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Introduction
The causes behind the Great Depression and its duration are numerous and complex. No one factor or person bears full responsibility; however, various factors and persons do bear partial responsibility. Inflationary credit policies in the 1920s partly led to the market crash of 1929 and moreover to the unusually severe depression that thereafter ensued. Beginning in 1933, President Franklin D. Roosevelt initiated a number of government programs designed to alleviate and reverse the effects of the Great Depression, and though FDR’s goal was recovery, his New Deal programs ultimately failed to restore the economy and further perpetuated the depression. Not only did government intervention in the economy lead to the Great Depression, government intervention further lengthened the Depression by repeating the same mistakes that led to the Depression in the first place.Background--Great Britain and Her Minions
To understand the context of the Great Depression, and also the nature of the New Deal, it is necessary to consider the developments in economic practice that preceded these events, and few accounts of the pre-Depression era compare to that offered by Murray N. Rothbard in his book A History of Money and Banking in the United States. According to Rothbard, the effect of World War I on the international economy was nothing short of disastrous, and at the close of the war, many of the world’s major powers set their sights on restoring the international economic order (439). Great Britain, in particular, hoped to regain its economic preeminence, though this task would prove difficult since WWI had left the British economy vulnerable due to its “wracking inflation” and its lack of resources (Rothbard, 439). WWI, moreover, had left the United States, who was a latecomer to the war, as the only country with a currency still based on a hard gold standard (Rothbard, 439). Having a gold-standard based currency simply entailed that currency obligations could be redeemed in gold. During WWI, European nations had gone off the gold standard due to the high rates of inflation each nation utilized to finance their war efforts (Rothbard, 439). If Britain were to have any hope of regaining its international economic supremacy, it could not return to a gold standard, since doing so would mean the deflation of the British pound by 30 percent of its original value (Rothbard, 440). Moreover, should Britain allow the deflation of the pound, the U.S. dollar, which was still based on a gold standard, would take the place of the pound as the “financial center” of the international economy (Rothbard, 440).To ensure that it would regain economic supremacy, Britain established a new sort of international economy; one based on the “gold-exchange standard,” which would permit Great Britain and the rest of Europe to keep their currencies inflated, and inflating (Rothbard, 440). To do this, Britain established the U.S. dollar as the primary support for all other currencies, and it used the dollar, rather than gold, for its reserves, and it then forced other, smaller European countries to use the pound for their reserves, rather than gold (Rothbard, 440). In short, Britain established a veritable upside-down economic pyramid with the United States at its base. Britain’s plan might have worked, too, if the U.S. had not also “unduly” inflated the dollar during the 1920s (Rothbard, 441). Inflating currency tends to render it “shaky,” and according to Rothbard, “the inability of this system, with pseudo gold-standard countries pyramiding on top of an increasingly shaky dollar-gold base, was to become evident in the Great Depression” (440).
Crash and Depression--The Mechanisms of Economic Homeostasis
Though by all accounts the economy prior to 1929 was booming at an unprecedented level, this “boom” resulted from “wasteful misinvestment” and the unduly inflation and expansion of bank credit (Rothbard, 12). As a consequence, the market crashed in 1929, and depression thereafter ensued (Rothbard, 12). This descent into depression followed by a boom reflects what many refer to as the “boom-bust” cycle; though, according to Rothbard, economists often misunderstand the nature of this cycle. It is often thought that periods of economic growth and contraction result naturally from the ebb and flow of the free market, primarily as a result of “a sudden general cluster of business errors” (Rothbard, 8). To the contrary, as argues Rothbard in his book America’s Great Depression: “The ‘boom-bust’ cycle is generated by monetary intervention in the market, specifically bank credit expansion to business” (9). During the 1920s, this very sort of monetary intervention was utilized to artificially fuel the economic boom, and by 1929, this economic growth came crashing to halt. During the 1920s, business leaders had been misled by the undue inflation of credit to overinvest, and by 1929, it had become evident that this overinvestment in fact represented wasteful investment (Rothbard, 12). As inflation permeated into the consumer market, the ratio of consumption to investment readjusted to reflect pre-boom levels with the result that the market crashed in 1929 (Rothbard, 12).The depression that followed, which proved notably severe in contrast to the unprecedented boom of the 1920s, was, according to Rothbard, nothing short of a “necessary and beneficial return” to a normal economy, devoid of “the distortions imposed by the boom” (12). In short, the depression was a necessary and natural self-corrective response of the free-market economy to reestablish balance. Had this fact been recognized by government officials and the general public, and had they left the depression to work itself out, the Great Depression might have proved “mercifully short.” Government intervention only tends to lengthen and deepen depressions, yet, between 1929-1933 government intervention characterized government policies (Rothbard, 4). Practices such as lending money to failing businesses, spurring greater amounts of inflation, maintaining higher wages, keeping prices elevated, promoting consumption rather than saving, and subsidizing unemployment constituted the government’s response to the depression, and as a result, the Great Depression was only prolonged (Rothbard, 19-21). Such practices are counterproductive, and even harmful, primarily because they interfere with and oppose the elements of natural recovery.
