Four Myths About Americas Great Depression
NOVEMBER 01, 1994 by RONALD NASH
Dr. Nash, Professor of Philosophy at Reformed Theological Seminary-Orlando, and a Contrib uting Editor to The Freeman, is this month’s guest editor. He has published more than 25 books including Poverty and Wealth (Probe Books), Social Justice and the Christian Church and Freedom, Justice and The State (both published by University Press of America).
America’s Great Depression is often cited as the primary example of the failure of free market economics. According to the official liberal interpretation of the Depression, both the economic collapse that began in 1929 and the nation’s eventual recovery prove that the American government must never again allow its economy to operate in a free market mode. The common view is that the 1920s in America was a period of unbridled free enterprise. In order to restore stability to the nation’s economy and bring the nation out of the depths of the Depression, the government had to step in and do what businessmen could not or would not do to correct the weaknesses of the free market system. The decade of the 1930s proves the importance of governmental control over the economy and justifies continuing interventionist or statist measures.
It would be difficult to imagine an explanation that is more in conflict with the evidence. This essay will examine four myths that ground this mistaken explanation of the Depression. Once the myths are recognized for what they are—unintentional distortion of the truth—one of the major ploys used by academicians and politicians to deceive the American people into supporting bigger government will be exposed.
Myth Number One: The Case of Business Cycles
The first myth can be summarized as follows: A free market is notoriously unstable and leads inevitably to economic cycles in which periods of prosperity are followed by recessions and depressions. These irregularities in a nation’s economy can be either eliminated or made less severe by proper government intervention.
The recurrence of business cycles is one of the most frequently cited reasons for the need of governmental intervention with the economy. The often unstated and always unproven assumption behind this claim is that business cycles and, more specifically, economic depressions are caused by free market economics. This assumption is clearly false.
Business cycles in general and depressions in particular are caused not by free markets, but by governmental intervention with a nation’s economy, specifically with its money supply. As nations expand credit and the money supply, a pattern becomes apparent. First, there is a governmentally induced period of economic expansion as easy credit and a larger money supply mislead businessmen into making bad investments. Markets unhampered by governmental intervention keep sending signals to astute investors and entrepreneurs. The rise or decline in prices along with the cost of borrowing money (interest rates) can tell a wise investor whether a particular opportunity is a good risk at that particular time. But governmental intervention in the form of monetary and credit expansion affects the reliability of normal market signals. Interest rates may be artificially (and temporarily) reduced while inflation causes many prices to rise. The rise in prices eventually affects the prices of capital goods required for business expansion. This increase in business costs finally affects the profitability of many businesses, leading them to find ways to cut costs. In the later stages of the boom, interest rates begin to rise, which also increases the cost of doing business and often affects loans incurred when money was much cheaper.
Because governmental intervention with the economy sends the wrong signals to businessmen and investors, their subsequent investment in the wrong things at the wrong time makes a day of reckoning inevitable. While that day can be postponed by even more expansion of credit, it cannot be postponed forever. When the quantity and degree of bad investments in any economy passes a certain point, the economy can no longer absorb them. Ventures must be terminated; businesses must be closed; bills must be left unpaid; workers must be laid off; unemployment will increase; savings will be depleted.
A recession or depression therefore is a necessary step in an economy’s return to normal after the misinformation and distortions caused by monetary inflation during the boom have produced a large amount of malinvestment. The recession or depression that follows periods of governmentally induced booms is a necessary time of readjustment. Prices must be readjusted to new consumer preferences. Interest rates must be readjusted to reflect the new demand for savings along with the actual supply of savings. Bad investments must be reduced through such means as greater managerial efficiency or lower labor costs. These lower costs may be reached through greater productivity; often they result from a business employing fewer workers. There must be a general cutting back across the board until businesses can once more be profitable, until investments can earn a proper return, and until the economy once more functions efficiently. What people call a recession or depression, therefore, is actually an adjustment of the economy to the wasteful and mistaken errors made during the boom. The process of adjustment is a return to a more sane set of economic arrangements which means, among other things, that many of the bad investments are liquidated.
