Myths of the Great Depression
in Ideas on Liberty - August 1998
by Lawrence W.
is president of the Mackinac Center for Public Policy, a free-market research
and educational organization in Midland, Michigan, and chairman of FEE's
Board of Trustees. His monthly column in The Freeman, "Ideas and Consequences,"
will resume with next month's issue. This essay is condensed from a longer
monograph of the same title, available for $5 postpaid from FEE.
Many volumes have
been written about the Great Depression and its impact on the lives of
millions of Americans. Historians, economists, and politicians have all
combed the wreckage searching for the “black box” that will reveal the
cause of this legendary tragedy. Sadly, all too many of them decide to
abandon their search, finding it easier perhaps to circulate a host of
false and harmful conclusions about the events of seven decades ago.
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.
Old myths never
die; they just keep showing up in college economics and political science
textbooks. Students today are frequently taught that unfettered free enterprise
collapsed of its own weight in 1929, paving the way for a decade-long economic
depression full of hardship and misery. President Herbert Hoover is presented
as an advocate of “hands-off,” or laissez-faire, economic policy, while
his successor, Franklin Roosevelt, is the economic savior whose policies
brought us recovery. This popular account of the Depression belongs in
a book of fairy tales and not in a serious discussion of economic history,
as a review of the facts demonstrates.
Great, Great, Great, Great Depression
To properly understand
the events of the time, it is appropriate to view the Great Depression
as not one, but four consecutive depressions rolled into one. Professor
Hans Sennholz has labeled these four “phases” as follows: the business
cycle; the disintegration of the world economy; the New Deal; and the Wagner
The first phase
explains why the crash of 1929 happened in the first place; the other three
show how government intervention kept the economy in a stupor for over
I: The Business Cycle
The Great Depression
was not the country’s first depression, though it proved to be the longest.
The common thread woven through the several earlier debacles was disastrous
manipulation of the money supply by government. For various reasons, government
policies were adopted that ballooned the quantity of money and credit.
A boom resulted, followed later by a painful day of reckoning. None of
America’s depressions prior to 1929, however, lasted more than four years
and most of them were over in two. The Great Depression lasted for a dozen
years because the government compounded its monetary errors with a series
of harmful interventions.
economists, particularly those of the “Austrian school,” have observed
the close relationship between money supply and economic activity. When
government inflates the money and credit supply, interest rates at first
fall. Businesses invest this “easy money” in new production projects and
a boom takes place in capital goods. As the boom matures, business costs
rise, interest rates readjust upward, and profits are squeezed. The easy-money
effects thus wear off and the monetary authorities, fearing price inflation,
slow the growth of or even contract the money supply. In either case, the
manipulation is enough to knock out the shaky supports from underneath
the economic house of cards.
One of the most
thorough and meticulously documented accounts of the Fed’s inflationary
actions prior to 1929 is America’s Great Depression by the late
Murray Rothbard. Using a broad measure that includes currency, demand and
time deposits, and other ingredients, Rothbard estimated that the Federal
Reserve expanded the money supply by more than 60 percent from mid-1921
to mid-1929. The flood of easy money drove
interest rates down, pushed the stock market to dizzy heights, and gave
birth to the “Roaring Twenties.”
By early 1929,
the Federal Reserve was taking the punch away from the party. It choked
off the money supply, raised interest rates, and for the next three years
presided over a money supply that shrank by 30 percent. This deflation
following the inflation wrenched the economy from tremendous boom to colossal
The “smart” money—the
Bernard Baruchs and the Joseph Kennedys who watched things like money supply—saw
that the party was coming to an end before most other Americans did. Baruch
actually began selling stocks and buying bonds and gold as early as 1928;
Kennedy did likewise, commenting, “only a fool holds out for the top dollar.”
When the masses
of investors eventually sensed the change in Fed policy, the stampede was
underway. The stock market, after nearly two months of moderate decline,
plunged on “Black Thursday”—October 24, 1929—as the pessimistic view of
large and knowledgeable investors spread.
