Chapter: 12

The Great Depression and its aftermath—a fundamental change in America

“The crash of 1929 and the Great Depression . . . clearly demonstrate how radical government intervention [in economic life] can generate a severe depression.”–Hans F. Sennholz  1

SYNOPSIS

In the 1930s America commenced a fundamental change–from a country of largely free, independent, and self-responsible individuals to one where nearly half the people are dependent on the state for sustenance either wholly or to a significant extent. 2 The accumulation of state power that changed America was gradual, with periods of immense increase during the Civil War, in the “progressive” era of the 1890s to 1920s, during World War I and during the Great Depression of the 1930s.

Nevertheless, by the 1920s the state was still relatively small in comparison to what it would become starting with the Great Depression of the 1930s.

World War II and more political actions following World War II further increased the power of the state as more and more Americans became dependent on the state for employment and sustenance. Since the state produces nothing and has no revenues other than what it takes from individuals, it could only provide sustenance for some at the expense of others.

The following discussion of the Great Depression of the 1930s is based on the ideas of “liberal” economists, i.e. those espousing free market principles. The word “liberal” is used as Galambos uses it, in the sense of pertaining to freedom and its derivation from the Latin word “liber,” meaning free. In Europe and Australia the word “liberal” in politics continues in use to describe the philosophy of “laissez faire,” meaning the state should leave individuals free to rule their own affairs.

THE POLITICAL STATE CAUSED AND PROLONGED THE GREAT DEPRESSION

The Great Depression of the 1930s was manifested in a deep and sharp economic downturn, losses of savings due to bank failures, a deeply depressed stock market and, worst of all, wide-spread and long-lasting high levels of unemployment and under-employment. When President Franklin D. Roosevelt was inaugurated on March 4, 1933, the unemployment rate was over 20%; farm prices had dropped by 60%; industrial production had fallen by more than half since 1929; the stock market was down 85% from its 1929 peak; two million people were homeless; and 32 of the 48 states plus the District of Columbia had closed their banks.

It was then, and still is, widely believed that the Great Depression was due to a failure of capitalism; and that it was necessary to look to the state for relief from depression and for laws designed to prevent another depression. However, contrary to general belief, the depth and length of the Great Depression of the 1930s was caused not by capitalism but primarily by presumably well-intentioned but misguided state interventions in the economy.

The “New Deal” of President Franklin D. Roosevelt (President 1933-1945) took actions that worsened conditions they intended to improve. For example, at a time when many people in America were hungry and could not even afford to buy food a federal law was passed with the objective of raising farm income by reducing production. “The objective was to cut the acreage planted, to destroy the crops in the field, and pay the farmers to refrain from farming. The expenses of the program under which farmers [were required] to plow under their [crops] and kill their livestock were to be covered by a new ‘processing tax’ levied on agriculture.” 3

America had economic depressions before the 1930s but they generally ran their course without hardships like those of the 1930s. For example, the sharp depression of 1920-1921 lasted only a year and one-half. During that time the federal state did virtually nothing to halt or reverse the depression. Liberal (free market) economists argue that the depression of 1920-1921 was due to necessary and massive adjustments undertaken by private business and industry to adapt to the reduction of state spending for war and war-related activities during America’s involvement in World War I (1917-1918).

Liberal economist Benjamin M. Anderson claimed that the primary causes of economic downturn in 1929-1931 were tariffs (taxes on imported goods) enacted in 1921, 1922, and 1930, and the lax lending policies of the Federal Reserve (the Fed) from 1922 to 1928. The tariffs restricted international trade in harmful ways that not only caused depression in the U.S. but also contributed to the global scope of the Great Depression. The Fed’s easy money policies caused an excessive expansion of bank credit during the years 1922-1928. In consequence there was extreme speculation with borrowed money that led to a boom and bust in real estate and the stock market. 4

Although three generations of economists have analyzed the Great Depression, economists are still in disagreement over the cause of its length and severity. A cogent, readily comprehensible explanation has been provided by liberal economist Hans F. Sennholz in his essay entitled The Great Depression: Will We Repeat it? (1988). 5

Sennholz agrees with Benjamin Anderson that the seeds of the economic disaster of the 1930s were sown in the 1920s in tariff legislation (taxes on imports) and the lax credit policies of the Federal Reserve. The American economy was adjusting to the initial downturn of 1929-1930 until recovery was aborted by political actions including, but not limited to, the following actions taken in 1930-1932 under the presidency of Herbert Hoover and continuing in 1933-1940 under the presidency of Franklin D. Roosevelt.