But Something Must Be Done...Right?--The Ethical Drive to "Experiment"
Not everyone, however, agrees that the government should have taken a non-interventionist stance during the Depression. Arguably, had the government failed to offer immediate relief, countless people would have lost their lives due to hunger or illness. Up to the 1930s, the U.S. government had never recognized a responsibility to care for the elderly, the unemployed, the ill, and generally all others who were most vulnerable in times of economic hardship (Biles, 96). As FDR took the office of President, nearly eighteen million Americans needed relief, and almost one-fourth to one-third of the U.S. population had no way of supporting themselves due to unemployment, inadequate wages, or disability (Biles, 97-98). Though waiting out the depression would have shortened it, failure to act in the short-term would have proved particularly destructive, to the extent that inaction, though beneficial in the long-term, would have been morally untenable for the short-term. While by all accounts, immediate government action may have been ethically justified, the fact remains that government intervention, handled in the way it was by FDR’s administration, had the side effect of lengthening the depression.It would be wrong, however, to fault FDR for trying to do something to help the suffering masses. In many respects, the New Deal was uncharted territory, an “experiment” to see what would work. Amity Shlaes notes in her book The Forgotten Man that most everyone recognized from the time of his inauguration that FDR “would experiment with the economy” (148). However, his experiments hardly consisted of anything truly novel. According to Roger Biles in his book A New Deal for the American People: “for all of Roosevelt’s famed willingness to experiment, [never] did New Deal policies originate from vernal ideas” (226). The centralized economic planning of the New Deal reflected President Wilson’s War Industries Board from World War I, and the establishment of social insurance policies had already taken place in Britain and Germany prior to World War I and also in various states (Biles, 226). The only remotely original New Deal policy, Keynesian deficit spending, did not overtly take place until later in FDR’s presidency after various other reforms had been tried (Biles, 226). Nevertheless, original ideas or not, FDR had no way of knowing what policies would or would not work prior to their implementation.
Keynesian Economics--The Failed Experiment
The long-term ineffectiveness of the entirety of the New Deal aside, Keynesian Economics proved particularly destructive for the economy. In 1933, British economist John Maynard Keynes, after whom Keynesian Economics is named, wrote a letter to FDR wherein he advised the president that government policy must entail intervention in the free market (Keynes, n.p.). In particular, Keynes argued for government deficit spending, or government investment beyond the federal government’s ability to maintain a balanced budget because, according to Keynes, an equalized balance between supply and demand could not guarantee full employment without government intervention in the market (Lawlor, 4).Keynes advocated for various government policies, though two in particular were enacted during the Depression: deficit spending and low interest rates (Hazlitt, 421-422). Deficit spending entailed using government spending deficits to artificially maintain higher wages (Hazlitt, 421). The maintenance of low interest, which required printing more money to spur inflation, would supposedly combat unemployment (Hazlitt, 422). As it turned out, both of these policies failed to spur recovery as Keynes supposed they would. According to Henry Hazlitt, who thoroughly critiqued Keynesianism with his book entitled The Failure of the “New Economics,” Keynes’s theory had a number of flaws. According to Hazlitt, Keynes had a naïve definition of “full employment.” Keynes apparently failed to qualify full employment as “the absence of abnormal involuntary unemployment,” which would better define the nature of “optimum employment” in a free market (Hazlitt, 435). Moreover, Keynes mistakenly assumed that full employment was an end in itself for the free market. Instead, according to Hazlitt, optimal employment levels were merely a means to the achievement of more wide-ranging goals, such as maximizing consumer satisfaction (Hazlitt, 435).
