The Great Depression was a very severe recession in United States(U.S.) history, what many believe to be the worst one in US history, as is typically taught in U.S. school curricula. The purpose of this post is to explain not just the history, but also the facts about the causes of the Great Depression, especially the facts that at least at the time of this writing, are not well understood, if at all, by most people.
Causes of the Great Depression
The second cause is actually the cause that is the more poorly understood, so this post will start with it, despite it being in reverse chronological order. After the severe decline in the stock and other financial markets at the time, which is the first cause(more on this later), The government did not allow or provide the environment to enable the enterprises in the economy to lower their costs to produce and supply goods and services to the market; what this also meant is that enterprises couldn’t lower the prices of those goods and services. Millions of people lost their jobs and incomes as layoffs were part of how enterprises a.k.a. employers, especially the inefficient ones who relied too much on the performance of their stock price rather than their cash-flow generating operations, liquidated themselves to generate enough cost-savings in order to continue paying dividends to shareholders and/or cut losses. Therefore, it was imperative for business costs, especially production costs, to come down along with the prices of stocks and other financial instruments; after all, business costs are prices too, of productivity and supplying goods to the people. Because business costs couldn’t come down, neither could prices, which threw the millions who lost their jobs into poverty, unable to buy enough goods to sustain themselves and their families. Because those businesses couldn’t sell their products to impoverished customers, as they couldn’t lower their prices while people couldn’t afford to buy their products, they too went out of business. This in turn caused a shortage of goods, because the businesses providing them were going bankrupt and could therefore no longer supply goods; this also included farmers, which in turn caused the infamous and dreaded food shortages and eventually, widespread starvation. Those bankruptcies also exacerbated the already large unemployment problem; as explained by G. Edward Griffin in The Creature from Jekyll Island, “Unemployment didn’t become rampant until the depression years which came later and were caused by continued government restraint of the free market”(Griffin 501). Every single human being must read Griffin’s book at least once, as it details, with documentation and indisputable logic, how the Federal Reserve Bank(FED), rather than free-market capitalism, which wrongly gets the blame by the public, caused the Great Depression, as well as most other significant recessions following the creation of the FED in 1913. The next section will get into the specific details of these three main methods that the government used to prevent costs and prices from going down to the appropriate free-market levels that would’ve helped end the Great Depression much sooner; regulations, taxes, and tariffs. First of all though, it’s imperative to understand that had these regulations, taxes, and tariffs not been imposed, enterprises could’ve lowered their prices, the people could’ve afforded the goods and services that they weren’t able to, and so enterprises would’ve stayed in business, preventing the shortages of goods, including food, as well as the prolonged unemployment, poverty, and other overall economic harm. The Great Depression may likely not have materialized, or at least not lasted as long, had the regulations, taxes, and tariffs not been imposed.
Tariffs
Among the tariffs, the Smoot-Hawley tariff is the most significant, as it raised tariffs by some 20% on several industrial and agricultural goods. Intended to protect U.S. manufacturers from competition, the tariff ended up harming both U.S. imports and exports, as other nations raised tariffs on U.S. exports in retaliation. This is why tariffs are nearly always a harmful policy, except in very rare and darn-near impossible circumstances where nearly ALL other taxes, ranging from the income tax to welfare(Social Security, Medicare etc.) taxes are either eliminated or non-existent. Sadly, the politicians at the time didn’t learn the errors of their ways, and kept the Smoot-Hawley tariff, among other tariffs, in effect for several years. These tariffs, along with the regulations and taxes, prolonged the Great Depression.
Taxes
The Cato Institute provides an excellent and thorough explanation of all taxes, including the tariffs as discussed earlier, that went up and pushed the economy down; here is a quote of some examples: “and many new taxes were added, such as the Smoot‐Hawley tariffs in 1930, taxes on alcoholic beverages in December 1933, and a Social Security payroll tax in 1937. Annual growth of per capita GDP from 1929 to 1939 was essentially zero” (Johnston and Williamson 2019). That post by the Cato Institute covers in detail many more details and examples of other kinds of taxes that were passed and thereby also prolonged and exacerbated the Great Depression.
