Mackinac Center for Public Policy | Great Myths of the Great Depression 1 “HERBERT HOOVER believed government should play GREAT no role in the economy.” “GOVERNMENT PROGRAMS MYTHS helped lower unemployment by putting many Americans to work.” of the “FRANKLIN ROOSEVELT’S ‘New Deal’ saved America from the GREAT failure of free-market capitalism.” These and other DEPRESSION myths are dispelled This edition is a joint project of the Mackinac Center for Public Policy and the Foundation for Economic Education by the facts in this essay by economist Lawrence W. Reed Mackinac Center for Public Policy | Great Myths of the Great Depression 2 TO JAMES M. RODNEY a great friend of truth, character and liberty Great Myths of the Great Depression by Lawrence W. Reed. Original edition printed in 1981. This edition was printed in 2010 as a joint project of the Mackinac Center and the Foundation for Economic Education. Mackinac Center for Public Policy | Great Myths of the Great Depression 1 GREAT MYTHS of the GREAT DEPRESSION tudents today are often given a skewed account of the Great Depression of 1929-1941 that condemns free-market capitalism as the cause of, and promotes government intervention as the Ssolution to, the economic hardships of the era. In this essay based on a popular lecture, Mackinac Center for Public Policy President Lawrence W. Reed debunks the conventional view and traces the central role that poor government policy played in fostering this legendary catastrophe. INTRODUCTION four workers was out of a job at the Depression’s nadir, and ugly Many volumes have been written rumors of revolt simmered for the about the Great Depression of first time since the Civil War. 1929-1941 and its impact on the lives of millions of Americans. “The terror of the Great Crash Historians, economists and has been the failure to explain it,” politicians have all combed the writes economist Alan Reynolds. THE GREAT DEPRESSION devastated every wreckage searching for the “black “People were left with the part of America, even its smallest towns. box” that will reveal the cause of feeling that massive economic the calamity. Sadly, all too many contractions could occur at of capitalism, the stock market, of them decide to abandon their any moment, without warning, crashed and dragged America search, finding it easier perhaps without cause. That fear has into depression. President to circulate a host of false and been exploited ever since as the Herbert Hoover, an advocate harmful conclusions about the major justification for virtually of “hands-off,” or laissez-faire, events of seven decades ago. unlimited federal intervention economic policy, refused to use Consequently, many people in economic affairs.”1 the power of government and today continue to accept critiques conditions worsened as a result. of free-market capitalism that Old myths never die; they just It was up to Hoover’s successor, are unjustified and support keep showing up in economics Franklin Delano Roosevelt, government policies that are and political science textbooks. to ride in on the white horse economically destructive. With only an occasional of government intervention exception, it is there you will find and steer the nation toward How bad was the Great what may be the 20th century’s recovery. The apparent lesson Depression? Over the four years greatest myth: Capitalism to be drawn is that capitalism from 1929 to 1933, production at and the free-market economy cannot be trusted; government the nation’s factories, mines and were responsible for the Great needs to take an active role in utilities fell by more than half. Depression, and only government the economy to save us from People’s real disposable incomes intervention brought about inevitable decline. dropped 28 percent. Stock prices America’s economic recovery. collapsed to one-tenth of their But those who propagate this pre-crash height. The number A MODERN FAIRY TALE version of history might just of unemployed Americans rose as well top off their remarks from 1.6 million in 1929 to 12.8 According to this simplistic by saying, “And Goldilocks million in 1933. One of every perspective, an important pillar found her way out of the forest, Mackinac Center for Public Policy | Great Myths of the Great Depression 2 Dorothy made it from Oz back There was already a long to Kansas, and Little Red Riding history of margin lending on Hood won the New York State stock exchanges, and margin Lottery.” The popular account of requirements — the share the Depression as outlined above of the purchase price paid in belongs in a book of fairy tales cash — were no lower in the and not in a serious discussion late twenties than in the early of economic history. twenties or in previous decades. In fact, in the fall of 1928 margin PeopLE Who argUE that the free-market requirements began to rise, and THE GREat, economy collapsed of its own weight in borrowers were required to pay GREat,GREat,GREat the 1930s seem utterly unaware of the DEPRESSION