My Two Cents - "Revisionist History and the Great Depression"

10/21/2011

Over the past several years, the term ‘Great Depression’ has made a grand re-entry into the American mainstream and has as a consequence become perhaps one of the most misunderstood terms. We are told it was everything that it wasn’t and that it wasn’t everything that it was. Like many important historical events, there is a good bit of revisionist history at work with regards to those dark 12 years in American history when it seemed as though there was nothing but despair and governments tripping over themselves to fix something they didn’t have the tools or the business monkeying with in the first place. Think of it like a butcher going to work on the engine of a ’57 Chevy with baseball bat. The results are predictable.

Unfortunately for us here the United States, there are so few people alive who actually experienced the Depression at a time in their lives when they could remember and understand what was going on. We’ve lost our perspective, and our experience from the patriarchs of the day, and that is a dangerous combination. It means we’ll be pitched to and fro in the breeze and will buy almost anything that comes in a newscast, daily paper, or monthly magazine. It is really time for a thorough, while brief, reset on what the Great Depression was – and wasn’t.

The first really big misunderstanding about the Great Depression is that it happened because the stock market crashed. You can go into a bookstore and pick up countless history and economic texts and nearly all of them promulgate the absolute lie that the stock market crash of 1929 was responsible for the Depression. I don't think, however, that it is enough to just call this out as a lie. WHY wasn’t the crash responsible for the Depression in and of itself?

Contributory Factors vs. Causes

Many people often confuse contributory factors for causes. It is certainly true that a crashing stock market erodes confidence. This is mostly true because so many people subscribe to another fairy tale – that the stock market is the economy when it has devolved into little more than a momentum casino for banks and hedge funds to shave pennies from each other. Another contributory factor is the idea that a crashing stock market makes people poorer, and thus gives them less discretionary funds with which to spend. Consider this – during the past several years, people have gotten hit with two hammers – a housing crash and a market crash. Yet the spending continues for the most part. People didn’t stop spending so much because of the stock market, but rather because they lost their jobs – an important distinction.

So the ‘official story’ of the Great Depression is that capitalism (in the form of the stock market) collapsed of its own weight and that Hoover, a laissez-faire believer, failed to use the full power of the government to manage the crisis. Later, FDR came in and, in similar fashion to today, wielded the power of government to ‘manage’ the crisis. And where power didn’t exist, it was created – in many cases outside the Constitution. The obvious takeaway here is that capitalism is a failure and only naked socialism can save us from the evils of economic torment. Don’t laugh folks – there are a lot of people who believe this nonsense. And many of them hold important roles in our government.

Multiple Depressions vs. a Single Event?

A reasonable assessment of the facts surrounding the Great Depression points to the fact that there were at least three, and possibly four, actual depression-like events rather than the single event depicted in the ‘official story’.  For the purposes of this paper, I am going to focus on three of these events: a low in the business cycle, global involvement in the US collapse, and the New Deal.

I - The Business Cycle – Monetary implications

One of the biggest facts left out of the official story of the Depression was that it wasn’t the first. In fact, it takes quite a bit of digging in the history books to find any mention of previous tragic deflagrations of the business cycle. I am not going to outline each of them here in the interests of time, however, I am going to list them: 1819, 1836-37, 1857, 1873, 1893-95, and 1921. I have omitted banking panics such as 1907 since we’re discussing the business cycle. The very interesting fact about all of these sharp downturns of the business cycle is that ALL of them coincided with a complete and utter failure of the management of the money supply by the government. However, as can easily be inferred by the dates of these crises and by closer study of the crises themselves, these were all short-lived events. Most lasted two years with a couple of them lasting 4, but that was the most. The Great one was three times that long. Was this just because of monetary errors? Of course not. It was monetary errors compounded by policy missteps and ill-advised interventions on the part of government. In short, it wasn’t a failure of capitalism that caused the Depression, it was the failure to adhere to the free market that caused it – and then compounded it.

