Nobody uses the term “depression” any more to describe periods of economic slowdown, although it has become temporarily a fad to describe the current economic situation by reference to the 1930s. The current recession is very mild so far, although the recent election hype added trash-talk about the failure of free markets and analogies to F.D.R. Fear of yet-unknown 2009 economic news has put “depression” on the op-ed pages.
In the 1930s, the prolonged nature of the economic downturn was new and unexpected. The stock market crashes in 1929 and 1930, the wave of bank failures in the United States, and the extent of unemployment – particularly in urban areas, where it was highly visible – were not understood. Nobody believed it was natural or normal to have such an economic downturn. The Soviet revolution only 15 years earlier raised the fear that Marx had been correct about the collapse of capitalism.
Along came John Maynard Keynes and the creation of modern macroeconomic theory: the idea that economic science had to have a different theory for the economy as-a-whole, apart from a theory of “micro” business and consumer choices. “Macro” economics wants to look down on the earth from space and examine why booms and busts, inflations and recessions, and unemployment, happen. Like any scientist, the economist also wants to have some suggestions for curing the ailments.
The one detail about macroeconomics, which is special, is how it engages in politics. One feature of the economy as-a-whole stands out from “micro” economic theory: government policy can be changed, and this can affect the entire economic system. Microeconomics relies on government too, but in a relatively unchanging way. Individual markets rely on property rights and contract law, which are things courts and cops enforce.
Macroeconomics puts “economic policy” on the agenda of presidents and lawmakers as “leadership” – just as generals and admirals command armies and fleets.
“The Free Market Has Failed”
At a time like today, many people around the world are concerned about their jobs or their retirement funds invested in the stock market, or about losing their homes. Our political leaders are all too eager to step forward “to save us.” The lessons of elections since 1932 are very clear. No political leader can survive unless he or she is very visible “doing something.”
The very idea of a free market is that businessmen and consumers do their own things. Prosperity and economic growth just happen, without government doing more than enforcing long-established property rights and holding court when individuals want to quarrel over them. In the Great Depression of the 1930s, the idea was born that government had to “do something” because nobody wanted just to wait for things to get better.
Perhaps the first question should be, “Why Did the Free Market Fail?” The Marxists and other critics of free markets in general do not ask this question because they assume markets don’t work in the first place. Or they assume markets work temporarily, but do not serve humanity with social justice or equality and therefore breakdowns – causing poverty, suffering, and injustice – are just normal problems that require fixing.
Earlier recessions and depressions had been severe, but short. The market always recovered. By 1933, people had begun to ask
(1) why has this problem lasted longer than normal?
and (2) why hasn’t President Hoover “done something?”
Five excellent books look at the question of what Hoover and Roosevelt, and Congress did both to cause and to prolong the Great Depression:
Amity Schlaes, “The Forgotten Man” (2007) Jim Powell, “FDR’s Folly; How Roosevent and His New Deal Prolonged the Great Depression” (2003) Jude Wanniski, “The Way the World Works” (1978) Murray N. Rothbard, “America’s Great
Depression” (1963)Milton Friedman, “The Great Contraction” (1963) Friedman highlights the mistakes of Federal Reserve policy, Rothbard concentrates on Hoover’s mistakes, Wanniski identifies the impact of the Smoot-Hawley tariff, and Powell examines the consequences of F.D.R.’s taxes and regulations in preventing recovery.
Rigging or Regulating Markets?
Economists study markets and how they work. It is not our scientific, scholarly view that markets fail. Markets do not fail, because people keep on trading with each other. Economic life goes on. And we all agree that “rigging” a market will not make it work better, although many economists believe that “regulating” a market can help.
The difference between “rigging” and “regulating” is subtle: the former is deemed greedy and criminal whereas the latter is benevolent and prevents crime. Yet, of course, all regulations help some businesses and impose costs on others, just as “rigging” a market will do. Lobbyists make a living fuzzing up the fine details for the benefit of their clients.
The idea of centralized economic planning, Soviet style, has been discredited. Economic science did make a lot of progress after World War I – the war introduced centralized economic planning. Germany set the example for Lenin to inflict it on Russia. Economists Ludwig von Mises, in “Socialism” (1922), and Nobel Laureate F.A. Hayek in “The Use of Knowledge in Society” (1945), demonstrated why, in principle, centralized planning cannot succeed. The collapse of the Soviet Union in 1991 settled any controversy. So, the free market does work, spectacularly well, most of the time. What needs explanation is why it seems to fail.
Failure from External Shocks, or Internal Contradictions?
External shocks to society, like Hurricane Katrina in 2005 or Pearl Harbor in 1941, can clearly throw normal economic activity out the window. Extraordinary actions are required. External shocks can take two forms, however, and the best response depends on what has actually happened. Natural disasters that are localized, such as earthquakes and hurricanes, can be resolved by thousands or millions of people pitching in to help; relief organizations, and governments, can mobilize resources to rescue victims and rebuild. Man-made disasters are different.
