The Great Depression Explained for Grandma and Grandpa

This is dedicated to my grandmother and all the grandmothers and fathers out there who were so profoundly affected by the Great Depression but to this day do not have a coherent factual understanding of what happened.
One of the biggest areas of rewriting history is the Great Depression. We all know the story. The greedy capitalist had a stock market crash in 1929 and the economy was destroyed. Republican President Hoover who was a laissez faire, hands off, president who sat in his office counting his money while the United States economy went into collapse. Democrat President Roosevelt came to the rescue on his white horse and gave America the New Deal and got the people back to work. The history books paint Hoover as the villain and Roosevelt as the hero. Even today some of the most astute political pundits believe this fairy tale like Dick Morris. In one of his blogs he classifies Hoover as a laissez-faire president “Americans have learned their lesson, just as they learned from Hoover the evils of Republican laissez-faire economics.” Dick Morris is reported to be a Republican these days and he should certainly know better. Even Glen Beck gets it wrong sometimes. On 10-5-2010 he said because of the uncertainty of Roosevelt economic policies in 1937 the economy that was previously recovering was sent back to the dog house because of Roosevelt. Partially true but not the main culprit as we shall see. So what is the truth?

93 year old Ruth Bechtel still idolized FDR and likes government control over the economy

The roaring twenties were the result of President Harding (1921-1923) and Coolidge (1923-1929) sound economic policies. Harding entered office in 1921 with budget deficits, inflation, and 20% unemployment. He is consistently ranked as one of the worst presidents’ because of political scandals but economically he was a superstar. He laid the groundwork for the roaring 20’s with what we would call today simple conservative values.
Harding was very effective at cutting spending. He reduced the federal budget 50% in just two years. Taxes were cut from 77% to eventually 25% in 1925 posthumously under President Coolidge. He restricted immigration to protect American jobs from cheap foreign labor. The affect was dramatic and almost immediate reduction in unemployment to an astonishing 3.3% for the remainder of the decade.
Unfortunately Harding passed the Fordney–McCumber Tariff bill in 1922 that implemented tariffs on agricultural products at a 38.5% effective rate. As usual when one country passes increased tariffs other countries are sure to follow. France raised their tariffs on automobiles 45% to 100%. Spain raised tariffs on American goods 40% and Italy and Germany raised tariffs on American wheat. Henry Ford protested vigorously but to no avail. Unfortunately this series of tariffs would eventually end in disaster a decade latter with the passage of Smoot-Hawley.
And so Harding and Coolidge really did for the most part practice laissez-faire economic policies with the exception of trade. And the roaring 20’s was born.
During the 20’s a situation with the stock market developed very similar to our recent housing bubble and bust. Stock brokers were allowing small investors to borrow typically 67% and even up to 90% of the purchase price of a stock. It was a scam that worked very well as long as the market went up. Everyone made money in the up market very similar to the peak in housing values during the boom. Of course in the long run all speculative bubbles run out of steam and must bust sooner or later. And so did the stock market bubble on October 28 and 29th of 1929 with the DJIA losing 24.55% if it’s value.

Unemployment averaged 17.2% in the 1930’s under FDR’s (1933-1944) leadership but the old folks still love him

