise
conquered our colleges and universities. The professors of earlier years
were as guilty as the political leaders of the 1930's.
Social and economic decline is facilitated by moral
decay. Surely, the Great Depression would be inconceivable without the
growth of covetousness and envy of great personal wealth and income, the
mounting desire for public assistance and favors. it would be
inconceivable without an ominous decline of individual independence and
self-reliance, and above all, the burning desire to be free from man's
bondage and to be responsible to God alone.
Can it happen again? Inexorable economic law ascertains
that it must happen again whenever we repeat the dreadful errors that
generated the Great Depression.
Editor's Note: The foregoing review, of the monetary
manipulations and other interventions that led to the crash of 1929 and
prolonged it for a decade, first appeared in the October 1969 FREEMAN.
It also has been widely distributed as a Bramble Minibook. The lesson,
however, remains to be learned. A depression has a message, if we will
heed it.
At the time of the original publication, Dr. Sennholz
headed the Department of Economics at Grove City College in
Pennsylvania and is a noted writer and lecturer for freedom.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
April, 1975, Vol. 25, No. 4.
Yourname@libertyhaven.com