Let’s look at the causality of how monetary policy impacts, and as some would argue, even creates the business cycle. The cycle begins with a bolus of fresh money into the system. This oversupply of money drives down interest rates in the market place and causes businesses to undertake capital spending projects. Many businesses improperly interpret the bolus of fresh money and its effects as an increase in aggregate demand. Thus many of these capital spending projects are foolish in nature. I am sure it won’t take much intellectual gymnastics to figure out what some of today’s foolish endeavors happen to be.  As this move continues, business costs begin to rise due to the oversupply of money. This is further proof that inflation is a monetary event not an economic one. As cost increases persist, the monetary authorities begin to worry about inflation. Remember, their job is to manage inflationary expectations within a fiat system. So they turn off the pump, or even reverse it. As a result the ‘boom’, which was never real to begin with, comes crashing down once the supports are knocked out from under it. The business cycle bottoms and it starts all over again. This sequence of events was precisely played out during the latter part of the 1920’s. Austrian economist Murray Rothbard estimated that the money supply ballooned by around 60% between 1921 and 1929. There is a good deal of evidence that suggests the main reason the USFed kept the heel to the steel so long on monetary expansion in the 1920s was to enable the Bank of England to maintain low post WWI interest rates. Remember the fact that our USFed is beholden to the British by virtue of its owners.

The roaring 20s were just that – roaring. And nobody was paying any attention either. One of the biggest problems with advancements in technology – even then – is that they assist in masking the effects of monetary inflation. As such the 1920s saw a period of relatively stable prices for goods. The inflation made it into rampant asset speculation. Sound familiar??  As has been the case in so many subsequent boom cycles, the USFed has telegraphed its actions with regard to taking the punch bowl out the back door. By 1928, interest rates on the short end had begun to increase. Between January 1928 and August 1929, the discount rate was increased 4 times from 3.5% to 6%. It gets better. For the next three years into the depths of the first leg of the crisis in 1932, the USFed allowed the money supply to shrink by 30%.

Let’s keep score here. In the 1920s the Fed allowed the money supply to rise by over 60%, then allowed it to crash by 30% in the three years following August 1929.
Looking back in history, this has been the pattern of every boom-bust. Overissuance followed by contraction. The sad thing is that ending the USFed probably wouldn’t make too much of a difference – if only in this regard. Our government has shown complete ineptitude and an inclination to corruption as well when it comes to regulating the money supply. The one thing that would result in an ending of the USFed, at least in theory, is greater accountability. As an interesting aside, the St. Louis Fed in its most recent bimonthly ‘Review’ features an article that argues what a great creation the central bank is, and how it is directly accountable to the people. It is so biased as to be almost entertaining.

Friedman and Schwartz argued a ‘seismic incompetence’ by the USFed. It is my humble opinion, however, that these events constitute a self-inflicted wound. Why say such a thing? Look at the results; they are undeniable. A massive consolidation as the elite snapped up paper assets at fire sale prices and the unmistakable intrusion of government into the social and economic fabric of this nation, and a calling in of a fiat money’s only competition are three salient examples. Now take a look at the crisis of 2008 and ask yourself the same questions. Look at what has happened since. Government has gotten larger, and more intertwined with banks and in the regulation of everyone’s business. These are the events and facts. Draw your own conclusions.

II – Global Involvement and Resultant Disintegration

Unlike today, where collapses can happen across the globe in mere hours, the initial shocks of the Great Depression were limited to the United States. Ironically, had policy mistakes not been made at numerous times, the Great Depression would never have been great at all. It would have been just a footnote, like the aforementioned periods of economic duress. I mentioned previously that it is my opinion, based on the preponderance of the evidence, that the USFed precipitated the economic crash intentionally. However, what is certainly open to much speculation is the influence the central bank had on subsequent policy decisions. I am not going to go there since politics is not my field. What I will say in post-mortem fashion is that there were gross gaffes made that took a pinhole in the proverbial dyke and ran a train through it.

First lets look at unemployment. Granted, the methodologies were much different in the 1930s than they are today, but I am quite certain the numbers were much less maligned in those days. 1929 unemployment averaged a mere 3.2%, a figure that rose to a recessionary 8.9% in 1930. Oddly enough, calling 8.9% unemployment  ‘recessionary’ was not my label, but the labeling of the economists of the day. Contrast that with today’s metrics and the outright refusal to admit the continuing contraction in today’s economy.