There is a common thread that runs through every period of economic decline in American history, namely, governmental manipulation of the money supply. The obvious culprit in these economic down-turns was not the free market but the government-indeed, the very government responsible for the downturns in the first place. What then should one think of economists and politicians who appeal to such periods of economic decline as justification for increased amounts of the very types of economic interventionism that produced the depressions?
But what about the Great Depression? As everyone thinks they know, the decade prior to the economic collapse of 1929 was a period of unbridled economic freedom. It was, so the official doctrine goes, the extent of America’s experiment with free enterprise in the 1920s that led to the greatest depression in our history. But this belief is also a myth that must now be unmasked.
Myth Number Two: The Unbridled Capitalism of the Twenties
According to the official liberal dogma, the seriousness of the Great Depression was in direct proportion to America’s reliance upon a noninterventionist economy during the decade of the twenties. The unparalleled economic freedom of the twenties did more than make the Great Depression inevitable; it also made it the worst depression in the nation’s history.
Even a brief survey of the evidence, however, will reveal how mistaken the common wisdom about the twenties is. The decade that preceded the Crash of 1929 was anything but a period of unbridled capitalism. It was actually a time of continued governmental intervention with the money supply. The foundations for the Depression can indeed be found throughout the preceding decade. But the causes of the Depression were a string of governmental actions that resulted in an expansion of credit and the money supply that was similar to the interventionism that led to earlier economic downturns.
A good place to begin one’s search for the causes of the Great Depression is the establishment of the Federal Reserve System in 1914. The Federal Reserve was given the power to increase the nation’s money supply in response to what it regarded as justifiable circumstances. For most of the sixteen years following the creation of the Fed, the nation’s money supply was subjected to an almost steady increase. Between 1914 and 1917, this took the form of massive amounts of credit extended to nations like England and France for their purchase of war material. Following America’s own entry into World War I, the money supply was expanded even more as a way of paying for our own war effort. When the war was finally over, the now greatly expanded money supply produced the inevitable inflation.
The higher postwar prices led in turn to an increase in cheaper imports. But this hurt American businesses, which led businessmen, farmers, and labor unions to pressure Congress to do something about foreign competition. This pressure led to two unfortunate tariff acts (tariffs are clearly antithetical to capitalism). The Emergency Tariff Act of 1921 increased duties on such commodities as wool, sugar, and wheat. Another tariff act passed in 1922 imposed the highest duties to that time in the history of the nation. It also gave the President the power to change tariffs as he thought necessary. These high tariffs produced a serious instability in agriculture, other export industries, and the rest of the American economy.
All of this intervention with the economy had the effect of reducing foreign trade. Prospective foreign customers could not buy American products until they accumulated credits; but such credits could be accumulated only after they first sold their products to us, something the increased tariffs made much more difficult. In an effort to offset some of this harm, the government adopted cheap money policies. To make it easier for foreign buyers to purchase American goods (while still making it difficult for them to sell their goods in the United States), bankers floated enormous loans and bond issues in this country. Between the end of World War I and 1929, American lenders provided more than $9 billion in foreign loans, done largely to shore up America’s sagging export markets which had been hurt as a result of earlier interventionist measures (the tariffs) to reduce imports. While the cheap money policy of the twenties produced temporary increases in exports, it was accompanied by a huge burden of internal and international debt.
The Federal Reserve System continued to follow an easy money policy during the second half of the twenties. Between July 1924 and 1929, the money supply increased more than 20 percent. Farm and urban mortgages increased more than $10 billion between 1921 and 1929. Because much of the new money created by the system was channeled into speculation in real estate and the stock market, rapid price rises occurred in the stock market and in real estate. (Other significant forms of statist intervention with America’s economy that helped lay the foundation for the Depression must be discussed elsewhere, due to a lack of space.)