Regardless of Keynes’s flawed presuppositions, the policies that emerged from his theorizing during the Great Depression had disastrous effects. In terms of deficit spending, data from 1931 to 1940 reveal that as deficit spending increased, so did the number and percentage of unemployed Americans (Hazlitt, 421). Going by these numbers alone, it seems evident that Keynesian deficit spending only served to perpetuate and worsen the levels of abnormal involuntary unemployment. The maintenance of low interest had a similar effect. As data from 1929 to 1940 demonstrates, as interest rates increased, via deliberate inflation nonetheless, unemployment increased as well (Hazlitt, 423). In Hazlitt’s view, deficit spending would not do the trick, and neither would low interest rates; rather, the economy required a “proper” balance between wages and prices (426). The only sort of policy intervention that the government needed to concern itself with was the maintenance of “sound currency,” the enforcement of “laws against violence and intimidation,” and the elimination of “laws which confer exclusive legal privileges and immunities on union leaders, or abridge the freedom of employers and individual workers to bargain” (Hazlitt, 426). In other words, the government should have let the economy recover on its own, all the while ensuring that people’s rights and their freedom to bargain would be upheld. As notes Murray Rothbard:
If government wishes to see a depression ended as quickly as possible…[t]he first and clearest injunction is: don’t interfere with the market’s adjustment process. The more the government intervenes to delay the market’s adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery (19).Yet, FDR and his administration did interfere, resulting in the near decade long extension of the Great Depression.
Regime Uncertainty--Fallout from the New Deal
Beyond the counterproductive effects of deficit spending and artificially maintained low interest rates, government intervention during the Great Depression also may have had a negative psychological effect on private investors, further delaying economic recovery. Robert Higgs, in his article entitled “Regime Uncertainty,” suggests that the political atmosphere created by New Deal policies undermined private investors’ faith in the future viability of private property rights in the U.S. (586). From a legal standpoint, private property rights serve to guarantee private individuals the right to exclude others from using their resources, goods, or services (Sowell, 244). Private property rights allow for the existence of a “profit-and-loss economy,” and they further incentivize economic investment by ensuring that individuals can keep their returns on investment (Sowell, 177 & 245). Investment is a risky enterprise, coming at the cost of interest, dividends, and having to wait for future returns, and if the promise of future returns does not outweigh the present cost of investment, potential investors are more apt to hold onto their money (Sowell, 177).According to Higgs, during the Great Depression, private investors were unwilling to invest their money because their hopes for gaining returns on their investment had been smashed by various government programs that seemed to threaten private property rights (586). Higgs lists a litany of acts passed by Congress between 1933 and 1940 that instilled doubt in the minds of investors that a private property regime would survive intact (571). In fact, some investors feared “more drastic developments” might ensue, such as the development of a “collectivist dictatorship” (Higgs, 571). Of course FDR’s administration had no desire to institute a collectivist dictatorship, as evidenced by the fact that many New Deal policies relied on private investment. Nevertheless, much of the rhetoric surrounding the New Deal “precluded the private confidence to invest” (Badger qtd. in Higgs, 572).
Despite the psychological fear that ultimately resulted from New Deal policies, at the start of his presidency, FDR had hoped to avoid damaging the confidence to invest. However, by 1934, under pressure from various outspoken radicals, a note of hostility began to emerge in FDR’s stance towards private investors (Higgs, 572). By 1935, FDR was surrounded by younger New Dealers and people who doubted whether business could act in accordance with the nation’s interests. As a result, FDR, no longer paying attention to the interests of business groups, supported various laws that went counter to the desires of private business leaders (Higgs, 572). Other actions by FDR, such as his 1937 “court packing scheme” and his attempts in 1937 and 1938 to reorganize the executive branch further dampened the hopes of private investors. Many saw the court packing scheme as nothing short of “‘a naked bid for dictatorship’” (Anderson qtd. in Higgs, 572). Moreover, his attempt to reorganize the executive branch convinced several that FDR intended “‘to subvert democratic institutions’ by ‘importing European totalitarianism into the United States’” (Leuchtenburg qtd. in Higgs, 573).