Regulations
Numerous regulations were passed during the Great Depression, especially after Franklin D. Roosevelt(FDR) became U.S. President in 1932. Along with many laws, several new agencies and departments were created; many of them were part of FDR’s New Deal Program, which is the name commonly associated with vast quantity of regulations and government programs created during the Great Depression. Some of these agencies, like the FDIC, still exist at the time of this writing. These regulations and regulatory agencies, both those passed as part of the New Deal and the ones outside of it, not only incentivized unproductive business activity, like reducing productive output or encouraging risky lending as in the case of the FDIC, but they also increased the previously explained business costs. Because these regulations were too costly for enterprises to comply with, they either couldn’t lower their prices, stay in business, or both. This in turn increased unemployment and thereby made the Great Depression longer and more severe than it most likely would’ve been had these regulations never been passed, along with the elimination of previously existing regulations at the time. As Griffin explains, “Herbert Hoover launched a multitude of government programs to bolster wage rates, prevent prices from dropping, prop up failing firms, stimulate construction, guarantee home loans, protect the depositors, rescue the banks, subsidize the farmers, and provide public works. FDR was swept into office by promising more of the same under the slogan of a New Deal” (Griffin 501).
Tightening of Money & Credit Supply, coupled with increasing the interest rates
This is the first cause of the Great Depression. Like many recessions, the ones the public was told the Federal Reserve(FED) would prevent if passed into law yet came after the Great Depression, the severe stock and broader financial market correction was triggered by the FED first inflating the money supply, and thereby lowering interest rates below free market equilibrium levels, followed by tightening the supply of available money and credit, along with raising interest rates. As Griffin explains, “During the final phase of America’s credit expansion of the 1920s, the rise in prices on the stock market was entirely speculative. Buyers did not care if their stocks were overpriced compared to the dividends they paid. Commonly traded issues were selling for 20 to 50 times their earnings; some traded at 100. Speculators acquired stock merely to hold for a while and then sell at a profit. It was the “Greater-Fool” strategy. No matter how high the price is today, there will be a greater fool tomorrow who will buy at an even higher price. For a while, the strategy seemed to work” (Griffin 492-493). Until it didn’t, and because many investors were over-levered in many financial instruments, such as the popular acceptances at the time, they suffered when the FED raised interest rates. Many investors were also buying stocks and acceptances on margin, meaning taking out massive loans to fund the purchase of stocks in hopes that capital appreciation of stocks, along with dividends, would provide the funds to pay back the loan and interest, with a remainder for profit of course. As Griffin also points out, “Loans to commercial enterprises for the production of goods and services-which normally are the backbone of sound banking practices-were losing ground to loans for speculating in the stock market and in urban real estate. Between 1921 and 1929, while commercial loans remained constant, total bank loans increased from $24,121 million to $35,711 million. Loans on securities and real estate rose nearly $8 billion. Thus, about 70% of the increase during this period was in speculative investments. And that money was created by the banks(primarily the Federal Reserve)” (Griffin 493-494).