The stock market
crash was only a symptom—not the cause—of the Great Depression: the market
rose and fell in near synchronization with what the Fed was doing.
II: Disintegration of the World Economy
If this crash
had been like previous ones, the subsequent hard times might have ended
in a year or two. But unprecedented political bungling instead prolonged
the misery for twelve long years.
1930 averaged a mildly recessionary 8.9 percent, up from 3.2 percent in
1929. It shot up rapidly until peaking out at more than 25 percent in 1933.
Until March 1933, these were the years of President Herbert Hoover—the
man that anti-capitalists depict as a champion of noninterventionist, laissez-faire
Did Hoover really
subscribe to a “hands off the economy,” free-market philosophy? His opponent
in the 1932 election, Franklin Roosevelt, didn’t think so. During the campaign,
Roosevelt blasted Hoover for spending and taxing too much, boosting the
national debt, choking off trade, and putting millions of people on the
dole. He accused the president of “reckless and extravagant” spending,
of thinking “that we ought to center control of everything in Washington
as rapidly as possible,” and of presiding over “the greatest spending administration
in peacetime in all of history.” Roosevelt’s running mate, John Nance Garner,
charged that Hoover was “leading the country down the path of socialism.”
Contrary to the modern myth about Hoover, Roosevelt and Garner were absolutely
The crowning folly
of the Hoover administration was the Smoot-Hawley Tariff, passed in June
1930. It came on top of the Fordney-McCumber Tariff of 1922, which had
already put American agriculture in a tailspin during the preceding decade.
The most protectionist legislation in U.S. history, Smoot-Hawley virtually
closed the borders to foreign goods and ignited a vicious international
trade war. Professor Barry Poulson notes that not only were 887 tariffs
sharply increased, but the act broadened the list of dutiable commodities
to 3,218 items as well.
Officials in the
administration and in Congress believed that raising trade barriers would
force Americans to buy more goods made at home, which would solve the nagging
unemployment problem. They ignored an important principle of international
commerce: trade is ultimately a two-way street; if foreigners cannot sell
their goods here, then they cannot earn the dollars they need to buy here.
and their workers were flattened by Smoot-Hawley’s steep tariff rates,
and foreign governments soon retaliated with trade barriers of their own.
With their ability to sell in the American market severely hampered, they
curtailed their purchases of American goods. American agriculture was particularly
hard hit. With a stroke of the presidential pen, farmers in this country
lost nearly a third of their markets. Farm prices plummeted and tens of
thousands of farmers went bankrupt. With the collapse of agriculture, rural
banks failed in record numbers, dragging down hundreds of thousands of
increased government spending for subsidy and relief schemes. In the space
of one year alone, from 1930 to 1931, the federal government’s share of
GNP increased by about one-third.
bureaucracy doled out hundreds of millions of dollars to wheat and cotton
farmers even as the new tariffs wiped out their markets. His Reconstruction
Finance Corporation ladled out billions more in business subsidies. Commenting
decades later on Hoover’s administration, Rexford Guy Tugwell, one of the
architects of Franklin Roosevelt’s policies of the 1930s, explained, “We
didn’t admit it at the time, but practically the whole New Deal was extrapolated
from programs that Hoover started.”
To compound the
folly of high tariffs and huge subsidies, Congress then passed and Hoover
signed the Revenue Act of 1932. It doubled the income tax for most Americans;
the top bracket more than doubled, going from 24 percent to 63 percent.
Exemptions were lowered; the earned income credit was abolished; corporate
and estate taxes were raised; new gift, gasoline, and auto taxes were imposed;
and postal rates were sharply hiked.
Can any serious
scholar observe the Hoover administration’s massive economic intervention
and, with a straight face, pronounce the inevitably deleterious effects
as the fault of free markets?
