The new deal and modern memory.

• Author: Shughart, William F., II
• Position: 2010 Presidential Address

It seems odd, fifty years after the event, that economists still do not understand, or at least agree on, the world depression of the 1930s. (Kindleberger 1986, p. 1)

For history does in fact repeat.

--Franklin Delano Roosevelt (1)

1. Introduction

   It is now more than 80 years since the onset of the Great Depression, a crisis that, in lay person's discourse at least, was triggered by the stock market crash of October 1929. (2) Although most professional economists rightly discount the popular story [indeed, there are reasons for believing that equities actually were in general undervalued in 1929 (Fisher 1930; McGrattan and Prescott 2004)], (3) the causes and consequences of the global economic collapse of 1929-1933 continue to be topics of considerable scholarly interest and of yet unresolved academic debate.

   The macroeconomic events of the past three years have, not surprisingly, redirected the attention of students of economic history, policymakers, and the public to those of the earlier period. How could they not? The similarities between now and then are in some respects so compelling that the economic downturn underway since the bursting of the real estate "bubble" became evident in December 2007 is often referred to as the "Great Recession." The comparisons are valid insofar as both slumps were preceded by extraordinary expansions of bank credit, which fueled run-ups in stock prices and real estate values. Those asset prices subsequently declined precipitously when the Federal Reserve, belatedly recognizing that it had gone too far, reversed course and began pursuing tight-money policies. Many homeowners were plunged under water as the market values of their principal investment fell below the debt they owed. Purchases of durable consumer goods thereafter predictably went south, and mounting defaults on home loans were transmitted to the balance sheets of mortgage lenders, triggering bank failures, declines in production, and increases in unemployment. The two economic crises also elicited similar (and equally counterproductive) fiscal policy responses, combining substantial increases in federal spending, financed primarily by borrowing, with higher taxes and more regulatory controls on the private sector. (4)

   But the similarities end there. During the Great Recession, which according to the National Bureau of Economic Research ended in June 2009, GDP fell by at most 3.8% (Smith and Gjerstad 2010) and was growing by (an anemic) 1.6% by the second quarter of 2010; the rate of unemployment peaked at just below 10% and has remained stuck there ever since. Those numbers pale in comparison with those of 80 years ago. Industrial production in the United States fell by 21% in the first year of the Great Depression and declined from its 1929 peak by more than 60% when that indicator hit bottom in 1932 (Romer 1993, pp. 21-2). (5) All other customary measures of macroeconomic performance moved sharply downward once the slump was underway: "Net national product in current prices fell by more than one-half from 1929 to

   (3) Irving Fisher (1930) attributed the market's undervaluation of equities ahead of October 1929 to its failure correctly to price the intangible capital of publicly traded companies. But whether undervalued or overvalued, stock ownership was not nearly as widespread then as it is now (IRAs and 401ks had not been invented in 1929), there was a lesser propensity to finance consumption out of wealth, and, while the stock market's crash indeed was dramatic, share prices initially remained above the level they had reached in early 1928 (Temin 1976).

   Two weeks before the "Great Crash," Professor Fisher famously said that, "Stock prices have reached what looks like a permanently high plateau." Apparently willing to put his money where his mouth was, "his considerable fortune, invested in the market, followed the Dow Jones Industrial Average into a death spiral" (Okrent 2010, p. 330). 1933 and net national product in constant prices by more than one-third": "money income fell 53 percent and real income 36 percent" (Friedman and Schwartz 1963, pp. 299, 301); real output per capita decreased by 31 percent over the same period (Vedder and Gallaway 1993, p. 75). By March 1933, one in four Americans was unemployed--many had been out of work for a year or more (Vedder and Gallaway 1993, p. 75) (6)--and well over one third of the commercial banks in the United States had suspended operations, had been liquidated, or had disappeared through consolidation or merger (Friedman and Schwartz 1963, p. 299). (7)

