Chapter Content
Okay, so, let's talk about the Great Depression, huh? You know, it's wild to think about how something that massive could even happen.
So, to really understand the whole thing, we gotta kinda go back to the 1800s. Back then, economists were just starting to see how the market economy was, you know, *emerging*. And, uh, they were worried. They weren't sure if everything was gonna just, like, magically fall into place. They were thinking, "Hey, what if farmers can't sell their crops? Because, you know, artisans can't sell their goods? And what if merchants can't make money 'cause nobody's buying?" It was a whole cycle of potential failure.
But this French economist, Jean-Baptiste Say, he was like, "Nah, don't sweat it!" He wrote that there's no reason to worry about this "general glut"—basically, too much stuff being made and not enough people buying it. He thought it was, like, impossible. He said nobody would ever make something to sell unless they were planning to use that money to buy something else. It's called “Say's Law.” So, like, the amount of stuff people *plan* to make for sale should always be equal to the amount people *plan* to buy.
Now, he wasn’t saying that individual things couldn't be in short supply or, you know, oversupply. Like, of *course*, you could have too much of one thing and not enough of another. He thought that was actually a *good* thing. It gave the market a reason to shift resources around. But, like, a shortage of demand for *everything*? Nope, he said it couldn't happen.
But other economists, like, weren't so sure. They were like, "What if you wanna buy something before you've even sold anything? Like, the artisan needing food before anyone buys their textiles?" Say’s response was basically that banks and credit would take care of that. But Karl Marx was like, "That's just childish babble!" You don't always sell just to buy something else. Sometimes, you're forced to sell just to pay off, you know, old debts. If everyone's trying to sell to pay off debts, there's gonna be a general glut, right? And if the banks see businesses failing, they're not exactly gonna be lining up to give out more credit.
So, yeah, Say was wrong. There *can* be too much demand for money and not enough demand for, well, everything else. If you have a lot of demand for a good, then people will pay more for it. But with money, it's different. People "buy" more money by working more. But, and this is the killer, you can just *stop spending*. And when you stop spending, everyone else loses their markets, their income, and their jobs.
If people want money way more than goods, then factories shut down, workers get laid off. The people don't have dividends, and the workers don't get wages. This just widens the gap between what the economy *could* produce and what people *actually* want to buy.
Say eventually kinda came around to this idea, especially after the British Canal Panic. Banks in England were like, "Whoa, we lent out too much money to people whose investments are flopping!" So, they stopped lending. Boom. Say wrote that commerce was, “deprived at a stroke.” It led to financial collapse. Because money and credit are basically just trust. And if you don't trust the other guy, the money dries up.
Okay, so, if everyone is worried then where can they go? Well, there's one place that's almost *always* trusted: the government. The government accepts its own money for taxes. So, everyone who owes taxes is gonna be willing to sell stuff to get that government-issued money. If the economy freezes up 'cause nobody's buying anything, the government can fix it. As long as people trust the government's finances, they can just pump more money into the system. People start buying stuff, that becomes income for others, and the economy starts moving again.
So how can the government do this? Well, they can just, you know, throw cash out of helicopters, which is a crazy idea, I know. Or they can hire people, give them jobs, and pay them. Or, they can just buy stuff, which creates demand and encourages businesses to hire more people. Another thing they can do is to have a central bank trade assets for cash.
Historically, governments often go with the central bank thing. Back during that Canal Crisis, the Bank of England did everything it could to get cash into the hands of people, businesses, banks, *everybody*. They bent the rules. It still resulted in a short depression. But it could have been way worse, especially if they’d acted like central banks did later on.
And that brings us to the Great Depression, right? The central banks didn't take those big emergency steps. The 1920s saw a stock market boom. Everybody was optimistic. They thought the Federal Reserve would stabilize the economy. The Fed, though, worried that speculation would cause overleveraged financial institutions that would collapse at the slightest price drop. The Fed tried to curb the stock market bubble to *prevent* a depression, but its attempt to head off a depression *brought* one on.
I mean, previous depressions were way smaller. And future ones have been too. Even those close in time. But in the Great Depression, the US unemployment rate peaked at, like, 23%. The Great Depression was especially bad in the industrial sector with unemployment. It was greater and longer than anything before or since.
The start of the recession in '29 was the first confidence shock. Then, there was the stock market crash, which was another massive shock. Then, the banking crisis. People were worried they couldn't get their money out of the bank. Bank deposits weren't really "money" anymore because you couldn't be sure you'd get them back. Then, another banking crisis in '31. The summer of '31 saw panics in other countries.
Up until late 1930, people wanted cash. Shortly after that banks restricted the amount of cash they provided. They called in loans and cancelled lines of credit as they sought to raise their own reserves. Households raised the amount of cash they held rather than depositing it in the bank.
From late 1930 to 1933, the reserves-to-deposits and currency-to-deposits ratios grew as confidence fell and the money supply shrank. 1931 was a year of crises. 1932 saw no crises, but there was also no recovery because things were already so dire.
Some economists argued that depressions get fixed faster if wages and prices fall. More stuff for each dollar will provide demand for more workers. The problem is when wages and prices fall, debts don't. Deflation during the Depression caused bankruptcies, which led to falling production, which led to more falling prices, bankruptcies, and so on.
Banking panics and the collapse of the world monetary system made people think they should wait to spend or invest. Demand for cash went up. The excess supply of goods and services grew. As prices fell, investors had compelling reasons to wait because waiting to invest would let them buy more. Unemployment rose. Production fell. Prices fell. The newly elected Herbert Hoover had a rough time.
Workers were idle because firms wouldn't hire them. Firms wouldn't hire workers because they saw no market for goods. There was no market for goods because idle workers had no incomes.
There is no great explanation as to why this happened just when it did. Why were there not more great depressions?
