As the financial panics on Wall Street seem to be never-ending, a lot of commentators are openly asking whether the United States will slide into something akin to the Great Depression of nearly 80 years ago. Certainly, there is real fear in the air, and at this writing, the current and future states of the economy are front-and-center in people’s minds.
There can be no doubting the seriousness of these recent financial meltdowns. Trillions of dollars have disappeared as asset values have plunged, venerable banks and brokerage houses either are teetering on the brink of bankruptcy and insolvency or have gone under altogether. The housing market, which a couple of years ago was roaring along has become moribund, and markets where houses once sold in a matter of days now see houses for sale for a year or longer.
In response to these financial crises, the federal government and the Federal Reserve System have moved to shore up some of the markets and, in the case of AIG Insurance Corp., the Fed actually has taken a huge ownership share in the business itself, a first in U.S. history. Congress passed a bill, signed into law by President Bush, authorizing the U.S. Department of the Treasury to purchase $700 billion worth of mortgage-backed securities from banks and brokerage houses that had seen their asset values tumble. The Fed has been purchasing assets such as commercial paper, and the government is going to be taking equity positions in some companies. At last report, the U.S. government itself is taking an equity position with some banks, an unprecedented move in this country’s history.
A number of people, including economist (and 2008 Nobel Prize-winner) Paul Krugman of Princeton University and a columnist for the New York Times, have called for the installation of another series of government programs akin to the New Deal, a “new” New Deal. For example, William Greider, writing for The Nation, declares,
Let me be clear. The scandal is not that government is acting. The scandal is that government is not acting forcefully enough — using its ultimate emergency powers to take full control of the financial system and impose order on banks, firms and markets.
He adds,
The government, meanwhile, may have to create another emergency agency, something like the New Deal, that lends directly to the real economy — businesses, solvent banks, buyers and sellers in consumer markets. We don’t know how much damage has been done to economic growth or how long the cold spell will last, but I don’t trust the bankers in the meantime to provide investment capital and credit. If necessary, Washington has to fill that role, too.
Because “New Deal” talk is in the air, perhaps we need not only to understand the programs of Franklin Roosevelt’s New Deal, but also to understand why the economic conditions existed that made his series of radical programs politically possible. Fear and economic chaos give politicians an opening they might not otherwise have when times are normal or even good. However, most, if not all, of the time, politicians and government policy-makers are the ones who are responsible either for the crises themselves or for creating the conditions that brought the crises into existence. The events leading up to the Great Depression were no exception, just as the current financial crises have government intervention stamped all over them.
In looking at the New Deal and the things that led up to it, we first have to understand the economic events that occurred before the huge stock-market crash in 1929. Furthermore, we have to understand that the crash did not cause the Great Depression. In a recent article in the Wall Street Journal, Amity Shlaes, author of The Forgotten Man, a book about the 1930s, points out,
The stock-market crash of October 1929 and the Great Depression were not the same thing. What made the depression great was not magnitude but duration — the fact that unemployment was still 20 percent 10 years later. In the 1930s, policies like the ones described above (such as stopping short selling of stocks) did not speed recovery; they impeded it.
Thus, in making sense of the Great Depression and the New Deal, we have to examine a number of things. First, we must look at the economic conditions that led to the 1929 crash; and second, find why the policies that both Herbert Hoover and Franklin Roosevelt put into place “impeded” the economic recovery. Both have relevance in the discussion of what to do in the current situation. Third, we must look at the specific policies of the New Deal, what they were supposed to accomplish, and their actual results.
FDR’s Folly: How...
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Whether or not George Santayana ever made that famous statement attributed to him about knowing history, the advice implicit in it is valuable. There are real lessons from history about the Great Depression; unfortunately, because statism triumphed over freedom during that sorry decade, most people have never heard the lessons even for the first time.
Inflation and the Roaring ’20s
The decade of the 1920s is an era associated with good times and economic growth, with speakeasies where people drank illegal liquor, with the growth of the automobile industry, and as a time when the nation pursued “normalcy” after the madness of World War I. Typical history textbooks portray the 1920s as a time of uneven economic growth, where some prospered at the expense of others, and where greed and rampant capitalism combined to create a huge bubble in the stock market.
As the story goes, the stock bubble burst in October 1929, and then the country began a slow but sure slide to depression. Herbert Hoover, a staunch “true believer” in laissez faire and the “invisible hand,” stood by and did next to nothing while increasing numbers of people slid into poverty as the economy fell apart. Banks failed by the thousands; people lost their homes, farms, and businesses; but all Hoover did was to start an agency, the Reconstruction Finance Corporation, that lent money to big businesses in the hope that money given to the rich ultimately would “trickle down” to everyone else.
