FREE ESSAY ON AMERICA'S GREAT DEPRESSION

AMERICA'S GREAT DEPRESSION

America's Great Depression
by Chima Lonstone
The Great Depression is probably one of the most misunderstood events in American
history. It is routinely cited, as proof that unregulated capitalism is not the best in
the world, and that only a massive welfare state, huge amounts of economic regulation,
and other Interventions can save capitalism from itself. Among the many myths surrounding
the Great Depression are that Herbert Hoover was a laissez faire president and that FDR
brought us out of the depression. What caused the Great Depression? To get a handle on
that, it's necessary to look at previous depressions and compare. The Great Depression
was by no means the first depression this country ever had, but it was clearly the worst.
What made it different than the rest? At the time of the Great Depression, government
intervention in the economy was higher than it had ever been and a special government
agency had been set up specifically to prevent depressions and their associated problems,
such as bank panics. This agency was the Federal Reserve Board and it was to have been
the loaner of last resorts for banks in order to prevent collapses as had happened during
earlier depressions. But as America sees, there is good reason to believe that the
Federal actions explain many of the problems that lead up to the stock market crash and
the subsequent depression.
Although there are many macroeconomics schools of thought, this paper will be
concentrating on two initially, Keynesian economics and Austrian School economics.
Keynesian economics got its start during the Great Depression with the publication in
1936 of The General Theory of Employment, Interest, and Money, by John Maynard Keynes.
Austrian School economics began much Earlier, most notably with the publication in 1871
of Carl Menger's Principles of Economics. While the Austrian theory has Never been
mainstream (economist Paul Krugman refers to it as the economic equivalent of the
phlogiston theory), its adherents are some of the harshest critics of Keynesian
interventions. The greater of the two economic systems used has got to be Keynesian. 
The exact cause of business cycles is one of the biggest problems in economics. There are
several explanations. The current Keynesian models rely on what is referred to as sticky
wages (or sticky prices) to explain why the cycles occurs. Under these models, wages or
prices fail to reach their market clearing level. The Austrian School explanation is that
all business cycles are due to government intervention in the economy. In particular,
government efforts to manipulate the interest rate causes a boom and bust cycle because
people over-invest (malinvestment) when interest rates are low and when interest rates
are Raised to stave off the inevitable inflation, a bust is caused due to the mismatching
of consumer and business goods. There are six depressions in American history that is
thought to be the worst since detailed records of economic data started To be kept
(around 1867), 1873-79, 1893-97 (actually two contractions separated by an incomplete
expansion), 1907-08, 1920-21, 1929-33, and 1937-38. Although depressions vary on length
and severity, the similarities are so profound that Nobel Laureate Robert Lucas has
stated; business cycles are all alike. Since it's been about 60 years since we've had a
depression, One might think that the economy is being managed better than it used to be.
It's not clear why the economy is being managed better. The Federal Reserve Board was
created in 1913 and yet half of the worst depressions happened after its creation. A
Better candidate might be the adoption of Keynesian management techniques, which were not
fully implemented until after the Last severe contraction in 1937. But there are some
indicators that that is not responsible either. Detailed studies have been done to
compare post-war business cycles with prior ones. At least one indicates that there was
no improvement. Obvert Lucas made a key insight into the difficulties of managing the
economy. Looking at post-World War II business Cycles, he argued that if one could choose
between smoothing out the cycles completely and increasing the annual economic Growth by
0.1%, the latter would make people better off overall. As we consider the different
policy options, it is important to keep this insight in mind as one more trade off that
has to be considered. 
The Federal Reserve Board was created in 1913. Ostensibly, it was to act as the lender of
last resort to prevent bank panics like the one that had occurred in 1907. Although some
conspiracy minded folks might weave elaborate tales regarding its Creation, the reason is
rather straightforward. The big banks simply wanted government protection and bailouts
and were more than willing to endure a little government regulation in return. Like the
Interstate Commerce Commission before it, the Federal Government would be staffed with
people from the industry that it was supposedly a watchdog over and who would most likely
feel that what's good for banks are good for America? Throughout the years preceding the
Stock Market crash, the Federal Government did just that. The Federal Government set
below market interest rates and low reserve requirements that all favored the big banks.
The money supplies actual Increased by about 60% during this time. The phrase buying on
margin entered the American vocabulary at this time as more and more Americans
over-extended themselves to take advantage of the soaring stock market. So what went
wrong? It was in 1929 that the Federal Government realized that it could not sustain its
current policy. When it started to raise Interest rates, the whole house of cards
collapsed. 