Often overlooked as a major contributing cause of the Depression was what became known as the Smoot-Hawley Tariff Acts. Even though Smoot-Hawley was not passed until June of 1930, it makes sense to view the measure as a significant cause of the Crash. The bill had been widely discussed and debated in Congress throughout much of 1929. By the autumn of 1929, Wall Street had begun to realize that passage of the tariff bill was inevitable. It also realized that President Hoover would not veto the damaging measure. Hence, it seems clear, the damage from Smoot-Hawley was not confined to the period of time following its passage, as bad as that was. It also had a major effect on events prior to its passage, including the October Crash of the Stock Market.
As important as the Stock Market Crash of October 1929 was, it did not mark the beginning of the Depression. The economy actually began to recede during the summer of 1929. Economic troubles had been brewing long before the Crash. What the collapse of the stock market did was make those troubles visible and mark the end of an incredible period of speculation that had to end sometime.
The October Crash is often exaggerated with regard to its supposed effects on the Great Depression. While the Crash was clearly very bad for the many unwise investors and speculators who had been wiped out, America was still far from anything resembling what we now think of as the Great Depression. That was still to come; and like previous depressions, it would result from further governmental mismanagement. The collapse of the stock market provided clear evidence that badly mistaken policies had been followed. The time for necessary readjustments had finally come.
Even with the crash of the stock market, the economy was strong enough so that the nation should have entered a normal period of readjustment.1 Even during 1930, unemployment averaged less than 8 percent of the work force. Barring mistakes on the part of the government, 1931 should have been the start of a recovery. Obviously it was not, and the reason can be found in the mistaken, often foolish policies of the federal government.
The economic decline that began at the end of 1929 could and should have been of short duration, if only Hoover and the Congress had acted in an economically responsible way. Unfortunately, they did not. Hoover and his administration were in no mood to admit their mistakes. Had they taken their medicine, paid their dues, and suffered through the severe but limited depression that would have followed, the economy soon would have made the proper adjustments. Instead, the Hoover administration piled error on top of error. Its mistakes plus the blunders of Congress plus the economic malfeasance of the Roosevelt Administration turned what would have been an economic downturn like every other one in the previous history of the country into an economic nightmare that lasted eleven years.
Myth Number Three: Hoover’s Commitment to Free Market Economics Deepened the Recession
As we have seen, liberals want to lay all of the blame for the Depression at the feet of the free market. With such a convenient scapegoat available, they can then use the Depression to justify statist measures they wish to impose upon the economy in the future. Their rewriting of history requires, however, that they turn Herbert Hoover into a flaming advocate of free market economics whose stubborn refusal to adopt interventionist measures made the Depression worse until Franklin Roosevelt’s courageous adoption of wise statist policies finally turned things around. Nothing could be farther from the truth.
In late 1929, the nation’s economy was in need of a number of major readjustments. But these necessary readjustments all took the form of decreasing or terminating various interventionist measures of the twenties that had produced the Depression. What Hoover and his administration did however was reject the adjustments that should have been made and opt instead for a course of more governmental control over the economy.
Herbert Hoover was not a champion of a free market economics whose conservative principles helped first to produce the Depression and then caused it to worsen. In truth, Hoover was a proven interventionist whose interventionist policies helped bring about the start of the Depression and whose succeeding interventionist actions helped to make it worse.
Following the 1929 Crash, the Hoover Administration and Congress committed three major blunders that were to deepen and prolong the Depression. Each blunder was a typically interventionist measure.
(1) Hoover did everything he could to keep wages and prices high during 1930. For one thing, his administration took action designed to keep the prices of wheat, cotton, and other agricultural products up. The unfortunate result of these farm policies was to encourage larger crops and greater farm surpluses for which no markets could be found. This had the effect of depressing farm prices even more.
Also in 1930, Hoover attempted to persuade business leaders to keep wages and prices high. In place of cutting wages and prices—the normal practice in a time of recession—Hoover urged businessmen to increase their spending on wages and capital outlay in the belief that this would preserve the purchasing power of consumers. The Hoover Administration pursued a policy of deficit spending and public works projects. Local and state governments were asked to borrow money to support their own public works projects.
