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Sunday, April 1, 2012

26. The Great Depression

The Concise Guide To Economics

by Jim Cox

26. The Great Depression

The Great Depression, as with previous and subsequent downturns in the economy, was brought on by an artificial increase in the money supply, in this case engineered by the Federal Reserve during the 1920's.  The increased money supply resulted in an artificially low interest rate and stimulated investment in capital projects--in particular the stock market and real estate. 
The necessary adjustment began in 1929 as such malinvestments were being liquidated and production was once again shifting to that based on genuine consumer demand.  Unfortunately, unlike many previous downturns, this one was fought tooth and nail by the Hoover administration thus turning it into the GREAT depression. Hoover's first intervention thwarting the needed adjustment was in calling in the major industrialists of the day and extracting guarantees of continued high wages for their employees on the faulty theory that high wages cause prosperity (rather than prosperity causing high wages).  Also, the Smoot-Hawley tariff signed by Hoover in June 1930 resulted in a 50% tariff wall against trade with other countries thereby interrupting the international division of labor. 
In 1932 Hoover managed an increase in the income tax from a top rate of 25% to 64%, further burdening a weakened economy.  Hoover was thus no laissez-faire champion.  Additionally, the feds created a new agency to prop up failing large businesses with the Reconstruction Finance Corporation in 1930.  As Hoover stated in 1932:  "I have waged the most gigantic program of economic defense and counter-attack ever evolved in the history of the Republic." Rather than allowing the recovery to proceed, the federal government took numerous measures which prolonged the conditions and prevented the much needed recovery. 
Against this massive series of interventions, the Democrats offered a candidate for president committed to reduced intervention, lower taxes, less federal spending and maintenance of the gold standard.  Unfortunately, once in office Franklin Roosevelt governed very differently than he had campaigned. Within a month gold had been confiscated from the American people upon penalty of a ten year prison sentence and a $10,000 fine. The dollar was devalued by 40%, and the National Industrial Recovery Administration was established to reduce competition and output.  The NIRA cartelized industries with councils establishing codes for minimum prices, including minimum wages, the net effect of which was to increase business costs by 50%.  In addition, the Agricultural Adjustment Act authorized crop destruction as a way to boost farm prices (reducing output during time of need is surely among the most heartless acts one could imagine!). 
Fortunately, the Supreme Court began finding much of this central planning for favored businesses unconstitutional in 1935 and these offensive programs were ended.
But Roosevelt was not through with his social engineering.  In 1937 an undistributed profits tax was signed, Securities and Exchange regulations were increased and the Wagner Act of 1935 went into effect.  The Wagner Act undermined free labor relations, empowered unions and generated greater misery for those in search of employment.  Also, Roosevelt brought back a less constitutionally offensive version of the Agricultural Adjustment Act in 1936 and 1938. 
In 1937-38 the economy experienced a sharp drop as the first known depression within a depression occurred.  To further compound the misery, the Wage and Hours Act became law in 1938.  This act mandated 48 hour pay while reducing the workweek to 40 hours, thereby increasing business costs and limiting the freedom of labor to contract.  The 1930's downturn became the Great Depression because of massive government intervention, the climate of uncertainty all businesses faced as new laws were passed at breakneck speed and then struck down and then reestablished in altered form, higher taxes, mandated costs, and currency manipulation (and this recounting is only a fraction of the innumerable interventions).  As Hans Sennholz has stated, "the 1930's was a case of politics running wild in economic life."
Those economists who blame the Great Depression on the free market are playing wildly loose with the facts; there has been no less free market in so rapid a fashion as there was during this period of American history.  When Keynesians say the free market failed and demonstrated the need for widescale government management of the economy they are doing so oblivious to the facts.  The two major camps are in effect talking past one another as the free marketeer explains that a free market is stable, only to have the Keynesian respond with a proof to the contrary based on an episodelacking a free market.

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