The Stock Market crashed and the bank panics began. But what would make this depression
worse than all the rest? There was a depression in 1921, but no one remembers that one.
What was Different? As we'll see, there were a number of policies enacted over the next
few years that, from both a free market and a Keynesian perspective, would do nothing to
help America recover and do everything to exacerbate the depression. Over the next few
years, the Federal Government would allow the money supply to contract by a third. A free
market advocate's response would be to do nothing and let the market work itself out.
Ideally, what would happen is that businesses would realize that no one was buying and
lower prices accordingly until people started buying again. The same thing would happen
with labor and capital. Prices would be lowered until they reached the market-clearing
price and the economy would recover. Keynesians claim that some prices or wages will be
sticky and may take a long time to reach their market clearing price thus, causing
needless suffering along the way. The Keynesian prescription is two-fold. First, the
Federal Government should inflate the money supply. Keynes even whimsically suggested
leaving jars of money around where enterprising young boys could find them. However, this
may not work if the depression is severe enough to enter what is called a liquidity trap.
Under this scenario, no amount of running the treasury's printing press will restore
order. In this case, the government should simply start spending money itself, thus
priming the pump so to speak. As we'll see, Hoover (and later FDR) implemented a mixture
of policies, some of which were Keynesian (increased government spending) and some of
which were not (price supports and other attempts to keep prices and wages high). 
Herbert Hoover has been accused of being a do-nothing president who allowed the country
to continue to slide into its worst depression ever. Some will grudgingly admit that
Hoover did take some action, but that it was too little, too late. But the truth is far
more complex. Hoover did intervene after the Stock Market crash, but the acts passed by
Congress and signed by Hoover were the worst kind of intervention: they actually
exacerbated the problem. The most famous of these interventions was the Smoot-Hawley
Tariff Act. Raising tariffs was one of the worst things that could be done. Remember that
both free markets advocate and Keynesians agree that lowering prices would cure a
depression, it's just that the Keynesians believe government intervention is necessary. A
tariff does exactly the wrong thing by raising prices. Thus Smoot-Hawley was guaranteed
to worsen any depression, not improve it. Other acts passed during Hoover's
administration had similar effects of either raising prices or keeping them artificially
high when they should have been dropping. Thus, it's not that Hoover was a do-nothing
president, it's that he intervened in exactly the wrong way. 
Ironically, FDR, the president who implemented so many government programs himself, was
elected on a platform of a balanced budget and economic non-intervention. So what did he
do upon getting into office? He promptly expanded on Hoover's programs. Some of these
programs, the ones that increased spending, would get approval from Keynesians. Others,
however, like the minimum wage and the Davis-Bacon Act, suffered from the same problems
that Hoover's programs did: they reduced price flexibility, often setting a minimum and
thus continued to exacerbate the Great Depression. FDR's policies seemed to work at
first. The economy began to expand again in 1933 and continued to do so until May of
1937. At that point, a second depression began and lasted until June of 1938. 
The United States entered World War II in December of 1941, the year generally considered
to be the end of the Great Depression. Because of all the over production and people not
at work, it hurdled us for WWII for we had the land and materials to go to the war and we
had the people also. This Keynesian style boost to the economy seems to have brought the
depression to an end.
Works Cited: 
-  Bernstein, Irving, A Caring Society: The New Deal, the Worker and the Great Depression
(1985); Boardman, Fon W., Jr., The Thirties: America and the Great Depression (1967); 
-  Davis, Joseph S., The World Between the Wars, 1919-39: An Economist's View (1974);
Galbraith, John K., The Great Crash, 3d ed. (1972; repr. 1980); 
-  Garraty, John A., The Great Depression (1986); Kindleberger, Charles P., The World in
Depression, 1929-1939 (1975; repr. 1983); 
-  Markowitz, Gerald, and Rosner, David, eds., Slaves of the Depression (1987); Mitchell,
Broadus, Depression Decade, 1931-1941 (1977); 
-  Rothbard, Murray N., America's Great Depression (1975; repr. 1983); Schlesinger,
Arthur M., Jr., The Age of Roosevelt, 2 vols. (1959); 
-  Swados, Harvey, ed., The American Writer and the Great Depression (1966); Wecter,
Dixon, Age of the Great Depression, 1929-1941 (1971).