(2) The Hoover Administration instituted large tariff increases that had a disastrous effect on international exchange. With tariffs already higher than they should have been and a huge burden of international debt hanging over the world’s economy, Hoover went along with Congress’s passage of a huge tariff increase. Already high tariffs made it almost impossible for foreign goods to reach our markets. Hoover’s acceptance of a new round of even higher tariffs was the major blunder that turned the recession of 1930 into the Great Depression. The Smoot-Hawley Tariff Act of June 1930 was the most protectionist law in the history of the nation. America’s borders were effectively closed to foreign goods. The government’s intentions with regard to the new tariff act no doubt seemed good at the time. It wanted to raise farmers’ low incomes that resulted from the low prices they were getting for their products. But in economics, good intentions often produce disastrous results.
Other nations responded to the increase in our tariffs by raising their own. This had the effect of cutting off international markets and narrowing lines of trade. The new protectionist policies created enormous problems for countries that owed money and needed to pay off their debts with goods. Since so much of this mountain of debt was unsound to begin with, creditors could not collect. In the two years that followed passage of Smoot-Hawley, American exports declined by almost two-thirds. The politicians had ignored a fundamental principle of international exchange; exports pay for imports. If people in other nations cannot sell their goods to us, they cannot earn the money they need to buy our products. Closing the door to imports will result eventually in closing the door to exports.
While farm prices dropped precipitously throughout 1930, the sharpest decline followed passage of the Smoot-Hawley Act in June. While American exports had totaled $5.5 billion in 1929, they had by 1932 fallen to just $1.7 billion. All of this led to a collapse of American farming. Hundreds of thousands of American farmers lost their farms. America’s recession was being turned into a world depression.
(3) The government proceeded to raise taxes, an incredible move under the circumstances. In fairness to Hoover, it should be noted that much of the blame for the tax increase belonged to the Congress. After the midterm elections of 1930, there was a Democratic majority in the House of Representatives.
The tax increase of 1932 was the largest increase in federal taxes in the history of the nation to that point. The income tax was doubled. Estate taxes were raised, corporation tax rates were increased, exemptions were lowered, and postal rates were raised. There was also a 2 cent tax on checks, a 3 percent automobile tax, a tax on telephones and telegraph messages, and a 1 cent a gallon gasoline tax. Faced by declining revenues, state and local governments followed Washington’s lead and imposed new taxes of their own. The total tax burden of the nation almost doubled in the period after 1932. If the politicians had been seeking a way to bring the nation’s economy to its knees, they could not have found a better strategy. The huge tax increases guaranteed that the Depression would not end soon. Real Gross National Product fell by 14.8 percent in 1932, the year the tax increase went into effect. An unemployment rate that had averaged 3.2 percent in 1929 and 7.8 percent in 1930jumped to almost 25 percent in 1932.
By the end of Hoover’s term, unemployment had reached 25 percent of the work force or more than twelve million workers. The Depression had spread beyond the borders of the United States and had become a worldwide depression. Nations like Germany and Austria stopped making foreign payments and froze American credits. England ended gold payments in September 1931. Foreign bond values fell drastically, which led to a collapse of the bond market in America. This proved to be an additional blow at American banks, in this case, a blow at their own investments.
The collapse of so many American farmers put their major creditors—the rural banks—in jeopardy. Many of them were forced to close. Between August 1931 and February 1932, approximately 2,000 banks closed, still owing depositors more than $1.5 billion. Banks that did not close were often forced to take extreme measures. New loans were often refused, and old loans were pressured to make payment. This banking panic led to even greater pressures on the market as many banks dumped many of their own stock holdings.