Alas, Hoover’s inaction was fatal, as prices plummeted, factories were closed, and the nation plunged into rates of unemployment of 25 percent and more. In 1932, the voters overwhelmingly elected Franklin Roosevelt, who promised a “new deal” to the country. After he took over, Roosevelt vigorously fought to bolster the economy by helping the poor instead of the rich. Although the rich resisted by staging what Roosevelt’s attorney general, Robert Jackson, called a “strike by capital,” nonetheless the economy slowly recovered, but it was only after World War II began that the nation really came out of the Great Depression.
The supposed history lessons here are simple: if government wants to help the economy grow, it must do so by taking away from the rich capitalists and giving to everyone else. By ensuring that everyone has “purchasing power,” a government can keep an economy on its feet and avoid the economic calamities of the past. On the other hand, if the government permits a laissez-faire regime, ultimately only the rich will benefit, as the “gap” between the wealthy and everyone else will grow until the economy slides back into the doldrums.
For example, Krugman says that the way to “stimulate” the present economy to keep it out of recession is for government to raise the minimum wage to improve “purchasing power” for workers, encourage more labor-union growth so other workers can receive raises, increase marginal taxes on the wealthiest Americans, increase business and financial regulation, and have a government takeover of the medical-care industry. These measures, he has argued in a number of his columns, will not only improve individual incomes, but also ensure that dire circumstances will not put someone into poverty.
The Federal Reserve and the Great Depression
Like so much retelling of history, the standard story is close to a big lie. To gain a much clearer — and factual — understanding of both the Great Depression and the decade of the 1920s, a good place to start is Murray Rothbard’s America’s Great Depression, a book that covers the 1920s and the Hoover years. (Rothbard does not deal with the Roosevelt administration, something done by other writers in the Austrian free-market tradition.)
The first thing that Rothbard notes is that there was a large growth in the stock of money during the 1920s, with the overall money supply nearly doubling during that period. Austrian economists differ from other economists in that they define inflation as a growth in the money stock, while most economists define inflation as an increase in the overall level of prices. If one holds to the latter, then the 1920s would be seen as a time of deflation, since prices as measured by official government price indices either held steady or even dropped slightly.
Rothbard, however, is undaunted. He looks squarely at the role of the Federal Reserve System, which had been created in 1913 ostensibly to help serve in a backup role to U.S. banks in order to help prevent bank runs and financial panics. The Fed, and especially the New York Federal Reserve Bank, according to Rothbard, aggressively pursued a policy of “open market operations,” which involved the purchase of U.S. government bonds in the financial markets, which then greatly increased the reserves of private banks.
One reason for the expansion of the U.S. money supply was that the Federal Reserve System was attempting to help Great Britain keep the pound sterling at its pre—World War I level of $4.86. Following the war, which had exhausted the British economy, the pound was trading in open markets at about $3.50, but British authorities wanted to establish the old relationships, even if the market was saying something different.
As a result, the decade of the 1920s, with the pound being well overvalued (and the U.S. dollar subsequently undervalued), saw high rates of unemployment in Great Britain, as British exports were expensive relative to products made elsewhere. At the same time, the undervalued U.S. dollar (which was becoming the world’s “reserve” currency after World War I had destroyed the international gold standard) made U.S. exports attractive, thus fueling the American production machine — for a while.
Whenever monetary authorities aggressively expand a currency, as was done during the 1920s, the new money has to flow somewhere. In a system such as that in the United States, where new money comes through the banking system, the people who obtain it first are people receiving loans, and the largest loans tend to be business-capitalization loans. (In countries where governments own a lot of the assets, such as Argentina or Bolivia, the new money comes in directly as payment to government workers.)
The new capital spending then sets off a whole chain of events. First, the markets anticipate new production and higher asset prices, and that optimism is reflected in the stock market and elsewhere (often real-estate markets). Second, at some point in the future, it becomes obvious that the overinflated markets do not have the fundamentals to match the financial optimism, and then there is a correction.
The Florida Land Boom of the mid 1920s was one of the first manifestations of U.S. monetary policy, as new money flowed into that state, which stood to gain greatly from the increased prosperity of the times. Even before a series of hurricanes put an absolute end to the land boom, it was obvious that the property values could not be sustained. The economic fundamentals there could not support the building of new hotels and other projects that were supposed to accompany the rush of nouveau riche who were going to “remake” the southern beaches of Florida.