In the spring of 1928, the Federal Reserve was concerned about the very high level of speculation in the stock market and decided to curb the expansion. Consequently, when the FED raised interest rates and tightened the money and credit supply, many of those investors’ loans were called, which meant they had to pay back the loans prematurely. As such, almost all investors panicked to rapidly sell off their stocks and other financial holdings to generate cash to pay for the called loans. Because there was a sudden frenzy of sales on the stock and financial markets, those markets underwent a severe correction. I say correction instead of crash because the financial markets didn’t cease to exist at that point; rather, the majority of stock prices severely declined, accompanied by the bankruptcy of over-levered and inefficient enterprises whose stock was publicly traded at the time. While it is common to think of the Great Depression as a stock and broader financial market crash, it is mistaken; it is more accurate to call it a correction, a severe one in the case of the Great Depression. The other reason for calling it a correction is that those declines in prices on the traded financial markets corrected the excessively high prices of stocks and other financial instruments at the time. Of course, the publicly traded companies that went bankrupt at the time did see their stock prices collapse all the way to zero, but this was a healthy correction of the market, as those companies, and their stock prices, were overvalued and therefore needed to be liquidated. The FED artificially expanded the money supply, and so those stock prices, inflated by the artificial money created by the FED, were too high, because they were bought with inflated money. Therefore, the reduction in those stock prices was a correction in the too high prices. Furthermore, as Griffin explains, many of those companies whose stocks plummeted were actually healthy, efficient, and good companies, just at appropriate, and thereby lower, stock prices. Many of those enterprises were still able to stay in business, up until all the previously explained taxes, tariffs, and regulations were passed, making it too hard for those enterprises, and thereby nearly the entire economy, to stay viable, profitable and in business.
How the Great Depression Eventually Ended – Debunking Common Fallacies
This gets into yet another common fallacy – that World War II, especially all the aggregate demand and spending on industrial war-time production for weapons and heavy machinery, like tanks and airplanes, ended the Great Depression. First of all, you cannot spend yourself out of a recession; you can only improve your productivity of goods and services and refrain from tampering with the money supply, such as through inflation. Second, there was only demand for wartime spending and wartime employment during the war; once the war ended, the demand for those jobs and spending collapsed. By this logic, it would’ve meant that ending the war, and consequently the wartime spending, would’ve precluded the end of the Great Depression, which makes no sense at all. After all, the American Civil War did not boost economy prosperity, though it should’ve by the logic, albeit false logic, of those who insist that World War II ended the Great Depression, when it did no such thing at all. As stated in this FEE article, the U.S. merely traded debt, not sustainable long-term productivity, for unemployment. Even FDR feared that the Great Depression would return with the surrender of Adolf Hitler and then Japanese Emperor Hirohito, the two main adversaries of the U.S. during World War II. As the FEE explains the rest of the true story behind what truly ended the Great Depression:
FDR had halted many of his New Deal programs during the war—and he allowed Congress to kill the WPA, the CCC, the NYA, and others—because winning the war came first. In 1944, however, as it became apparent that the Allies would prevail, he and his New Dealers prepared the country for his New Deal revival by promising a second bill of rights. Included in the President’s package of new entitlements was the right to “adequate medical care,” a “decent home,” and a “useful and remunerative job.” These rights (unlike free speech and freedom of religion) imposed obligations on other Americans to pay taxes for eyeglasses, “decent” houses, and “useful” jobs, but FDR believed his second bill of rights was an advance in thinking from what the Founders had conceived.
Roosevelt’s death in the last year of the war prevented him from unveiling his New Deal revival. But President Harry Truman was on board for most of the new reforms. In the months after the end of the war, Truman gave major speeches showcasing a full employment bill—with jobs and spending to be triggered if people failed to find work in the private sector. He also endorsed a national health care program and a federal housing program.
But 1946 was very different from 1933. In 1933, large Democratic majorities in Congress and public support gave FDR his New Deal, but stagnation and unemployment persisted. By contrast, Truman had only a small Democratic majority—and no majority at all if you subtract the more conservative southern Democrats. Plus, the failure of FDR’s New Deal left fewer Americans cheering for an encore.
In short, the Republicans and southern Democrats refused to give Truman his New Deal revival. Sometimes they emasculated his bills; other times they just killed them.
Senator Robert Taft of Ohio, one of the leaders of the Republican-southern Democrat coalition, explained why he voted against much of the program:
“The problem now is to get production and employment. If we can get production, prices will come down by themselves to the lowest point justified by increased costs. If we hold prices at a point where no one can make a profit, there will be no expansion of existing industry and no new industry in that field.“
Robert Wason, president of the National Association of Manufacturers, simply said, “The problem of our domestic economy is the recovery of our freedom.”