  1. In 1930 a huge increase in tariffs (taxes) on imports caused a large reduction in American exports, since to export a country must also import from others. 6 To buy from America people in other countries must earn U.S. dollars by selling to America or must acquire U.S. dollars from other countries through international trade. For example, for the Japanese to buy American farm products, the Japanese must sell their manufactured products (automobiles, consumer electronic appliances, etc.) to customers in the U.S. or elsewhere.
  2. The federal state increased its spending to stimulate the economy and in 1932 Congress enacted the biggest tax increase in American history (to that point) to pay for all the new spending. The higher taxes and consequent reduced saving for investment choked off economic recovery and deepened the depression. In 1933, 1934, and 1935 further tax increases were imposed.
  3. Other legislation was enacted in 1933 and the next few years with the goal of raising farm prices by reducing farm output through destruction of crops and livestock and paying farmers to refrain from farming—at a time when hunger was becoming a problem for many Americans.
  4. The U.S. abandoned the gold standard in 1933 and in 1934 Congress devalued the U.S. dollar to promote American exports by reducing the price of American goods in comparison to world market prices for similar goods. Sennholz commented that “the devaluation failed predictably because foreign countries promptly raised their barriers against American goods and devalued their currencies in tandem with the United States.”
  5. Other new federal laws were intended to maintain and enhance the “purchasing power” of individuals by raising the cost of labor. Consequently, labor costs were prevented from going down to levels that would have made it advantageous for employers to hire the unemployed during an economic depression. Instead the unemployment problem was addressed by welfare payments and a variety of jobs created by the state and paid for by taxes and borrowing.

In 1939, after nine years of the Great Depression, the Secretary of the Treasury, Henry Morgenthau, Jr., is reputed to have said the following in comments to members of the Ways and Means Committee of the House of Representatives.

“We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong . . . somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises . . . I say after eight years of this Administration we have just as much unemployment as when we started . . . And enormous debt to boot!” 7

The unemployment of the Great Depression was eliminated by World War II, when the personnel of the U.S. armed forces grew from less than 250,000 in 1938 to twelve million during the war, and another 10.5 million people went to work in war-related civilian industrial production. 8 In the words of economist Hans F. Sennholz, “The Great Depression . . . was not liquidated until the impact of massive defense spending [immediately before and during WW II] substituted production of destructive weapons in place of stagnation and unemployment.” 9

However, there was fear that when the war ended unemployment would return to the level of the Great Depression. Instead, the end of the war started a long period of prosperity and economic expansion in America.  10

Among the factors that may explain the low rate of unemployment after World War II are that personal and business debt was low due to the elimination of debt via bankruptcies and risk averse behavior during the depression; and the American people had built up a large store of savings during the war when personal incomes were regular and high, and there was relatively little to spend money on due to a dearth of production of consumer goods and rationing of much that was available. Therefore, the combination of low debt and high savings caused prosperity based on a boom in consumer spending after the war.

NEGATIVE CONSEQUENCES OF GROWTH OF STATE POWER AFTER 1929

Since 1929 the American federal state, its taxes and its debts have all grown enormously. The initiation of large federal welfare programs in the 1930s was just a beginning. In the 1960s Congress enacted additional expensive social welfare programs including federal financing of health care expenses for nearly half the country’s population, and a “War on Poverty” to create a “Great Society.” 11 The War on Poverty included economic support for about 5% of the population whose incomes fell below a state-determined “poverty level.”

There have been unintended and sometimes financially disastrous consequences of lavish federal state spending, subsidies and intervention in the economy, including:

  • Persistent monetary inflation which has devalued the U.S. dollar by 93% since 1930, and by nearly two-thirds in the decade of the 1970s when consumer prices rose an average of nearly 11% a year.
  • Americans’ average “real” (inflation-adjusted) incomes increased only 18% between 1967 and 2012. 12
  • Despite trillions of dollars in spending in the War on Poverty since it started in 1965 until the beginning of the second decade of the 21st century, there has been no meaningful decrease in the percentage of people with incomes below the state-defined poverty level. That percentage has fluctuated between 12% and 15%.
  • Failure of over 1,000 savings and loan banks from 1986-1995 at a cost to taxpayers of more than $150 billion.
  • Artificially low interest rates engineered by the Federal Reserve between 2001 and 2004 to aid the banking industry and stimulate the economy, fostered speculation in the stock market and in real estate. 13
  • Federal subsidies for home loans that were a major factor in causing the housing bubble of the 2000s by over-stimulating home buying until the debt-financed boom turned into a real estate bust. In that crisis many of America’s largest financial institutions, including federally-sponsored enterprises, 14 either failed or would have failed but for intervention and bailouts by the federal state, millions of home mortgages went into default then foreclosure, and the nation sunk into economic recession with high employment.  15
  • Most importantly and dangerously, federal debt, including unfunded future liabilities for social welfare programs, expanded so much that it will be an unsupportable burden on generations to come.