Unemployment would peak at the now-famous 25% level in 1933. Much of this increase was blamed on the free market and its advocate, Herbert Hoover. However, a more in-depth and complete study of the policies Hoover endorsed and championed demonstrated that he wasn’t the free-market advocate he claimed to be. In fact, Roosevelt’s running mate John Nance Garner asserted that Hoover was ‘leading the country down the path towards socialism!’ Franklin Roosevelt of all people also rang the bell of Hoover’s socialist tendencies – and both were absolutely right. The true irony here is that FDR ended up being the one who would lead America perhaps the furthest down the path to socialism with the myriad programs enacted during his tenure, almost all of which put the destinies of the people in the hands of central planners.

In my opinion, Hoover’s biggest mistake was his enactment of the Smoot-Hawley Tariff Act. This one is actually in the history books, but it is always portrayed positively, when in fact it was almost singlehandedly responsible for passing the banner from the first phase of the crisis – that of America – to the rest of the world.
Smoot-Hawley was piggybacked right on top of Fordney-McCumber; another tariff act passed in 1922 that had devastated US agriculture. Smooth-Hawley was a protectionist bill at the time when it was least needed and it ended up triggering an international trade war. It essentially closed the border to foreign goods. Tariffs on agricultural goods were raised from an average of 20% to 34% and from 50% to 60% on wool and wool products. 887 tariffs were increased as a result of Smoot-Hawley and the list of dutiable goods increased to over 3,000. The biggest gaffe of Smooth-Hawley is that many of the tariffs were stated as an absolute amount as opposed to being a percentage of the price. As prices cratered as the USFed’s consolidative deflation kicked in, the flow of foreign products nearly stopped, as it no longer made sense for foreigners to export goods to America. Thousands went home jobless from the steel, paint, and clothing industries alone.

It was evident that the thinking behind Smoot-Hawley was to force Americans to buy products made at home, which would stimulate aggregate demand, thereby solving the unemployment problems. Unfortunately, the trade dynamics at the time dictated the other half of that equation. Foreigners with no place to export to won’t have the disposable income to purchase our exports. In a world where countries produce based on competitive and comparative advantages, a healthy trade environment is essential to the success of everyone. Societies that have not designed themselves to be self-sufficient can’t suddenly become so with the stroke of a politician’s pen. And that is what Smooth-Hawley tried to do – and it helped to take an American problem and make it a global one. Put another way, Smoot-Hawley was to the 1930s what the repeal of Glass-Steagall has been to the first part of this new century. Foreigners reacted in predictable fashion; they cut off the United States from the trade picture, refusing to purchase American goods. With trade sufficiently disrupted, the surpluses and shortages of goods around the globe worsened, and the economic calamity that had hit the US became a global problem.

The US agriculture industry in particular was devastated, losing around one-third of its market almost overnight. Food prices collapsed and the dominoes starting falling. 9,000 bank failures, mostly ones that held farm loans, rocked the financial sector between 1930 and 1933. Here is another point where facts diverge from populist historical opinion. The banks failures are today blamed on the stock market crash, and in effect, the failure of capitalism, when it was government intervention that was directly responsible for those failures. The stock market, which at that time was a better reflector of policy and the economy, peaked at DOW 381 in 1929, crashed to 198 in 1930, then rallied up to 294 by April 1930. The DOW would begin to fail again as Smoot-Hawley made its way through the legislative process. The bill would be signed, the bank failures would begin, the economy would tank due to a collapse in aggregate demand (which was exacerbated by a deflationary stance by the USFed), and the DOW would crater at 41 – a 90% loss two years later. As a side note, it would take 25 years for the DOW to reach 381 again. Feeling good about DOW 14,000 again anytime soon?