UCLA Prof. Jack Hirshleifer in “Disaster and Recovery: A Historical Survey” (1963), observed that using free markets (free prices; free trade) to coordinate recovery speeds up effects. Restricting markets, e.g. by price controls and resource allocations, slows down recovery.
This is due to the decentralized nature of information: when the state of our world changes, the problem is how to adapt to new conditions and move forward. If only central planners are allowed to make decisions, and others must wait for orders and directions, the amount of information about the problems and solutions must be smaller than if everyone were encouraged to use localized information and to take personal action immediately.
Hirshleifer published his research project for the RAND Corporation and the Air Force, which was researching a nuclear war disaster.
Is an economic slowdown or collapse more like a natural disaster, or more like a man-made disaster? Social science demonstrates that not all human-caused events are human-intended events. Not every good result is a product of good intentions, and not every bad result is a conspiracy. If economic slowdowns are more like natural disasters, we must look for systemic conditions that gradually build up during times of prosperity; then burst, or break out. Alan Greenspan called it “irrational exhuberance” during the boom times. Were the boom times themselves artificially stimulated?
Man Made Disasters
If an economic slowdown is more like a man-made disaster, we need to look at the specific events or policies that triggered it. The Great Depression was a man-made disaster; government caused it by wrong-headed policies.
Jude Wanniski points to the Smoot-Hawley tariff of 1930 as an external shock to the economic system, which was definitely man made. It caused (1) the bank failures in the farm (exporting) economy, which spread to the money centers; and (2) the stock market collapses, which were closely timed to the votes in Congress. The stock market collapse of October 1929 is a famous event at the beginning of the Great Depression. It is often cited; but the stock market recovered, and the stock market’s long decline began in April 1930, when the Smoot-Hawley tariff became law. The bank failures of 1930-33 were not caused by the stock market collapses. They were caused by Congress voting to hike the tariff tax, which raised costs at a time of tightening credit. Similar to today.
Milton Friedman points to the blunders of the Federal Reserve in 1930-33. The Fed presided over bank failures – and the disappearance of one-third of the American money supply during those three years. This caused the economic slowdown: higher costs, reduced sales, tighter credit, bank failures, appreciating monetary value. Friedman proves inflation is caused by too much money, and depressions are caused by too little money – and credit – in the economy.
Since the money supply shrank by one-third, all of the prices in the United States in 1930-33 should have also moved down by one-third. Nobody, of course, ever cuts his price (except tactically, to increase sales). Unemployment was the result of holding up prices, which was Herbert Hoover’s unique contribution to “doing something” about the depression. Rothbard points out that Hoover was very active in promoting higher prices and wages as a solution to the depression, as also did F.D.R. after 1933. Hoover did exactly the wrong thing, as the money supply was collapsing, when he tried to keep wages and prices higher. More unemployment was the result.
The conclusion has to be that the Great Depression of the 1930s was a man-made disaster, and it lasted for a decade because of man-made efforts to “do something” about it. This is not to say, of course, that nothing could have been done. Unfortunately the wrong things were done. F.D.R. might have declared, at the same time he closed all the banks, that all prices in America would immediately be cut by one-third. Since bank failures were an important cause of the monetary deflation, and one dollar in 1933 was more scarce and more valuable than one dollar in 1929, such a decree from the White House would have been just like what they did in France, Brazil, Argentina, et al. when they struck the extra zeroes off the money, to change a million-peso bill into a hundred-peso bill.
Man-made disasters can be fixed by man-made changes in policy or corrective actions in the opposite direction. But this also requires understanding of the economic causes of the problem. A direct reversal of course is not always a solution, just as the damage caused by a car running over a man would not be fixed by reversing gears and running backwards over him again. But cute examples aside, if we can see and understand what has caused an economic slowdown, we can also see what might make things speed up to normal again.
What Should Obama and Congress Do Now?
Perhaps the most important question is what should they avoid? Jim Powell’s masterly book, “F.D.R.’s Folly,” documents the events of 1933-41 and we can clearly see how the programs of the New Deal failed to make the Great Depression go away. Powell quotes the writings of F.D.R.’s cabinet members and White House advisors. It is clear that social reform was more on their minds than economic recovery – similar to Obama. Roosevelt’s talent as a political leader was clearly of the same magnitude as Hitler, Mussolini, Peron, and Churchill. They all aroused emotions and evoked love and loyalty to their leadership. But it is quite another thing to look back and ask about their accomplishments for the public good.
Barack Obama may preside over a short and perhaps not-severe recession, or he may choose to step on the stage of history and flex his ego. The 2008 election campaign theme of “Change” does not tell us very much, but it can signify the beginning of a long dark period in American history – like 1933-41.
As a University of Chicago man, I am hopeful Obama’s Chicago connections will keep him from repeating F.D.R.’s folly.