Alfred Sloan, the chairman of General Motors, framed the question this way: “Is American business in the future as in the past to be conducted as a competitive system?” He answered: “General Motors … will not participate voluntarily in what stands out crystal clear at the end of the road—a regimented economy.”
Taft, Wason, and Sloan reflected the views of most congressmen, who proceeded to squelch the New Deal revival. Instead, they cut tax rates to encourage entrepreneurs to create jobs for the returning veterans.
After many years of confiscatory taxes, businessmen desperately needed incentives to expand. By 1945, the top marginal income tax rate was 94 percent on all income over $200,000. We also had a high excess-profits tax that had absorbed more than one-third of all corporate profits since 1943—and another corporate tax that reached as high as 40 percent on other profits.
In 1945 and 1946, Congress repealed the excess-profits tax, cut the corporate tax to a maximum 38 percent, and cut the top income tax rate to 86 percent. In 1948 Congress sliced the top marginal rate further, to 82 percent.
Those rates were still high, but they were the first cuts since the 1920s and sent the message that businesses could keep much of what they earned. The year 1946 was not without ups and downs in employment, occasional strikes, and rising prices. But the “regime certainty” of the 1920s had largely returned, and entrepreneurs believed they could invest again and be allowed to make money.
As Sears, Roebuck and Company Chairman Robert E. Wood observed, after the war “we were warned by private sources that a serious recession was impending. . . . I have never believed that any depression was in store for us.”
With freer markets, balanced budgets, and lower taxes, Wood was right. Unemployment was only 3.9 percent in 1946, and it remained at roughly that level during most of the next decade. The Great Depression was over.
As also explained by the Heritage Foundation:
Here’s what happened: Government spending collapsed, from 41 percent of GDP in 1945 to 24 percent in 1946, then to under 15 percent by 1947. And there was no “new” New Deal. This was by far the biggest cut in government spending in U.S. history. Tax rates were cut, and wartime price controls were lifted. There was a very short eight-month recession, but then the private economy surged.
Personal consumption grew by 6.2 percent in 1945 and 12.4 percent in 1946, even as government spending crashed. Private investment spending grew by 28.6 percent.
The less the feds spent, the more people spent and invested. Keynesianism was turned on its head. Milton Friedman’s free-market advocacy was validated.
In 1946, the unemployment rate averaged below 4 percent and stayed that low for the better part of a decade. This all happened during the biggest reduction in government spending in U.S. history, under President Harry Truman.
In sum, it wasn’t government spending, but the shrinkage of government, that finally ended the Great Depression. That’s what should be, but isn’t, in every history book.
In line with what has been described earlier in this post, the rolling back of regulations on economic activity, reductions in taxes(even if sadly not all the way to zero), and overall shrinkage in government healed the economy and transitioned it from the Great Depression to the well-known robust economic boom and prosperity of the 1950s, when the United States become the world’s industrial & manufacturing powerhouse, though it has sadly since lost that magnificent status as of the time of this writing, approximately 70 years later.
What Should’ve Been Done Instead to Recover from the Great Depression
Similar to what has been explained above, the government needed to let the free market correct the inefficiencies in the economy. The free market is another way of saying the producers and consumers in the economy; perhaps a better way of describing it is We The People. Rather than tack on the regulations, tariffs, and taxes that it did, the U.S. government should’ve refrained from passing new regulations and also should’ve eliminated the existing regulations and taxes that were already on the books. This would’ve enabled the free market to liquidate the malinvestments and unproductive enterprises, like the ones whose stock valuations went all the way down to zero, and to restructure so that the existing productive enterprises and good investments could continue. Furthermore, the absence of excessive regulations that go beyond the scope of protecting fundamental rights, like enforcing contracts and punishing fraud, as well as the reduction in taxes would’ve enabled the free market to restructure and bring about the economic recovery as quickly as possible.