Galambos pointed out that there is never a recession or depression in communist countries like the former Soviet Union 16 because the economy is already at a permanently depressed level. I.e., a country has to first enjoy a relatively prosperous economy from which an economic downturn is called a depression.

Despite the popular belief that the Great Depression was caused by the free market, the foregoing illustrates that the multifarious political actions taken by the state not only caused, but then worsened and prolonged the greatest financial calamity in U.S. history. Moreover, these political actions (including state interference in business and the expansion of state welfare programs) set a new precedent for government involvement in the lives of Americans.

 

 

Notes:

  1. Quoted from “The Great Depression: Will We Repeat It?” (1988), p. 2 by Hans F. Sennholz
  2. Black slaves had not been free and independent, and even the abolition of the legality of slavery in 1865 did not fully emancipate America’s black citizens who suffered from legal disabilities in many states until the mid-1960s.
  3. The law was entitled The Farm Relief and Inflation Act of 1933. Quotation from Sennholz, Hans F. “the Great Depression: Will We Repeat It?” (1988), page 17
  4. Anderson, Benjamin M., Economics and the Public Welfare (2nd ed. 1979), pages 144-204. Benjamin M. Anderson (1886-1949) was a first-hand observer of the Great Depression and the events that led to it, first as a professor of economics at Columbia and Harvard Universities (1914-1918), later as chief economist at Chase Manhattan Bank (1920-1937) and finally as Professor of economics again (at the University of California at Los Angeles, 1939-1949).
  5. Professor Sennholz (1922-2007), author of 17 books and booklets and long-time college professor (Grove City College in Pennsylvania) was born in Germany where he experienced personally the Great Depression, the rise of Hitler’s National Socialism and World War II (as a pilot in the German air force). He immigrated to America after World War II. Sennholz held doctorate degrees in in economics from Marburg University in Germany and also in America from New York University.
  6. In 1930 Congress passed and the President signed the Hawley-Smoot Tariff Act which sharply increased tariffs on agricultural products and on most industrial goods. These were the highest tariffs in American history. Canada and other countries enacted retaliatory tariffs. Consequently world trade collapsed. The Hawley-Smoot Tariff was one of the major mistakes of the federal state. From1929 to 1932 American exports fell 78%, helping to cause what had been an ordinary economic recession to become the calamity of the Great Depression. “The Great Mistake,” by John Gordon Steele, Barron’s, October 25, 2010; and Anderson, Benjamin M., Economics and the Public Welfare: A Financial and Economic History of the United States, 1914-1946 (2nd ed. 1979), p. 229.
  7. Unemployment ranged from 14.6% to 17.4% in 1938-1940. See Shales, Amity, The Forgotten Man: A New History of the Great Depression (2007), pages 352 and 366. Quotation from pages 2, 144, and 248 of New Deal or Raw Deal? How FDR’s Economic Legacy Has Damaged America (2008) by Burton Folsom, Jr. The quotation source according to Mr. Folsom’s book is the “Morgenthau Diary,” reproduced in Rosenman, Samuel I. (ed.), The Public Papers and Addresses of Franklin D. Roosevelt (1950). Mr. Folsom is a professor of history at Hillsdale College in Michigan. Note that in May, 1939 the administration of Franklin D. Roosevelt Administration had been in office a little over six years, not eight years.
  8. According to “The American Economy during World War II,” by Christopher J. Tassava, at http://eh.net/encyclopedia/article/tassava.WWII, under heading “Expansion of Employment.”
  9. Quoted from Sennhoz’s Postscript to Ludwig von Mises, Notes and Recollections (1978), page 147
  10. See Post-World War II Economic Expansion, http://en.wikipedia.org/wiki/Post%E2%80%93World_War_II_economic_expansion#Libertarian_explanation
  11. The quoted titles were used by Lyndon B. Johnson, U.S. President from 1963-1969.
  12. Source: U.S. Census Bureau, Income, Poverty, and Health Insurance Coverage in the United States: 2012, Figure 1, Real Median Household Income by Race and Hispanic Origin: 1967 to 2012, http://www.census.gov/prod/2013pubs/p60-245.pdf
  13. See, e.gGreenspan’s Bubbles: The Age of Ignorance at the Federal Reserve (2008) by William A. Fleckenstein; Wall Street Revalued: Imperfect Markets and Inept Central Bankers (2009) by Andrew Smithers; and Financial Fiasco: How America’s Infatuation with Homeownership and Easy Money Created the Economic Crisis (2009) by Johan Norberg
  14. The federally sponsored mortgage giants, Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation)
  15. See, e.g.The Housing Boom and Bust (2009) by Thomas Sowell; Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis (2009) by John B. Taylor; and Financial Fiasco: How America’s Infatuation with Homeownership and Easy Money Created the Economic Crisis (2009) by Johan Norberg.
  16.  and communist China before its economic “modernization” began around 1979

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