Amity Schlaes’ book The Forgotten Man: a new history of the Great Depression was a timely read, considering all the recent references we’ve heard to this time and the policies of FDR. So, in reading this I set out to ask and answer a few questions that I felt were the most pertinent to our time today and to my understanding of the economic situation back then. This book read more like a biography as Ms. Schlaes gives us the backdrop for the time through the people. It is a wonderfully entertaining and very informative read!
Question #1: Why did the Great Depression occur?
Answer: Normal economic cycles. “Back then”, a depression was not a big deal. Macroeconomic swings were often wild and violent. This was at least the sixth depression in America’s history – and not even the worst one. The Great Depression did not occur because of the 1929 stock market crash, the “godlessness” of the 1920s or unfettered capitalism. Those all were incidental or at worst, a symptom. The real problem was deflation. And it was a problem that went undiagnosed and certainly untreated for almost ten years.
Question #2: If deflation caused the depression, then what made it “great”?
Deflation should have just caused a mild economic swing. So, why did it spark a long and deep depression, in which unemployment never fell below 10% until WWII? The answer lies in the activities of politicians. Everyone was trying out their philosophies to see if they might work. We didn’t have the sophisticated money management system back then that we do now. We didn’t have any way of reliably and quickly measuring macroeconomic indicators like unemployment, GDP or capital purchases. These had to be tallied from a variety of sources and took years to know. In essence, this meant that politicians and their advisors were flying blind in a mountainous region, with no radar. Hoover and Roosevelt were very similar in a few ways – one was their willingness to experiment with macroeconomic interventions. A story is told of FDR setting the gold exchange rate on a daily basis by dreaming up a number.
Question #3: So, if political interventions were haphazard, why couldn’t business lead the recovery on its own?
Business could not, because it was never permitted. During the Great Depression, Hoover and FDR created several governmental agencies meant to prop up the economy. They sounded smart, but they really destroyed capital initiative. Capital stayed out of the market and waited. These included the NRA (attacked small businesses with regulations), WPA (make-work, not real work), TVA (destroyed the privately held utilities), Smoot Hawley Protectionism (probably the worst offender as it destroyed exports), and the Revenue Act (raised estate, gift and capital gains taxes).
Question #4: If the stock market crash didn’t cause the depression, then why didn’t that index bounce back quickly?
Two reasons: deflation, which burst the balloon of the stock values of many index companies; and secondly, uncertainty created by governmental interventions and changes in policy. One of FDR’s management techniques was to pit opposing voices on his cabinet against each other and see who would win. This is an interesting management technique, but one that the markets didn’t enjoy. The market’s fluctuations were wild, for that time, and this had the effect of keeping capital at home, under the mattress.
Question #5: Why couldn’t America’s trading partners help bail us out – wasn’t Europe a stronger economy at that time?
Europe had just been through WWI and Germany, the largest economy, was mandated to pay back huge war reparations to France and England. FDR cancelled those, but not before they crashed Germany’s economy and led to hyperinflation. Like any smart government, the German government tried to pay off the debt by printing money, leading to hyperinflation. So, Europe was already in a mess. The situation was made worse by the protectionist tariffs of Smoot Hawley. Whatever exports we had to Europe vanished with that law – therefore no bailing us out by buying cheaper goods. And there was no precedent for international loans (IMF, World Bank both were formed afterward) at that time. Protectionism always turns around and bites you worse than you thought.
Question #6: How did the Depression really end?
We were all taught that the New Deal “tided the US over” until WWII. Is this true? No, the New Deal’s policies actually led to what we call the “depression within the depression” of 1937-8. If the government had done nothing (fiscal interventions) and left capital alone, the country might have recovered much sooner, even without effective monetary interventions. But we’ll never know that.
The Great Depression ended simply because of three reasons: (1) FDR finally wisened up and started reversing some of the more idiotic programs that were keeping capital under mattresses; (2) the economic cycle began swinging the other way all on its own (with the fat trimmed out, the US was now lean and mean and ready to produce); and (3) the world stopped paying attention to the economy and focused on something else.
The biggest driver of any economy is something called “confidence” – this is a trust that if you purchase something or invest in something you will get something in return. Confidence came back into the US because we as a nation started focusing on something other than ourselves. People want confidence to occur, as it brings them personal stability, so it is something that WILL come back as long as governments don’t mess it up with their programs.
To bring this into today – Former President Clinton recently admonished President Obama to begin “talking up the economy.” He is right – this is the confidence thing. The more we hear negatives, the more we believe it. Every one of us wants the economy to recover, we want our friends to find jobs, we want our stocks to do better. Confidence is what has brought the stock market from the Depression averages of 100-200 points to what was yesterday a “low” of 6700. That is between 35 and 67 times the depression-era level. All because of the engine of confidence in our economy, producing people who start businesses that create wealth for everyone.
I hope you are enjoying your reading – put a comment up about mine and lets learn from each other!
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