The great depression of the 1930s is one of the most misunderstood episodes in economic history. My estimation is that only about 5% of economists truly understand how the thing really went down. This is just another indictment of todays educational system.
Mainstream economists, and the textbooks that they write, will say that the 1930s depression was so grave, because of a laissez faire government, and also, tight monetary policy.
On the first issue, a closer look will tell us that this statement is plain wrong.
On the second issue, at that point the Federal Reserve was still operating under a gold standard, so base money was very stable. But let me elaborate.
The first thing we need to know is what brought on the depression. This had nothing to do with monetary policy, though economists keep insisting on this, even the Austrians. The depression was brought about by fiscal policy, this being a combination of great increases in both taxes and and tariffs.
I have already said before how detrimental taxes can be, and the argument against mercantilist protectionism has also been dispelled by classical economics since it first came about over 200 years ago.
So great tax hikes and trade barriers harm industry and trade, this then brings about the stock market crash.
Now the economy is in shambles, and what does the government decide to do? It could have easily done nothing, which was the norm until then. In fact, they did nothing during the depression of 1921-22 and that decade went on to become known as the roaring 20s. But this is NOT, what the Hoover administration did, it was not laissez-faire at all!
Both during the Hoover and Roosevelt administrations there was a lot of government intervention. This came in the form of:
-Spending on public works: This happened of course by expanding the deficit and as all public works, was just a futile attempt to create some employment. Even if this wasn’t productive employment. It’s like what economists call the “broken window” fallacy. You can’t, for example break a window and then hire someone to fix it and say hey, I just created employment. Obviously, no one is better off. Now I’m not saying that all public works have to be inefficient. But if government is simply doing these works out of obligation, to “create” employment, there will be a tendency for engaging in projects which are actually costly, rather than beneficial.
-Tax increases: Taxes were increased further, in part to sustain better the increase in spending.
– Price and wage controls: This is the reason why unemployment was so high for so long during this period, because prices and wages were not allowed to fall, businesses were not able to hire more people. It’s basic economics, and a problem very much present now in today’s welfare system.
This is in fact a summary of what the “New Deal” was about. What many people don’t appreciate, is that this was in fact an extension on what Hoover was doing during his term.
The price controls came about because of the irrational fear of falling prices. But prices falling was a natural response. Many banks had gone bust, so there were less notes circulating. The way for people to restore their money balance was for prices to fall. But Roosevelt wouldn’t have it. In fact, he got together with the industrial leaders and “asked” them not to lower prices. This was in fact achieved by limiting the supply of goods that were produced. Does this sound familiar?
To anyone reading this with a good grasp on microeconomics, you might have already noticed. Hoover was asking the industries to act as a monopoly or cartel, fixing the price and limiting the supply. Perhaps it was at this point that the Corporation that is the U.S. today began to emerge, but that is a topic for another post.
So to sum up very quickly. Tax hikes and tariff increases brought about the depression. Government policy during the depression accentuated the problems and were responsible for prolonging the depression until after world war 2, according to some economists.
Now on the subject of monetary policy, like I said, the Fed was still operating under the gold standard and it was doing so successfully, by which I mean that the value of the dollar was stable. (until the devaluation of 1933 of course) The fed was not responsible in any way for creating or prolonging the depression. No crisis ever has been caused by stable money.
And there you have it, welcome to the 5%