Yes, there would have been considerable financial and economic hardship during the time it would’ve taken to correct the inefficiencies in both the financial and main street economic markets, but the hardship was prolonged and exacerbated by the regulations and taxes that the government implemented. Instead, had the government refrained from passing those regulations and taxes, the hardship would’ve ended as quickly as possible and most likely, the initial severe stock market correction would not have materialized into the dreaded Great Depression that we know today. Furthermore, as Griffin vehemently and rightfully advocates, the government should’ve abolished the Federal Reserve banking system, and by extension, also should’ve abolished the Federal Reserve Act of 1913. After that, along with maintaining the gold standard, which the U.S. government did until 1971, the government should’ve let the free market, the people, decide what currency and media of exchange they wanted to use for their transactions, so long as every party involved legitimately agreed upon the currency to be used.
Will Humanity Learn What it Should – Forecast for the Future
The short answer is no, with the slightly longer answer being that humanity, even in the United States, has to this day, nearly a century later, failed to learn its lessons from the Great Depression. With a variety of new taxes aside from the income tax that didn’t exist in the 1940s-1960s in the United States, along with a whole slew of regulations and regulatory agencies, the United States has committed the same mistakes as in the days of the Great Depression, even if in different manifestations regarding the taxes and regulations. Among the biggest failure is the continued existence, rather than the abolition, of the Federal Reserve Banking System(FED). After causing the Great Depression, the FED has gained even more power over manipulating the money supply. In the 1930s and 1940s, the FED could not print more money and add it to the economy; this is commonly known as Quantitative Easing(QE). Because the U.S. and the rest of the world were still on a gold standard of sorts, QE was not possible; all the FED could do in those older days was raise or decrease the interest rates. Later on, QE became very possible and very much practiced after 1971, when then President Richard Nixon ended any last connection that the U.S. dollar had to gold; the currencies of all other countries followed suit. The FED’s continued manipulation of the money supply, through inflation, triggered several other recessions since the Great Depression, including the stagflation of the 1970s, the 2008 subprime-triggered severe recession, and the stagflationary recession of 2021-2022, which is ongoing as of the time of this writing.
Another common fallacy is that without a central bank like the FED, the United States would lack stability in the financial and banking sectors and would thereby suffer major recessions and economic harm. Nothing could be further from the truth; after all, Canada didn’t practice the kind of central bank controlled monetary inflation, yet it didn’t suffer such a severe Great Depression like the United States did. Canada also didn’t implement a New Deal or a whole slew of economic, financial and banking regulations, yet it still didn’t experience a Great Depression, at least nowhere near as severely as the United States did. Unless anyone can give a good and convincing enough answer as to why Canada, as well as other countries that didn’t practice the same kind of central banking and inflationary policies of the U.S., didn’t suffer a more severe recession like the Great Depression, it cannot be accurately argued that a central bank, like the FED, is necessary to protect the economy from recession, whereas the opposite position, which has been proven by history and reality, can, and should, be accurately argued.
However, the U.S., along with nearly every other country, still has a central bank, a money supply without strict pegging to gold or silver, excessive and thereby unreasonable regulations, as well as heavy tax burdens. As such, the economy, throughout essentially the entire world, is unstable and getting worse for nearly all people, whether through unemployment as in the case of the Great Depression, a nearly constant increase in the overall cost of living, and along those lines, shortages of consumer and industrial goods. Therefore, given humanity’s failure to learn its lessons from the Great Depression and the lack of care to even make the effort to learn such lessons, the forecast of this essay is that humanity will not learn to abolish central banks, return to sound monetary policy like the gold standard, roll back the majority of regulations on commercial activity, or significantly reduce or eliminate taxes, at least not in the lifetime of this author.
We should all pray that the forecast of this essay turns out to be dead wrong, however unlikely.
Sources
- The Creature from Jekyll Island, G. Edward Griffin