Although U.S. productivity did increase greatly during the 1920s and economic output also increased, the boom itself was unsustainable. What often confuses people about this boom, however, is that according to government statistics, consumer prices actually fell slightly. That fact is held as “proof” that there was no inflation during the 1920s. Yet, if we see inflation as the expansion of the stock of money, there is no confusion. During the 1920s, output increased at a level that outstripped some of the effects of the expansion of money.
By the fall of 1929, however, the frenzied pace of the stock exchanges could not be continued and in October of that year, the market crashed. That part is understood by all historians; however, the aftermath of the crash is where the confusion begins.
Hoover’s response to the crash
As stated before, the typical explanation of the Great Depression is that Herbert Hoover was a staunch believer in laissez faire and that he refused to involve the government in trying to stem the downward cycle in the economy. While Hoover did oppose direct relief to individuals, nonetheless he intervened in a way that no U.S. government had done in previous economic downturns.
This point is important, because the standard description of the “laissez-faire” Hoover is a falsification of what really happened, and plays to government activists such as Greider and Krugman who hold that only rigid state control can provide long-term prosperity. As Rothbard and others have noted, Hoover was a prominent progressive, not a proponent of free markets. Writes Rothbard,
Herbert Clark Hoover was very much the “forward-looking” politician. We have seen that Hoover pioneered in attempts to intimidate investment bankers in placing foreign loans. Characteristic of all Hoover’s interventions was the velvet glove on the mailed fist: i.e., the businessmen would be exhorted to adopt “voluntary” measures that the government desired, but implicit was the threat that if business did not “volunteer” properly, compulsory controls would soon follow.
When Hoover returned to the United States after the war and a long stay abroad, he came armed with a suggested “Reconstruction Program.” Such programs are familiar to the present generation, but they were new to the United States in that more innocent age. Like all such programs, it was heavy on government planning, which was envisaged as “voluntary” cooperative action under “central direction.” The government was supposed to correct “our marginal faults” — including undeveloped health and education, industrial waste, the failure to conserve resources, the nasty habit of resisting unionization, and seasonal unemployment. Featured in Hoover’s plan were increased inheritance taxes, public dams, and, significantly, government regulation of the stock market to eliminate “vicious speculation.” Here was an early display of Hoover’s hostility toward the stock market, a hostility that was to form one of the leitmotifs of his administration. Hoover, who to his credit had never pretended to be the stalwart of laissez-faire that most people now consider him, notes that some denounced his program as “radical” — as well they might have.
So “forward-looking” was Hoover and his program that Louis Brandeis, Herbert Croly of The New Republic, Colonel Edward M. House, Franklin D. Roosevelt, and other prominent Democrats for a while boomed Hoover for the Presidency.
Progressives long had been hostile to free markets and proposed programs that combined government ownership of some industries (such as railroads and electric-power companies) and other industries to be organized in a series of cartels. Their first success had come during World War I, in which the government took over operations (and had de facto ownership) of the railroads, while the industries deemed vital to the war effort were cartelized for the duration of the conflict.
In the latter part of 1920, the economy fell into a deep recession, which lasted well into 1921. As Murray Rothbard points out, it was the last downturn in which the government did not play much of a role. Newly elected President Warren G. Harding openly said that government should not be involved. Rothbard notes that at a 1921 conference on unemployment (called together by Herbert Hoover, the Secretary of Commerce) Harding emphatically made his views known:
President Harding’s address to the conference was filled with great good sense and was almost the swan song of the Old Order’s way of dealing with depressions. Harding declared that liquidation was inevitable and attacked governmental planning and any suggestion of Treasury relief. He said, “The excess stimulation from that source is to be reckoned a cause of trouble rather than a source of cure.”
When Hoover became president in 1929, he would not make Harding’s “mistake.” Indeed, in less than a year, he had signed the disastrous Smoot-Hawley Tariff, and had called together a conference of business and labor leaders and urged them to keep prices and wages from falling.
If there is one common error made by people of all groups, lay and professional, it is this: the belief that economic downturns are caused by falling prices. Indeed, Martin Feldstein of Harvard University, and President Ronald Reagan’s chief economic advisor, wrote in 2008 in the Wall Street Journal that falling housing prices were impeding economic recovery.
Because people believe that falling prices cause economic downturns, the solution seems simple enough: force up prices across the board. That is what both Hoover and later Franklin Roosevelt tried to do, and the results were disastrous.
Prices fall as a result of changes in economic activity; they are the effect of certain changes, not their cause. For example, in recent months, housing prices have fallen because the go-go lending system that poured money into that market has come apart as a result of its own excesses. To put it another way, the economic fundamentals of the housing market have changed, and an injection of new money into it will not change the fact that for the time being, it is a moribund market.