Though many of these accusations and fears were founded upon exaggerations of half-truths, these fears were nevertheless present. Regardless of the facts, investors were made sufficiently uncertain about the future of private property rights by FDR’s rhetoric and policies that they chose to abstain from investing their money. It ultimately was not until after World War II, with FDR dead and the New Dealers falling out of influence that faith in private investment finally returned (Higgs, 586). Though the federal government’s power had no doubt expanded significantly by the mid-1940s, “the nightmare was over” for investors, who no longer thought the government had “the terrifying potential” to undermine private-property rights (Higgs, 586).
Conclusion
The words of Thomas Sowell in his book Basic Economics appropriately convey a potential lesson to be gleaned from the Great Depression:The tragic bungling of economic policy…during the Great Depression of the 1930s has sobering implications for those who regard government as a force to save the economy from the imperfections of the marketplace. Markets are indeed imperfect, as everything human is imperfect. But “market failure” is not a magic phrase that automatically justifies government intervention, because the government can also fail—or even make things worse (263-264).Many government policies prior to the market crash of 1929 only contributed to the problem by encouraging easily available credit and maintaining low interest, which spurred unwise speculation and wasteful investment (Biles, 10). These policies further prolonged the Depression by preventing the economy from ultimately succumbing to necessary homeostatic mechanisms such as deflation, lowered wages, higher interest rates, and waning investment. Though such things would have proved notably harsh in the short term, they would have ultimately functioned as necessary and beneficial events that would have allowed the free market to self-correct for the artificially induced boom of the 1920s. Though the government may have been justified in trying to alleviate the suffering caused by the depression, it utilized various counterproductive policies that only served to prolong what was already an unprecedentedly horrible depression. Not only were these government policies themselves counterproductive, but the rhetoric surrounding them, along with FDR’s seeming disdain for the interests of private business, also undermined people’s certainty that a profit-and-loss economy and private-property rights would survive FDR’s administration. “Regime uncertainty” pervaded the minds of various investors, who as a result were reluctant to invest their money since they had little faith that they would receive any meaningful returns on their investment. The economy ultimately did not improve until after World War II, when New Deal policies no longer were in effect and the threat of a “collectivist dictatorship” no longer seemed possible. Though, of course, FDR had no intentions of instituting a dictatorship, certain of his actions gave sufficient cause to suspect the worst, and intentions can never replace outcomes when judging historical events.
Works Cited
Biles, Roger. A New Deal for the American People. DeKalb: Northern Illinois University Press, 1991. Print.Hazlitt, Henry. The Failure of the “New Economics”: An Analysis of the Keynesian Fallacies. New York: D. Van Norstrand Company, Inc., 1959. Print.
Higgs, Robert. “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War.” The Independent Review 1.4 (1997): 561-590. Print.
Keynes, John M. “An Open Letter to President Roosevelt.” New Deal Network. 16 December 1933. FDRL: PPF: 140: Frankfurter, Felix. Letter.
Lawlor, Michael S. The Economics of Keynes in Historical Context: An Intellectual History of the General Theory. New York: Palgrave MacMillan, 2006. Print.
Rothbard, Murray N. A History of Money and Banking in the United States: The Colonial Era to World War II. Auburn: Ludwig von Mises Institute, 2005. Print.
--. America’s Great Depression. 5th ed. Auburn: Ludwig von Mises Institute, 2000. Print.
Shlaes, Amity. The Forgotten Man: A new History of the Great Depression. New York: HarperCollins Publishers, 2007. Print.
Smiley, Gene. “Great Depression.” The Concise Encyclopedia of Economics. 2008. Library of Economics and Liberty. 30 September 2014. Web.
Sowell, Thomas. Basic Economics: A Citizen’s Guide to the Economy. New York: Basic Books, 2000. Print.
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