   Those remarkable declines in economic activity produced profound and sweeping human hardship, documented in grainy, black-and-white photographs of beaten men standing on soup-kitchen lines and of pinched-faced children selling apples on street corners, images that even today are graven on the national conscience (see, e.g., Watkins 1993). Perceived as being callously indifferent to the suffering of his fellow citizens--an indifference epitomized by Douglas MacArthur's brutal routing at saber's point of the "Bonus Army" camped on the mudflats of Anacostia--the economic debacle of 1929-1932 wrecked the presidency of Herbert Hoover and propelled Franklin Roosevelt into the White House pledging "a new deal for the American people" (Williams 1994, p. 167). The unprecedented depth and breadth of the collapse, along with the federal government's policy responses to it, supply ample justification for the era's continued fascination: the Great Depression is to economics what the "Big Bang" is to physics (Margo 1993)--or perhaps it is the profession's "Holy Grail" (Bernanke 2000, p. 5).

   In his two valuable collections of interviews with economists who either lived through the Great Depression, have devoted their academic careers to studying it, or both, Randall Parker (2002, 2007) poses five important questions: "What started it? Why was it so deep? Why did it last so long? Why did it spread so completely? Why did recovery come when it did?" (e.g., Parker 2007, p. 54).

   In this article, I offer admittedly incomplete answers to all of those questions based upon my own, perhaps idiosyncratic reading of--and modest contributions to--the vast literature on that era (Anderson, Shughart, and Tollison 1988, 1990; Couch and Shughart 1998, 2000, 2008; Shughart 2004, 2009). In so doing, I pay particular attention to two of Parker's queries, namely, what precipitated the Great Depression, and why did it persist in the United States longer than in any other developed country? The answer to those questions is public policy failure. In my judgment, as well as that of many other economists whose work I shall cite, the Great Depression likely originated in the monetary policy errors of the 1920s. The slump was then magnified by the Federal Reserve System's deliberate unwillingness to supply liquidity to a banking system in crisis--to perform the function of lender of last resort, the primary purpose for which it was created in the first place (Parker 2007, p. 13)--and was ultimately prolonged both by the policy experimentation of President Franklin Roosevelt's New Deal, many of his administration's initiatives plainly working at cross purposes, and by a second round of monetary policy blunders later in the decade, which interrupted incipient economic recovery and produced the so-called Roosevelt recession.

2. What Caused the Great Depression?

   Numerous explanations have been offered for why the events that began in the mid- to late 1920s produced the worst economic crisis of the Twentieth Century--indeed, in the whole of U.S. history. After all, while much sharper at its onset, the recession of 1920-1921 quickly was followed by brisk growth for the remainder of the decade (Parker 2007, p. 3). The explanatory theories can be divided into the following categories: post-First World War resumption of the international gold standard, underconsumption (reinforced by so-called debt deflation), productivity shocks, and monetary policy.

   These theories, I hasten to add, should be treated as complementary rather than as mutually exclusive. Complex events rarely have a single cause. As such, all may play greater or lesser roles in answering the question why the Great Depression happened when it did. But, with the exception of models based on yet unidentified productivity shocks, a fairly broad consensus currently exists pointing to the conclusion that the last of them--monetary policy, especially when embellished by the Austrian perspective--supplies an overarching framework that helps make sense of the economic events of the 1930s.

   The Gold Standard

   In the aftermath of World War I's bloodbath, which saw most of the belligerents abandon the gold standard temporarily, "resumption" was the order of the day. Britain, in 1925, was the first mover, but did so at an exchange rate that, set as it was at prewar parity, overvalued the pound relative to gold internationally. France also resumed its domestic currency's convertibility into gold but at an exchange rate that undervalued the franc. The resulting international gold flows--into France and out of the United Kingdom--required, under the operation of the prewar standard, French inflation and British deflation. (8)

   The latter nation did in fact pay the piper by contracting its domestic money supply and, hence, experienced falling prices, rising interest rates, and sharp reductions in economic activity. (9) France, for internal policy reasons, failed to adhere to the prewar standard's principles. Steadfastly refusing to accept a rehearsal of the run up in the domestic price level it had undergone in the recent past (1921-1926)--and with its central bank prohibited from engaging in open-market operations--France opted to pursue a deflationary monetary policy in response to accumulating gold reserves. (10) The United States, which also attracted gold during the Roaring Twenties and likewise...