Many historians accurately point out that it was likely the trade war that started with the signing of Smoot-Hawley that eventually precipitated WWII. I’ll cite the old economic axiom: When goods don't flow freely across borders, armies will. If you are feeling shivers up and down your spine right now – you should be. The environment in place today is eerily similar to that of the late 1920s and I am not even talking about the stock market. We’re hearing about potential trade wars over currency valuations, we are seeing foolish legislation fly through Congress on a regular basis, and we are seeing the USFed, in the middle of it all, as usual, rigging the system for its owners. Just like 1929, little has changed. Sure, the names, faces, and places have changed, but the song remains the same. Truly, there is nothing new under the sun.

III. The New Deal

Franklin Roosevelt rode into Washington on a political white horse in 1933, capitalizing in a huge way on the mistakes of his predecessor. He rode into town on the platform of reducing government spending by 25%, a balanced Federal budget, and a gold currency that would be defended at all costs. That was the platform. Also on the platform was the removal of the Federal government from all issues that would be better handled by private enterprises and the ending of the disastrous and terribly inefficient Hoover farm subsidies. You can do the research for yourself; this is what FDR promised when he ran for President. It all sounded very good. We got none of it and the mistakes and fiscal folly continued.

FDR’s first act, which would strike fear in the hearts of every American with a dollar to his name, came before his seat in the oval office was warm. On March 6, 1933, FDR declared a bank holiday that would last 9 days. Friedman and Schwartz also argued that the bank holiday was essentially a waste of time since it did nothing to correct the mischief of the USFed or reverse Smoot-Hawley. All the banking holiday did was deprive depositors of their funds and sow the seeds of further distrust – now directed at the new administration. 5,000 of the banks that closed their doors on March 6, 1933 did not re-open nine days later and of those 5,000, 40% of them never opened their doors again. Can you say consolidation?

Later that same year, Congress gave FDR the power to seize private gold and then fix the value thereof. The US was now well on its way to divorcing itself of the gold standard. This is where I must call into question the influence of the USFed and international bankers on US policy. Cui bono is clear in this case: the moneychangers. The Fed should have been abolished for its malfeasance in 1929, yet, essentially, it was handed more power when the private gold was called in. Sure, the USA would not totally leave the gold standard until 1971, but the die was cast - under a President who ran on the platform that such an event would never happen on his watch. This is not intended to be a hit piece of FDR; I am just stating the facts and events that took place. Senator Carter Glass summed it up in early 1933: “It’s dishonor, sir. This great government, strong in gold, is breaking its promises to pay gold to widows and orphans to whom it has sold government bonds with a pledge to pay gold coin of the present standard of value. It is breaking its promise to redeem its paper money in gold coin of the present standard of value. It’s dishonor, sir.”

The hits continued to roll throughout the 1930s. In the first year of the New Deal, the proposed budget was $10 billion, on revenues of just $3 billion. So much for the cut in government spending. Between 1933 and 1936, government expenditures increased 83%, with government debt increasing by an amazing 73%. Seriously, does ANY of this sound familiar? In 1935, we got Social Security, and it now hangs around the neck of America like a millstone. Three years later we would get the minimum wage law, which would ensure that more Americans would remain unemployed. Remember, absent Fed mischief and felonious behavior, your dollar would be a stable store of wealth and we would not need minimum wage laws, and increases of the same, to ‘keep up’.

Mainstream economists will be quick to extoll the virtues of both Social Security and minimum wage laws. In reality, the former told Americans that they could let up their guard – the government had their backs covered, while the latter ensured that many of them had no back to cover. The minimum wage law priced (and continues to) out the members of society at the bottom of the experience scales. Namely, teens, young entrants into the workforce, and the uneducated.  It does this by saying that a firm must pay a wage that is above equilibrium in order to have the privilege of that person’s time. Simply put, if a worker can’t produce the value of the cost of his employment, then that job will not be filled. By artificially raising the bar constantly (primarily due to the above-captioned inflationary shenanigans of the USFed), more of these people are never hired, and instead rely on government assistance to survive.