It’s important to emphasize that stock markets and other areas of the economy can and do crash periodically and economic activity resumes in a short period of time. On October 16th, 1987 the DJIA (2722.42) lost 22.6% of its value and as we know the federal government and Federal Reserve response was quite different than 1929 and the economy proceeded forward with positive growth for the year. By 1990 the DJIA was at an all time high of 2999.75. Clearly the federal government and Federal Reserve response in the 1980’s was much less damaging than in the 1920’s and 1930′s.
So what happened that made a stock market crash turn into a lost decade of economic contraction eventually sowing the seeds for WWII and 65 million dead?
As in 1987 by December of 1929 the stock market had stabilized. There were no major bank or business failures just like 1987. In fact the market was up 48% from its low of 198.69 in 1929 to 294.07 in 1930. Unemployment had increased from 3.2% to 8.7% but was nowhere near its eventual peak of 24.9% in 1933. It surly was a recession and not the best of times economically but it was not a depression.
So what happened to cause unemployment to increase so rapidly and the stock market to continue its plunge to 41.22 in 1932?
President Hoover the “laissez-faire” guy raised taxes from 25% to 63%. He raised the corporate tax rate from 11% to 15%. Hoover increased federal spending from $2.9 billion in 1928 to $4.6 billion in 1932. A huge 63% increase in four years. By 1932 the federal budget deficit was $2.7 billion. The budget deficit was 6.8% of the GDP. Not as high as today’s 9.6%, which should scare the hell out of anyone with any economic sense.
Last but certainly not least Hoover’s crowning achievement for economic incompetence was the protectionist Smoot-Hawley tariff act of 1930. Tariffs were raised on various products from the Fordney-McCumber rate of 38.5% to 41.14%. Some products saw rates climb as high as 77.21%. The movement of the tariff schedule from 38.5% to 41.14% may not seem significant but it could not have come at a worse time. The global economy was in a downturn and the pressure on foreign leaders to retaliate was enormous. And retaliate they did. Canada our largest trading partner accounting for 18% of our exports raised tariffs on 16 products making up 30% of US exports to Canada. The decline in exports contributed 21% to the US decline in GDP. 23 trading partners protested. France and Britain developed new trading partners. Germany cut off trade and concentrated on becoming self sufficient to the point of not trading with any nation. A precursor to a war economy? US imports decreased 66% and exports decreased 61%. Overall world trade decreased by 66% from 1929 to 1934.

Herbert Hoover (1929-1933) was not laissez faire as depicted by the progressives who have rewritten history. He destroyed the economy by making all the wrong moves.