III: The New Deal
Roosevelt won the 1932 presidential election in a landslide, collecting
472 electoral votes to just 59 for the incumbent Herbert Hoover. 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.
In the first year
of the New Deal, Roosevelt proposed spending $10 billion while revenues
were only $3 billion. Between 1933 and 1936, government expenditures rose
by more than 83 percent. Federal debt skyrocketed by 73 percent.
passage of the Agricultural Adjustment Act (AAA), which levied a new tax
on agricultural processors and used the revenue to supervise the wholesale
destruction of valuable crops and cattle. Federal agents oversaw the ugly
spectacle of perfectly good fields of cotton, wheat, and corn being plowed
under. Healthy cattle, sheep, and pigs by the millions were slaughtered
and buried in mass graves.
Even if the AAA
had helped farmers by curtailing supplies and raising prices, it could
have done so only by hurting millions of others who had to pay those prices
or make do with less to eat.
Perhaps the most
radical aspect of the New Deal was the National Industrial Recovery Act
(NIRA), passed in June 1933, which set up the National Recovery Administration
(NRA). Under the NIRA, most manufacturing industries were suddenly forced
into government-mandated cartels. Codes that regulated prices and terms
of sale briefly transformed much of the American economy into a fascist-style
arrangement, while the NRA was financed by new taxes on the very industries
it controlled. Some economists have estimated that the NRA boosted the
cost of doing business by an average of 40 percent—not something a depressed
economy needed for recovery.
Like Hoover before
him, Roosevelt signed into law steep income tax rate increases for the
high brackets and introduced a 5 percent withholding tax on corporate dividends.
In fact, tax hikes became a favorite policy of the president’s for the
next ten years, culminating in a top income tax rate of 94 percent during
the last year of World War II. His alphabet agency commissars spent the
public’s tax money like it was so much bilge.
For example, Roosevelt’s
public relief programs hired actors to give free shows and librarians to
catalogue archives. The New Deal even paid researchers to study the history
of the safety pin, hired 100 Washington workers to patrol the streets with
balloons to frighten starlings away from public buildings, and put men
on the public payroll to chase tumbleweeds on windy days.
the Civil Works Administration in November 1933 and ended it in March 1934,
though the unfinished projects were transferred to the Federal Emergency
Relief Administration. Roosevelt had assured Congress in his State of the
Union message that any new such program would be abolished within a year.
“The federal government,” said the President, “must and shall quit this
business of relief. I am not willing that the vitality of our people be
further stopped by the giving of cash, of market baskets, of a few bits
of weekly work cutting grass, raking leaves, or picking up papers in the
But in 1935 the
Works Progress Administration came along. It is known today as the very
government program that gave rise to the new term, “boondoggle,” because
it “produced” a lot more than the 77,000 bridges and 116,000 buildings
to which its advocates loved to point as evidence of its efficacy.
The stupefying roster of wasteful spending generated by these jobs programs
represented a diversion of valuable resources to politically motivated
and economically counterproductive purposes.
The American economy
was soon relieved of the burden of some of the New Deal’s excesses when
the Supreme Court outlawed the NRA in 1935 and the AAA in 1936, earning
Roosevelt’s eternal wrath and derision. Recognizing much of what Roosevelt
did as unconstitutional, the “nine old men” of the Court also threw out
other, more minor acts and programs which hindered recovery.
Freed from the
worst of the New Deal, the economy showed some signs of life. Unemployment
dropped to 18 percent in 1935, 14 percent in 1936, and even lower in 1937.
But by 1938, it was back up to 20 percent as the economy slumped again.
The stock market crashed nearly 50 percent between August 1937 and March
1938. The “economic stimulus” of Franklin Roosevelt’s New Deal had achieved
a real “first”: a depression within a depression!