Bank runs and other banking difficulties did not occur to any great degree until the fall of 1930. But once a number of Midwest and Southern banks failed, confidence in banks was undermined and many people rushed to withdraw their funds. In mid- 1929, America had almost 25,000 commercial banks. By the time of Roosevelt’s inauguration in 1933, this number had fallen to about 18,000. Another 3,000 were eliminated by the end of 1933.
There is no way to exaggerate the tragic desperation of the nation at the end of Hoover’s Presidency. But Hoover and his administration refused to admit that the disaster was a result of their interventionist policies; they continued to blame businessmen and speculators. But the truth is that Hoover’s economic interventionism had only made things far worse.
Myth Number Four: Roosevelt’s Interventionism Ended the Depression
If anyone was an interventionist, Franklin Roosevelt was. The mythical component in our fourth claim concerns the mistaken belief that the ultimate end of the Depression resulted from any of Roosevelt’s economic policies. The evidence makes it clear that late into the 1930s, Roosevelt’s interventionist measures were only making things worse!
During his first one hundred days in office, Roosevelt and his administration refused to remove the barriers to prosperity raised during the Hoover years. Instead, he erected dozens of new ones. Roosevelt’s first significant action with regard to the economy was to undercut the quality of the dollar by seizing people’s private gold holdings. In 1933 and early 1934, private holders of gold were forced to turn over their gold to the government at a price well below the market price, but equal to the official price of gold. By this act of confiscation, the federal government gained legal and physical control of the nation’s gold, which it replaced with certificates. The government’s action was legalized theft. Later, in 1934, the government raised the official price of gold to $35 an ounce, which was above the market price. This devaluation produced a de facto profit for the government of $2.8 billion. A dollar thus became worth whatever the government said it was worth.
Then Roosevelt’s advisers proposed the National Industrial Recovery Act (NRA), instituted in 1933 as a way of increasing the purchasing power of American workers. The Act established minimum wages, prices, and rates for specific industries. Its purpose was to raise prices at the same time that it increased purchasing power. The government did this by forcing employers to increase their payrolls by means of shorter work weeks and a minimum wage. It also banned jobs for youth. This government-mandated increase in business costs acted as a further brake on economic recovery. Unemployment increased still more, to almost thirteen million. The minimum wage provisions of the law caused enormous suffering in the South, where approximately a half million blacks were forced out of work. In 1935, the Supreme Court declared that the NRA was unconstitutional. But the policies of the Act had given the economy another severe jolt which had the effect of postponing any recovery.
Roosevelt’s results with American agriculture were just as bad. Congress passed the Farm Relief and Inflation Act, also known as the Agricultural Adjustment Act (AAA). It was supposed to increase the income of farmers by reducing the number of acres under cultivation and by destroying crops already in the field. Farmers were paid not to plant. The program spread rapidly from its original coverage of cotton to all basic cereals and meat and then to all cash crops. This expensive program was supposed to be paid for by a so-called “processing tax.” The new tax that the AAA placed on the agricultural industry provided money that was used to destroy crops and livestock. Healthy animals were slaughtered, and fields of cotton, wheat, and corn were plowed under. Farmers were paid not to plant crops. Like all interventionist acts, the government thought it was aiding one group of people in the market. But of course this “aid” would have to come at the expense of the many others who were forced to pay for it. Even if the program had helped the farmers—which it did not—it would have done so at enormous cost to the millions who had to pay higher prices or had less to eat.
When the Roosevelt interventionists saw that things were not going as they had planned, they proclaimed that the ensuing disaster was not the result of their efforts. It was a result rather of their measures not going far enough. What the nation needed was more priming of the economy by the federal government. Roosevelt’s budget message in January 1934 promised a $7 billion deficit in a total budget of $10 billion. This attempt to prime the economic pump failed to revive the economy. A slight recovery in the first half of 1934 was followed by a decline to an even lower economic level by September of 1934.
Roosevelt’s Administration raised taxes in 1933, in 1934, and again in 1935. Federal estate taxes became the highest in the world. By now, it was clear that the increased taxation was aimed not at the production of more revenue but at the redistribution of wealth.