Forcing up prices
Unfortunately, neither Hoover nor Roosevelt saw things that way, and both men were determined to force up prices by any means possible. For example, in November 1929, Hoover called a meeting of business and labor leaders to respond to the stock-market crash of a month before. Rothbard writes,
The most important White House conference was held on November 21. All the great industrial leaders of the country were there, including such men as Henry Ford, Julius Rosenwald, Walter Teagle of Standard Oil, Matthew Sloan, Owen D. Young, Edward Grace, Alfred P. Sloan, Jr., Pierre DuPont, and William Butterworth. The businessmen asked Hoover to stimulate the cooperation of government and industry. Hoover pointed out to them that unemployment had already reached two to three million, that a long depression might ensue, and that wages must be kept up! Hoover “explained that immediate ‘liquidation’ of labor had been the industrial policy of previous depressions; that his every instinct was opposed to both the term and the policy, for labor was not a commodity: it represented human homes…. Moreover, from an economic viewpoint such action would deepen the depression by suddenly reducing purchasing power.”
To force up prices, not only did Hoover urge that business keep prices and wages from falling, but he also signed the disastrous Smoot-Hawley Tariff the next year, which drastically increased tariff rates on large numbers of goods. Not only did the tariff invite retaliation from abroad, but it had the opposite effect on agriculture prices that Hoover supposedly had intended.
End the Fed
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With export markets eliminated, farm prices fell, and with them came down the rural and small-town banks that did not have the capital to survive the inability of farmers to repay crop loans. Furthermore, contrary to what one might read from other economic historians, the Federal Reserve System aggressively pursued open-market operations in an attempt to expand credit. However, with the previous lines of production having been tapped out in the bust, this action only blocked the necessary liquidation of the malinvestments, thus blocking the recovery.
Famed investor Jim Rogers, on a recent television appearance, said that in a crash the companies with bad fundamentals, including those with a lot of unpayable debt or asset sheets that are low on cash reserves, are the ones that go down. However, not all firms and individuals have been played for suckers during the unsustainable boom, and they tend to have much more solid fundamentals. It is precisely those firms and individuals, says Rogers, that lead the way out of the crash and bring about the economic recovery.
However, by insisting that the unhealthy firms be propped up, Hoover delayed the inevitable liquidations and in the process kept the firms with healthy balance sheets from taking the necessary leadership positions. From attempts to stop short-selling in financial markets to pushing a huge tax increase through Congress, he confounded good economics fundamentals with bad policies that made the trough deeper than it would have been had true laissez-faire policies been followed, and then blocked whatever recovery might have happened.
By the time Franklin Roosevelt took office in March 1933, the nation’s overall rate of unemployment was an astounding 28 percent. Thousands of banks had failed and the entire U.S. banking system seemed to hang in the balance. Writes Lawrence Reed,
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 pre-crash 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.
The Roosevelt administration promised it would end the Depression and bring the economy back to its feet. Instead, Roosevelt continued and expanded Hoover’s programs, and the high rates of unemployment would continue for almost nine years. At the end of that period, in Roosevelt’s unprecedented third term in office, America faced the most cataclysmic war in its existence.
Historians want us to believe that Franklin Roosevelt had nothing to do with causing the massive unemployment and World War II that came in the wake of the Great Depression. Instead, they tell us that Roosevelt simply did the best he could with the hand which he was dealt.
No doubt, the fireside chats were reassuring, and I still receive email from people who say that their parents claim they would have starved during the 1930s had it not been for Roosevelt’s programs of financial relief and public-works projects such as the WPA and CCC, which employed thousands of people. However, that is analogous to my secretly burning down your house and then letting you live in my cramped shed (no charge for the mice), and your thanking me for allowing you to have a roof over your head.
One must contrast Roosevelt’s many programs with his campaign promises. Writes Lawrence Reed,
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.
And what did Roosevelt deliver? In his first year in office, these were some of the things he did:
- Devalued the dollar and ended the gold standard, seizing private gold in the process;
- Tried to organize the entire U.S. economy into a series of cartels, from banking to the dog-food industry, with laws such as the Glass-Steagall Act and the National Industrial Recovery Act (NIRA);
- Destroyed crops and livestock in the name of saving agriculture by forcing up prices through the Agricultural Adjustment Act (AAA), financing the sorry operation through a tax on agricultural products;
- Openly blamed business owners for the economic problems and began verbal assaults on people he called “economic royalists.”
