The Real Cause of the Great Depression
Many myths abound regarding what caused the great depression. A familiar account is that excessive speculation and unregulated markets spurred the 1929 stock market crash and the policies enacted by FDR in the New Deal are responsible for America’s recovery. The true causes for this unprecedented disaster can be traced back to WW1 and the government interventions of the Hoover and Roosevelt administrations.
The Do-Nothing Boom vs the Do-Something Depression
The roots of the Great Depression can be traced back to the beginning of World War 1 in 1914. Up till this time the old economic order had prevailed with much success for decades among the worlds most advanced economies including the United States.
According to Wikipedia, Robert Higgs PhD is an economic history scholar. He’s a visiting scholar at Oxford and Stanford University and a scholar at the Cato institute. Higgs describes the old economic order, as a system of unrestricted free trade and investment, “a monetary system based on the “Gold Standard””, and a system of “reliable but limited government”. This system had outperformed any system the world had ever seen. Higgs farther says that:
“under this regime international trade, mass migration, and investment flourished. Nations developed their economic activities in accordance with their comparative advantages; and all the people of all the participating countries improved their economic well-being beyond any standard previously achieved by the masses and in certain regards even by the upper crust”.
WW1 all but totally destroyed the old economic order. Trade was disrupted; investments diverted to armaments production, millions were conscripted into military service, economic and civil freedoms were suspended and central planning and war socialism were implemented. By the end of the war, many of the worlds most advanced economies were in ruins.
After WW1 the advanced economic nations never returned to the economic system that had afforded them great success but handed over economic control to central bankers under the direction of their respective governments. Central planning intended to fix devastated economies, had instead spawned a host of economic distortions causing future problems.
In 1925 the British attempted to return to the gold standard, but their central bank intervened to set the value of the British pound higher than its market value, as a result British exports became too expensive and manufacturing suffered greatly. British investment capital flowed to the United States. In an attempt to help the British, The US Federal Reserve implemented policies to lower interest rates thereby making US investment less attractive to British investors. These artificially low interest rates created an unwarranted domestic demand for certain US stocks. This resulted in the creation of a bubble that would cause the stock market crash of 1929.
FDR and the New Deal
A common sentiment is that the 1929 Stock Market crash caused the Great Depression. If the stock market crash of October 1929 caused the Great depression, why is it then that the market was able to fully recover by April 1930- within six months?
It’s a common belief that the stock market crash precipitated massive unemployment buts let’s take a look at the available government statistics. Harvard economist Thomas Sowell quotes statistics by scholars Vedder and Gallaway regarding unemployment rates following the October 1929 crash.Here’s what they found-
“They put the unemployment rate at 5 percent in November 1929, a month after the stock market crash. It hit 9 percent in December-- but then began a generally downward trend, subsiding to 6.3 percent in June 1930.”
The Smoot Hawley tariff act was passed in June 1930, only 5 months unemployment reached double digits. For three years beginning in 1932 unemployment exceeded 20%, this coincided with the ill-fated policies of Hoover and FDR.
From our nation’s founding till 1930 the US economy experienced many downturns of differing severity. The government up till this point never thought to intervene and had assumed they had no Constitutional authority to do so. Mind you most economic downturns or panics as some call them corrected themselves inside a year with little or no government intervention.
Unemployment created by the New Deal
Massive Government Failure
The Great Depression was caused by a massive failure of government and not by a failure in the free market as many are led to believe. According to Chris Edwards, director of tax policy at the Cato institute, there were six major policy errors that kept the economy from recovering in the 1930’s. The errors included monetary contraction, tax hikes, barriers to international trade, keeping prices high, keeping employment costs high and harassment of businesses.
By sharply raising interest rates the Federal Reserve precipitated a 25% decline in the money supply from 1929-1933. By money supply I’m referring to money in circulation. Bank failures to a lesser degree also helped shrink the money supply and create a general panic.
Tax cuts in the early 1920’s, led to an economic boom, lessons learned from this where forgotten. Hoover signed the revenue act of 1932 which was the largest peacetime tax hike in American history, it raised the top individual rates from 25% to 63%. FDR increased top individual tax rates to 79% along with increasing corporate rates. Many state and local governments imposed income taxes for the first time along with increasing tax rates. All this did was to kill incentives for investment and job creation.
Barriers to international trade
The Smoot Hawley act was signed into law By Hoover in 1930. Smoot Hawley dramatically raised import tariffs on tens of thousands of products. Scores of our trading partners overseas responded by raising tariffs on us. World trade plummeted and US manufacturing was dealt a severe blow.
Keeping prices high
FDR’S National Industrial Recovery Act of 1933 set up cartels in hundreds industries for the purpose of limiting competition. Employers were coerced into limiting production in order to keep prices and wages high. Livestock and foodstuffs were destroyed in mass at a time when they were dearly needed. The Supreme Court stuck this legislation down in 1935. These misguided policies served to increase unemployment and raise prices on goods that families sorely needed. FDR’s 1932 Democratic primary rival Al Smith even called FDR’s New Deal programs Fascist.
Keeping employment costs high
New deal programs kept employment costs high thereby increasing unemployment. The NIRA mandated higher wages and minimum wages were enforced which decreased the demand for low skill workers. The Davis Bacon Act required very high wages on Federal work. Laws were passed that mandated joining unions and encouraged union bullying tactics. Millions of make work jobs were created by the government but the private sector actually shrunk after a decade of government interventions.
Harassment of businesses
Like today, in the 1930’s investment stagnated because of the atmosphere of uncertainty caused by the continual stream of government interventions. The government then like now, used a poor economy to demonize businesses and investors for political purposes. After encouraging cartels and high prices, for political reasons FDR hired hundreds of new lawyers to sue businesses for setting high prices and for creating monopolies. FDR used these self- created crises as an excuse to seize ever larger amounts of federal power, issuing thousands of executive orders.
What probably should have been a 2-3 year economic downturn, turned into a depression that really only ended in 1946. In 1946 the stock market had regained the levels reached in 1929. The lesson that should have been learned, is that government meddling in the private sector doesn’t work and worse yet, creates an environment of corruption where individual liberties are threatened and working people are hurt most severely. Unfortunately politicians, especially liberal politicians welcome this kind of crisis as it creates opportunities to usurp power, manipulate the economy to gain influence and give favors to political allies to buy votes and loyalty.