The effects of Hoover’s economic policies are reflected in the GDP decline of 26.7%! Imagine a president with a negative growth rate of 6.7% per year! Unemployment went from 3.2% in 1929 to a astonishing 24.9% in 1933. Is it any wonder the people voted for FDR?
Now before we go on from here lets not forget the Federal Reserves contribution to this mess. There are several things the Federal Reserve did to contribute. The first being to raise the Federal Funds rate consistently from 1928 into 1929 well after the recession had started. Typical Federal Reserve policy today would be to lower interest rates when economic activity declines. As investors panicked after the crash they began returning paper dollars for gold at their local banks. This cause a run on bank reserves which at that time was gold. The surplus of dollars and the scarcity of gold reserves caused the Federal Reserve to raise interest rates in 1931 to attract more reserves essentially making money more expensive during a recession. This runs opposite of what the Federal Reserve would do today. As the recession wore on price deflation was apparent and the Federal Reserve did not increase the money stock which is conventional practice today. Investors continued to withdraw funds from banks and failure rates skyrocketed with no intervention from the Federal Reserve to halt the panic. With no assurance from the Federal Reserve consumer confidence in banks plummeted resulting in more bank runs and liquidations. Consumers with cash seeing the rapid deflation did the prudent thing and held on to their cash “under the mattress.” In the end the comedy of errors reduced the money supply a staggering 30%.
Some Monetarist and maybe Austrian economist today would argue the Federal Reserve should have taken a more active role in backing up banks and trying to quell the fears of the nation. At that time the Federal Reserve had huge quantities of gold from WWI. During the war Europe sent gold over to the United States to pay for war supplies. By the end of the war the United States had 75% of the worlds $6 billion gold supply. Forget all the other interventionist policies proscribed above by Ben Bernanke and the Keynesians. If the Federal Reserve had shown up like the cavalry with some of that $4.5 billion gold supply to back up the banks under duress at the very minimum the people would have had real money in their hands for latter use. In the end no matter how you look at it the Federal Reserve compounded Hoover’s mistakes and made the economy much worse for their efforts.
Unfortunately for the people FDR was just as bad as Hoover and some would argue worse. FDR pretty much followed the same economic policies implemented by Hoover and then some. In Roosevelt’s first year in office he would institute massive expansion of the federal government including the Agricultural Adjustment Administration, the Civilian Conservation Corps, the Farm Credit Administration, the Federal Deposit Insurance Corporation, the Federal Emergency Relief Administration, the National Recovery Administration, the Public Works Administration, the Tennessee Valley Authority, the Emergency Banking Bill, the Glass-Steagall Act of 1933, the Farm Credit Act, the National Industrial Recovery Act and the Truth-in-Securities Act. Between 1934 and 1936 Roosevelt would institute the Federal Communications Commission, the National Mediation Board, the Securities and Exchange Commission, the Works Progress Administration, the National Labor Relations Board and the Rural Electrification Administration. Congress passes the Banking Act of 1935, the Emergency Relief Appropriation Act, the National Labor Relations Act, and the Social Security Act.
Tax rates went up from 63% to 79% in 1936. The federal debt increased 75% and the federal budget increased 61% from 1933 to 1940.
Despite FDR’s massive intrusion into the economy the unemployment rate averages a staggering 17.2% for the decade. The lowest peace time unemployment rate for FDR was 14.3% in 1937 which brings up the last blow to the economy of the 1930’s by the Federal Reserve.
Reserve requirements for banks were increased from 7% to 10.5% for county banks in 1936 and eventually to 14% in 1937. This was done to “soak up” excess reserves in the banking system and quell fears of inflation due to a increased monetary base. Federal spending was reduced from $8.2 billion to $7.6 billion. Combined with increased Social Security taxes the GDP plunges a staggering 18% and unemployment increased to 19.0% in 1938.
Austrian economist argue the tightening of credit was caused by economic uncertainty due to the drop in the stock market and the growing differential between real wages and productivity. They argue that a increased gold influx from Europe caused inflation, union wages combined with stagnant productivity and heavy stock market regulation caused the economic downturn and a collapse of banking reserves.
Either way you want to look at it the easy money policies of the Federal Reserve from 1933 to 1936, increasing the money stock 46% with inflation rate of 31% as well as increasing the monetary base by raising the price of a ounce of gold from $20.67 to $35 caught up with the rest of the economy in 1937 and 38. The Federal Reserve had screwed up again. FDR actually did something right in reducing federal spending.
The bottom line is between the Federal Reserve, Hoover and Roosevelt the people of the 1930’s were taking economic fire from all sides. All were guilty in creating the Great Depression. In this blog I have only scratched the surface of the blunders these institutions have made. What is important is to understand that the stock market crash did not cause the Great Depression. Recession yes, depression no.
The Great Depression was the result of large centralized banking and the federal government interfering in the economy without a clue as to what would help and what would hurt. We know now most of what was done was negative. I would argue 90% or more of the federal government and banking actions had a negative and profoundly devastating effect on the economy.
Today we have a battle between the discredited Keynesians who support many of the policies used by the federal government and the Federal Reserve during the Great Depression. The same policies we see today. Artificially low interest rates. Deficit spending. Huge federal budgets. Massive increases in the money supply. The same policies used during the Great Depression.
The Austrians and Monetarist economist who argue for little or no interference into the economy. Stable money supply in the form of gold or a stable dollar and a stable monetary base. The key point to grasp is that private markets are much better equipped to recover from a economic downturn than the federal government or the Federal Reserve interventionist policies. When resources are misallocated during a boom like the 1920’s stock market it is best to let the economy suffer the recession and in time without intervention private markets will reallocate resources back into productive sectors of the economy. The stock market data shows that the recovery was already under way in 1930 before disaster struck.
All those FDR work projects were nothing more than a misallocation of resources prolonging the depression. All the at first contractionary and then expansionist policies of the Federal Reserve simply made for more misallocation of resources. All that federal regulation from 1933 to 1935 didn’t do anything positive. By 1938 unemployment was back to 19.0%.
The lesson we should all take from this is that Harding and Coolidge and Federal Reserve Chairman Benjamin Strong (who passed away in 1928) were the economic heroes of that time and Hoover, FDR and the Federal Reserve were the villains