critical role played by the Federal Reserve a larger share of the purchase System’s gross mismanagement of money price of the stocks. To properly understand the and credit. events of the time, it is factually The margin lending argument appropriate to view the Great was disastrous intervention by doesn’t hold much water. Mischief Depression as not one, but four government, often in the form with the money and credit supply, consecutive downturns rolled into of political mismanagement of however, is another story. one. These four “phases” are:2 the money and credit supply. None of these depressions, Most monetary economists, I. Monetary Policy and the however, lasted more than four particularly those of the “Austrian Business Cycle years and most of them were School,” have observed the close II. The Disintegration of the over in two. The calamity that relationship between money World Economy began in 1929 lasted at least supply and economic activity. three times longer than any of the When government inflates the III. The New Deal country’s previous depressions money and credit supply, interest IV. The Wagner Act because the government rates at first fall. Businesses compounded its initial errors with invest this “easy money” in new The first phase covers why the a series of additional and harmful production projects and a boom crash of 1929 happened in the interventions. takes place in capital goods. As first place; the other three show the boom matures, business how government intervention CENTRAL PLANNERS FAIL costs rise, interest rates readjust worsened it and kept the economy at MONEtaRY POLICY upward, and profits are squeezed. in a stupor for over a decade. Let’s The easy-money effects thus wear consider each one in turn. A popular explanation for the off and the monetary authorities, stock market collapse of 1929 fearing price inflation, slow the PHASE I: concerns the practice of borrowing growth of, or even contract, the THE BUSINESS CYCLE money to buy stock. Many history money supply. In either case, texts blithely assert that a frenzied the manipulation is enough to The Great Depression was not the speculation in shares was fed by knock out the shaky supports country’s first depression, though excessive “margin lending.” But from underneath the economic it proved to be the longest. Marquette University economist house of cards. Several others preceded it. Gene Smiley, in his 2002 book “Rethinking the Great Depression”, One prominent interpretation A common thread woven through explains why this is not a fruitful of the Federal Reserve System’s all of those earlier debacles observation: actions prior to 1929 can be found Mackinac Center for Public Policy | Great Myths of the Great Depression 3 in “America’s Great Depression” by economist Murray Rothbard. Using a broad measure that includes currency, demand and time deposits, and other ingredients, he estimated that the Fed bloated the money supply by more than 60 percent from mid- 1921 to mid-1929.3 Rothbard argued that this expansion of money and credit drove interest rates down, pushed the stock market to dizzy heights, and gave birth to the “Roaring Twenties.” UneMPLOYMent SKYroCKeted after Congress raised tariffs and taxes in the early 1930s and Reckless money and credit growth stayed high as policies of the Roosevelt administration discouraged investment and recovery constituted what economist during the rest of the decade. Benjamin M. Anderson called “the beginning of the New Deal”4 prices lower than they would bank took further deflationary — the name for the better-known have otherwise been. action by aggressively selling but highly interventionist policies government securities for that would come later under Regarding Fed policy, free- months after the stock market President Franklin Roosevelt. market economists who differ on crashed. For the next three years, However, other scholars raise the extent of the Fed’s monetary the money supply shrank by 30 doubts that Fed action was expansion of the early and mid- percent. As prices then tumbled as inflationary as Rothbard 1920s are of one view about throughout the economy, the believed, pointing to relatively what happened next: The central Fed’s higher interest rate policy flat commodity and consumer bank presided over a dramatic boosted real (inflation-adjusted) prices in the 1920s as evidence contraction of the money supply rates dramatically. that monetary policy was not so that began late in the decade. The wildly irresponsible. federal government’s responses The most comprehensive to the resulting recession took chronicle of the monetary Substantial cuts in high a bad situation and made it far, policies of the period can be marginal income tax rates in far worse. found in the classic work of Nobel the Coolidge years certainly Laureate Milton Friedman and helped the economy and may THE BOTTOM DROPS OUT his colleague Anna Schwartz, have ameliorated the price “A Monetary History of the United effect of Fed policy.