IV: The Wagner Act
The stage was
set for the 1937–38 collapse with the passage of the National Labor Relations
Act in 1935—better known as the Wagner Act and organized labor’s “Magna
Carta.” To quote Hans Sennholz again:
law revolutionized American labor relations. It took labor disputes out
of the courts of law and brought them under a newly created Federal agency,
the National Labor Relations Board, which became prosecutor, judge, and
jury, all in one. Labor union sympathizers on the Board further perverted
this law, which already afforded legal immunities and privileges to labor
unions. The U.S. thereby abandoned a great achievement of Western civilization,
equality under the law.
Armed with these
sweeping new powers, labor unions went on a militant organizing frenzy.
Threats, boycotts, strikes, seizures of plants, and widespread violence
pushed productivity down sharply and unemployment up dramatically. Membership
in the nation’s labor unions soared; by 1941 there were two and a half
times as many Americans in unions as in 1935.
From the White
House on the heels of the Wagner Act came a thunderous barrage of insults
against business. Businessmen, Roosevelt fumed, were obstacles on the road
to recovery. New strictures on the stock market were imposed. A tax on
corporate retained earnings, called the “undistributed profits tax,” was
levied. “These soak-the-rich efforts,” writes economist Robert Higgs, “left
little doubt that the president and his administration intended to push
through Congress everything they could to extract wealth from the high-income
earners responsible for making the bulk of the nation’s decisions about
Higgs draws a
close connection between the level of private investment and the course
of the American economy in the 1930s. The relentless assaults of the Roosevelt
administration—in both word and deed—against business, property, and free
enterprise guaranteed that the capital needed to jumpstart the economy
was either taxed away or forced into hiding. When Roosevelt took America
to war in 1941, he eased up on his antibusiness agenda, but a great deal
of the nation’s capital was diverted into the war effort instead of into
plant expansion or consumer goods. Not until both Roosevelt and the war
were gone did investors feel confident enough to “set in motion the postwar
investment boom that powered the economy’s return to sustained prosperity.”
On the eve of
America’s entry into World War II and twelve years after the stock market
crash of Black Thursday, ten million Americans were jobless. Roosevelt
had pledged in 1932 to end the crisis, but it persisted two presidential
terms and countless interventions later.
Along with the
horror of World War II came a revival of trade with America’s allies. The
war’s destruction of people and resources did not help the U.S. economy,
but this renewed trade did. More important, the Truman administration that
followed Roosevelt was decidedly less eager to berate and bludgeon private
investors, and as a result, those investors came back into the economy
to fuel a powerful postwar boom.
The genesis of
the Great Depression lay in the inflationary monetary policies of the U.S.
government in the 1920s. It was prolonged and exacerbated by a litany of
political missteps: trade-crushing tariffs, incentive-sapping taxes, mind-numbing
controls on production and competition, senseless destruction of crops
and cattle, and coercive labor laws, to recount just a few. It was not
the free market that produced twelve years of agony; rather, it was political
bungling on a scale as grand as there ever was.
Hans F. Sennholz, “The Great Depression,” The Freeman, April 1975,
Murray Rothbard, America’s Great Depression (Kansas City: Sheed
and Ward, Inc., 1975), p. 89.
Lindley H. Clark, Jr., “After the Fall,” Wall Street Journal, October
26, 1979, p. 18.
“FDR’s Disputed Legacy,” Time, February 1, 1982, p. 23.
Barry W. Poulson, Economic History of the United States (New York:
Macmillan Publishing Co., Inc., 1981), p. 508.
Paul Johnson, A History of the American People (New York: HarperCollins
Publishers, 1997), p. 741.
Martin Morse Wooster, “Bring Back the WPA? It Also Had A Seamy Side,” Wall
Street Journal, September 3, 1986, p. A26.
Sennholz, pp. 212–13.
Robert Higgs, “Regime Uncertainty: Why the Great Depression Lasted So Long
and Why Prosperity Resumed After the War,” The Independent Review,
Spring 1997, p. 573.
Ibid., p. 564.