The AAA (Agricultural Adjustment Act) put a tax on food processors and the revenue from that program was used to destroy crops and cattle. See, there was a surplus as a result of Smoot-Hawley, so instead of solving the problem by abolishing the miscarriage of economics that was the law, the government taxed another area, then used the tax revenue to pay farmers to pour milk down the drain. It is kind of similar to the example of corn-based ethanol where the government taxes gasoline, then uses some of that revenue to burn up the food supply while corn prices hit record highs. I know it isn’t a perfect example, but it requires the same amount of insanity to justify.

Had enough yet? I’ve got just one more – the National Recovery Administration (NRA), brought into existence by the National Industrial Recovery Act, passed in July of 1933. Again, and I don’t care if I sound like a broken record – does ANY of this sound familiar? Under this law, many industrial businesses were forced into what might easily be considered cartels. The NRA was funded by taxes on the industries it regulated and it in many ways nearly dictated how they went about doing business. Here’s the kicker; in the months leading up to the passage of NIRA, there were signs that the economy might be finally on the verge of recovery. Factory employment had increased by 23% since its bottom, and payrolls were also on the rise. The NIRA was passed and work hours were cut, wages capriciously increased or decreased, and the full regulatory burdens of this new overlord of American industry were placed squarely on companies that were just starting to get a steady footing. The results were predicable and it would be absolutely obtuse of anyone to even suggest otherwise. Six months after the law was passed, industrial production had already dropped 25%. In fact, during the NRA’s entire existence, industrial production NEVER got as high as it had in the months before the passage of that bill in July of 1933.

I could spend another 5 pages and 5,000 words detailing the rest of the New Deal, the various agencies, Acts, and actions that put a boot on the throat of the American economy. But I think you get the point. In 1933, British ‘economist’ John Maynard Keynes would strut into the history books with what is really nothing more than a bunch of gobbledygook that would justify the preposterous and underhanded actions of Hoover, Roosevelt, and the USFed. His ‘work’ was called ‘The Means to Prosperity’, which when compared with the content, was an oxymoron of dictionary example quality.

As a footnote, many of the New Deal programs like the NRA and AAA, among others, were stomped by the Supreme Court in 1935 and 1936 as being unconstitutional. The economy would undergo some recovery from late 1935 through early 1937 before crashing again as the supports were blown out from under it by the Court. Oddly enough, revisionist historians blame the Supreme Court for the final leg of the Great Depression, when again it was government interference that set the stage for that portion of the collapse as well. Unfortunately, the government still wasn’t finished perpetuating the Depression and the Wagner Act (better known as the Labor Relations Act) was passed in 1935 after the voidance of the NIRA. This essentially resulted in organized labor kicking off an orgy of organizing activity from strikes to boycotts, to seizures of plants and violence. Just what the fledgling economic recovery needed. I am not against organized labor in principle, but again, the consequences of the mere timing of this action couldn’t have been that hard to fathom.

Conclusions

I am hopeful that I have established beyond reasonable doubt in this paper that monetary policy, and more importantly, the execution and timing of monetary policy, have a direct effect on the business cycle. The 21st century tendency towards booms and busts is a direct result of the mismanagement of both the currency and the supply thereof. As a corollary, mismanagement of the business environment by government can have consequences that are just as tragic as I discussed with regard to Smoot-Hawley, NIRA, AAA, and eventually the Wagner Act. We had two leaders and complicit Congresses in the 1930s that acted like proverbial bulls in the china shop. We had a central bank that was managing things for the benefit of those who own it, and what was even worse – we had a country that was very literally demanding all of the above. And I will say it one more time for posterity – does any of this sound familiar?

Graham Mehl is a pseudonym. He is not an ‘insider’. He is required to use a pseudonym by the policies of his firm when releasing written work for public consumption. Although not an insider, he is astonishingly bright, having received an MBA with highest honors from the Wharton Business School at the University of Pennsylvania. He has also worked as an analyst for hedge funds and one G7 level central bank.

Andy Sutton is a research and freelance Economist. He received international honors for his work in economics at the graduate level and currently teaches high school business. Among his current research work is identifying the line in the sand where economies crumble due to extraneous debt through the use of economic modelling. His focus is also educating young people about the science of Economics using an evidence-based approach.