When the Supreme Court judged that both the NRA (in 1935) and the AAA (in 1936) were unconstitutional, two awesome burdens were removed from the American economy. The end of NRA helped to increase productivity and reduce labor costs. The end of AAA lowered taxes on agriculture and ended the destruction of crops and livestock. Unemployment began to come down in the mid-1930s. But the planners in the Roosevelt Administration had not yet learned anything from their past mistakes. Anxious to earn the support of organized labor for Roosevelt’s re-election bid in 1936, Roosevelt and the Democratic majority in Congress gave them the Wagner Act of 1936, a price that Big Labor never forgot.
The Wagner Act or the National Labor Relations Act was a response to the Supreme Court’s decisions with regard to NRA and AAA. The Act totally revolutionized labor relations in the country. No longer could labor disputes be settled in the courts; they were now under the jurisdiction of the National Labor Relations Board, a new federal agency which served as judge, jury, and prosecutor. Following Roosevelt’s re-election in 1936, the big unions began to consolidate the massive new powers granted them under the Wagner Act. Millions of workers were forced to join unions. While wages were forced up, worker productivity declined. Strikes idled many plants. The ensuing jump in labor costs produced another decline in economic activity. Unemployment once again passed the ten million mark. At the end of 1937, the American economy collapsed once more. The Roosevelt Administration had accomplished something never before achieved in history. It actually managed to produce a depression within a depression.
While it is true that Roosevelt inherited an unemployment problem, he certainly did not fix it. Unemployment in 1933 (25 percent) was higher than the year before. During three years of Roosevelt’s Presidency, unemployment topped ten million. In only two of the seven years between 1933 and 1939 did unemployment drop below eight million. In 1938, unemployment jumped more than it did during the first year of the Depression, reaching 18.8 percent of the labor force or more than ten million workers. Viewed as an economic experiment to put people back to work, the New Deal was a fraud and a farce. The massive unemployment that still characterized the nation’s economy after years of New Deal intervention with the economy was ended only by the nation’s need to draft more than ten million men into the military.
The Depression did not result from some defect inherent within capitalism. It did not result from this nation’s love affair with unbridled free enterprise during the twenties. The first two myths about the Depression that we examined are clearly untrue. As Lawrence Reed explains, “The genesis of the Great Depression lay in the inflationary monetary policies of government in the 1920s. It was prolonged and exacerbated by a litany of political follies: tariffs, taxes, controls on production and competition, destruction of crops and cattle, and coercive union legislation, to recall just a few. It was not the free market which produced twelve years of agony; rather, it was political bungling on a scale as grand as there ever was.”2
According to Benjamin Anderson, the nation’s failure “to get out of the depression in the years 1933 to 1939 [was] due to the great multiplicity of New Deal ‘remedies,’ all tending to impair the freedom and efficiency of the markets, to frighten venture capital, and to create frictions and uncertainties, and impediments to individual and corporate initiative.”3 Murray Rothbard ends his long study of the Depression by stating: “The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free market economy, and placed where it properly belongs: at the doors of politicians, bureaucrats, and the mass of ‘enlightened’ economists.”4
Our study of economic events during the 1930s has revealed more than the mythical character of Hoover’s alleged commitment to free market economies and the supposed success of Roosevelt’s interventionism. It has unmasked the extent to which the enormous suffering of the thirties was a consequence of bad economics—to be more specific, interventionist policies that were proposed and enacted with good intentions and horrific results. 
- 1. See Benjamin M. Anderson, Economics and the Public Welfare (Indianapolis, Ind.: Liberty Press, 1979 ), p. 224.
- 2. Lawrence W. Reed, Unraveling the Great Depression (Caldwell, Idaho: The Center for the Study of Market Alternatives, 1985), p. 13.
- 3. Anderson, p. ,*83.
- 4. Murray N. Rothbard, America’s Great Depression, 3rd ed. (Kansas City: Sheed and Ward, 1975), p. 295.