Lew Rockwell, writing about the NIRA, noted that there were
police raids of factories, as workers were lined up and interrogated to make sure that they weren’t working overtime and weren’t accepting less than the government-approved minimum. Consumers were arrested for paying less than the approved minimum prices. A tailor named Jack Magid in New Jersey was arrested and jailed for charging 35 cents instead of 40 cents to press a pair of pants. In time, the NRA became unenforceable, as black markets sprang up in every industry. The crackdown became worse, with nighttime raids on factories, and bureaucrats chopping down doors with axes to make sure that no one was sewing clothes. The NRA staff ballooned from 60 employees to 6,000 at the national level.
Such measures hardly brought recovery, since during a recovery output expands and more people are employed. The Roosevelt programs, however, attempted to curtail manufacturing and agricultural production, forcing up wages and prices to levels above what free markets would have been, thus distorting the economy even further. It is no surprise that unemployment rates stayed high until the U.S. Supreme Court struck down a number of Roosevelt’s pet projects, including the NIRA and the AAA.
Economic historian Robert Higgs notes that during the 1930s, private investment levels stayed at extremely low levels, historically speaking. He argues that “regime uncertainty” was the main reason that private investors were reluctant to make long-range investment plans, as they did not know what kind of political economy the United States would have in the next decade, fascism as in Italy and Germany, communism as in the USSR, or something else. Uncertainty ruled, and the anti-business rhetoric that came regularly from the White House, academe, and the media made matters even worse. Higgs writes,
Accepting his party’s nomination for the presidency in 1936, Roosevelt railed against the “economic royalists” allegedly seeking a “new industrial dictatorship” (quoted in Leuchtenburg 1963, 183—84). Privately he opined that “businessmen as a class were stupid, that newspapers were just as bad; nothing would win more votes than to have the press and the business community aligned against him” (Leuchtenburg 1963, 183). Just before the election of 1936, in an address at Madison Square Garden, he fulminated against the magnates of “organized money [who were] unanimous in their hate for me” and declared, “I welcome their hatred.” To uproarious applause, he threatened: “I should like to have it said of my second Administration that in it these forces met their master” (quoted in Leuchtenburg 1963, 184).
New Deal aftermath
After the Supreme Court acted against much of his first set of New Deal legislation, Roosevelt railed against the Court and threatened to “pack the Court” with his allies. The justices “learned” their lessons, and in 1937 ruled that the National Labor Relations or Wagner Act (passed in 1935) was constitutional. That led not only to the growth of labor unions but also to drastically increased labor violence, as the federal, state, and local governments tended to side with strikers. The historian William E. Leuchtenburg writes,
Property-minded citizens were scared by the seizure of factories, incensed when strikers interfered with the mails, vexed by the intimidation of nonunionists, and alarmed by flying squadrons of workers who marched, or threatened to march, from city to city.
Indeed, business owners and investors came to realize that the government was dead set against them and would quickly confiscate their property on a whim or permit labor unions to destroy in a short time capital that had taken years to build. The damage done by Hoover through his wrong-headed policies was compounded by Roosevelt and his government, and unemployment stayed in the double digits, moving to nearly 20 percent by 1938, a “depression within a depression.”
As Higgs points out, the country escaped from this trap only after World War II, when subsequent administrations refused to follow Roosevelt’s anti-enterprise lead, and the New Deal planners had moved back into academe or died. Later presidential administrations were much more reluctant to change the institutional landscape in which business operated, and the certainty about the future also brought back the engine of private investment. Thus, by the 1950s, the U.S. economy was well back on its way to prosperity.
As noted at the beginning of this series, many commentators are claiming that the U.S. government needs to act in ways reminiscent of the Roosevelt administration, and the early actions by President Bush have moved in that direction. First, there have been the many financial bailouts of banks and other financial institutions that foolishly invested in large amounts of now-worthless mortgage securities.
The equity positions taken by the U.S. government in banks and businesses are setting another precedent and leading the country into unfamiliar territory. Typical economic commentators seem to be divided only regarding their views on whether these actions are sufficient or are “too little, too late.”
Unfortunately, the modern pundits and policymakers seem to believe that the U.S. government can inflate its way out of this economic morass. No one, administrator or member of Congress, wants to be seen as “doing nothing,” so the government presses on and repeats the same bad policies of the Hoover and Roosevelt administrations.
President Obama has promised to empower labor unions, force up wages, nationalize health care, and further nationalize the country’s financial system. His supporters want higher tariffs, more import quotas, a freeze on mortgage foreclosures, and direct economic relief, along with substantially higher taxes on wealthy people.
President Barack Obama has decided to follow Roosevelt’s lead, despite what we know about the true economic disaster he created. Government cannot create something out of nothing, the rhetoric of politicians notwithstanding. As investor Jim Rogers recently said in an interview, government leaders need to stay out of the way and let the bad investments liquidate and let the firms and individuals that are fundamentally strong lead the way into a recovery.
