Starting or Avoiding a Depression?

Our economy is in shambles but it is not as bad as it was in the Great Depression, yet. But if government makes the wrong moves, a depression like the 20's and 30's is still possible as this article from Kairos Journal makes clear.

The Great Depression of the 1930s—A Lesson in What Not to Do

The Great Depression of the 1930s was a nightmare:

Some 13 million Americans were unemployed, “not wanted” in the production process. One worker out of every four was walking the streets in want and despair. Thousands of banks, . . . thousands of businesses, and millions of farmers fell into bankruptcy or ceased operations entirely. Nearly everyone suffered painful losses of wealth and income.¹

And as the American economy spiralled downwards, it took the countries of the developed or semi-developed world down too—from Latin America, to Europe, to Australia and India.²

Many declare this economic collapse a failure of capitalism, but the claim will not hold water.³ As the “Austrian School” of economists have taught, it is only if governments interfere with or obstruct the self-regulating mechanisms of free and open markets that the conditions obtain for severe economic depressions. The economic history of the 1920s and ’30s provides a textbook example of the truth.⁴ Whilst the causes of the Great Depression are complex and many-sided,⁵ two culprits stand out: (1) government mismanagement of the monetary system; (2) government-imposed tariffs, taxes, price controls, and other regulations and restrictions, with their destructive impact on domestic and international trade.⁶

The “rot” began in the 1920s when, in an attempt to overcome a business downturn,⁷ the Coolidge administration recklessly expanded credit, rapidly increasing the money supply and slashing interest rates. At first, the effect seemed only positive—a burst of prosperity known as “the Roaring 20s.” But the consequences for the American economy were dire. The artificially low cost of loans led to a huge increase in farm and urban mortgages (and hence rising real estate prices); encouraged over-investment in capital goods (such as new factories), which inevitably distorted the production structure of American industry; and fuelled a stock-market boom.

The Federal Reserve moved to rein in the inflation it had caused, but when they cut the money supply and raised interest rates at the beginning of 1929, the stack of cards came tumbling down—business activity receded, bankruptcies and unemployment within the over-expanded capital goods industries began to soar, stock prices began to fall; then, in a final burst of panic selling, Wall Street crashed in October 1929.⁸

This slump, although bad, might have soon been corrected if prices had been allowed to adjust naturally downward. The real tragedy of the 1930s, however, lies in what followed—a catalogue of government disasters. The 1930 Hawley-Smoot Tariff Act, which practically closed American borders to foreign goods, was arguably the crowning folly. It generated unemployment in the export industries of all America’s trading partners; tit-for-tat protectionism ran wild all over the world; world trade contracted sharply;⁹ commodity prices (including those in agriculture) plummeted.¹⁰ As debt-laden American farmers ran into trouble in late 1931 and early 1932, they pulled down 2000 rural banks, wiping out the savings of other bank customers, causing more businesses to collapse. And at this point the Hoover administration chose to double income tax! Small wonder that unemployment rose inexorably throughout the 1930s.

The Great Depression, then, was not so much a failure of capitalism as a failure of government. Many have found it convenient to blame “big business,” but convenience has never been a trustworthy path to truth.

Footnotes:

1	Hans Sennholz, “The Great Depression: State-Caused Chaos,” The Freeman, April 1975, 204.
2	For a good description of the Depression throughout the world see W. Arthur Lewis, Economic Survey 1919-1939 (London: Unwin University Books, 1949).
3	“The causes of the present world depression lie deep down in the capitalist system.” These words were written by two famous British socialists, Ernest Bevin and G. D. H. Cole, in 1931, in their book, The Crisis, (London: The New Statesman and Nation, 1931), 43.
4	See also Kairos Journal articles, "What Causes Economic Depressions?" & "The Forgotten Forgotten Man."
5	Including, for example, severe drought in the American “Dust Bowl.”
6	For a detailed history of the political and economic causes of the Great Depression, see the relevant chapters in: Benjamin McAlester Anderson, Economics and the Public Welfare: Financial and Economic History of the United States, 1914-1946, 4th ed. (Princeton, NJ: Van Nostrand, 1965). See also Murray Rothbard, America’s Great Depression, 3rd ed.(Kansas City: Sheed & Ward, 1975), and Clarence B. Carson, “The Welfare State 1929-1985,” in A Basic History of the United States, vol. 5 (Wadley, AL: American Textbook Committee, 1986), chapters 1-4.
7	Which had itself largely been caused by protectionist trade policies—the 1921 Emergency Tariff Act imposed high import duties on a large variety of agricultural products, and the 1922 Fordeny-McCumber Tariff Act raised the import rates on many manufactured goods 100% or more. This meant America’s trading partners lacked the financial ability to buy American exports. See Hans Sennholz, The Great Depression: Will We Repeat It? (Irvington-on-Hudson, NY: Foundation for Economic Education, 1993).
8	The Austrian economist, Professor von Mises, has summarised this process as follows: “The attempts to lower interest rates by credit expansion generate, it is true, a period of booming business. But the prosperity thus created is only an artificial hot-house product and must inexorably lead to the slump and to the depression.” Ludwig von Mises, Planning for Freedom (Grove City, PA: Libertarian Press, 1974), 27.
9	Even if countries did not take retaliatory action against America, without being able to sell their exports they were unable to afford American goods. American exports hence fell from $5.5 billion in 1929 to $1.7 billion in 1932. Sennholz (1975), 208.
10	They had been well above the 1926 base (100) before the crisis, but fell to a low of 47 in summer 1932. Ibid.