Well, there were factors that all came together. The decision to cut immigration in 1924. The rapid expansion of financial markets. The shortage of monetary gold. The international monetary system's reliance on assets that were subject to runs. The point is that times were not uniquely vulnerable, as we’d been remarkably lucky before.
In the lead-up, policy elites doubled down on austerity measures. The first instinct of governments and central banks was to do nothing. Businessmen, economists, and politicians expected the recession to be self-limiting. They believed that prices would fall and, when they fell enough, entrepreneurs would gamble production would be profitable. That's how earlier recessions had come to an end.
As the unemployment rate rose to nearly a quarter of the US workforce, and production per worker fell by 40%, the government didn't prop up aggregate demand. The Fed didn't use open-market operations to keep the money supply from falling. After the UK abandoned the gold standard in '31, the Fed raised interest rates to discourage gold outflows.
The Fed let the private sector handle the Depression in its own fashion, and it feared that monetary policy or fiscal spending and the resulting deficits would impede readjustment.
Some of the most eminent economists agreed with the Fed. Schumpeter argued that depressions are not evils, but forms of adjustment. Hayek wrote that the way to mobilize resources is to let time effect a cure by adapting production. Hayek believed that businesses fail, so the best that can be done is to shut down the faulty ones. Depressions, he said, are this process of liquidation and preparation for the redeployment of resources.
Herbert Hoover moved from commerce secretary to president in '29, before the crash. He kept Andrew Mellon as treasury secretary. Mellon had been nominated in 1921 and stayed in his post. Hoover was a mining engineer who believed in experts, and Mellon was his expert.
Looking back from the '50s, Hoover cursed Mellon and his supporters. He said that Mellon had only one formula: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." Mellon held that panic was not altogether a bad thing as it would purge the system.
In his memoirs, Hoover wrote that he had wanted to pursue more activist policies, but Mellon had overruled him. But Hoover was the head of the executive branch.
This ruling doctrine, that the Great Depression would turn out to have been good medicine for the economy, was considered simply insane. John Stuart Mill said that an excess demand for money produced a general glut and there would be no depression if the money supply were matched. Practical central bankers had even developed a playbook. But it wasn't followed.
Why? Perhaps in previous downturns the excess demand for money had triggered a scramble for liquidity with people dumping assets. Central bankers had seen government bond interest rates spike, a signal that the economy needed more cash.
But the Great Depression was different as it was a scramble for safety. People were desperate for assets that they could turn into cash. They dumped stocks, bonds, and even furniture. Along with furniture left curbside, there was no government-bond interest-rate spike, leaving central bankers unsure as to what was going on.
Governments strained their every nerve to restore competitiveness and balance their budgets. This meant depressing demand and reducing wages and prices. In Germany, the prime minister decreed a 10% cut in prices and a 10 to 15% cut in wages. But every step made matters worse.
During the Great Depression you see a steadily widening gap between safe interest rates and the interest rates that companies had to pay. The vast majority of businesses found it next to impossible to obtain capital to finance investment because new investment expenditures were risky, and the financial economy was desperately short of safety.
The banking system froze up. Private investment collapsed. Falling investment produced more unemployment, further falls in prices, and more deflation. Deflation rendered investors less willing to invest and the banking system even more insolvent, deepening the freeze.
The spiral of deflation would continue to depress the economy until something was done to restore solvency to the banking system. Few economists understood this process during the Great Depression.
The ruling liquidationist doctrine overrode the anguished cries from those less hindered by theoretical blinders. Hawtrey wrote, "Fantastic fears of inflation were expressed. That was to cry, Fire, Fire, in Noah’s Flood.” The Great Depression was the twentieth century’s greatest case of self-inflicted economic catastrophe. Keynes said that the world was “as capable as before of affording for every one a high standard of life,” but that “we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand.”
He called for resolute, coordinated monetary expansion, but action never emerges from committees or international meetings. It emerges from the actions of a hegemon, but America didn't act.
And so Keynes's fears came to pass.
Broken by war, the system was shattered by the Depression. As Keynes had written, this destruction of trust was “fast rendering impossible a continuation of the social and economic order of the nineteenth century. But [European leaders had] no plan for replacing it.” He warned that the consequences could be dire.
A large part of what made the Great Depression so painful was that it was long.
A first reason was workers’ unwillingness to take risks. They were content to settle for what was most secure.
A second reason was the memory of the gold standard. This dissuaded governments from taking steps to boost production and employment. Currency depreciation was one of the only things that was effective.
A third reason was the lack of a hegemon to guide coordinated action in international monetary affairs. Recovery was national only, not global.
The sooner countries went off the gold standard, the better they fared. The Scandinavian countries did best. Japan was second. Britain abandoned the gold standard, but Japan embraced expansionary policies more thoroughly. The United States and Germany abandoned the gold standard in 1933, but Hitler had a clearer view that success required putting people to work than FDR did.
All of the opinions of the powerful blocked action toward "reflation," which is restoring the level of prices and spending. Instead, "austerity" was pursued. Those who proposed something were denounced.
Keynes said that policies of activism and reflation were the only means of avoiding the destruction of existing economic forms.
In one region of the North Atlantic, the Great Depression was shallow, short, and followed by strong growth: Scandinavia. The socialists of the Scandinavian countries pursued housing subsidies, paid holiday and maternity benefits, expanded public-sector employment, and government loans made possible by cutting loose from the gold standard. Thus socialists turned into social democrats.
Close behind was Japan, which abandoned fiscal orthodoxy and budget balancing. Thanks to Takahashi Korekiyo, Japan devalued its currency and embarked on a massive program of armaments manufacturing. It proved to be a bad long-run strategy.
Elsewhere, the Great Depression was a long disaster. It was worst in Germany, where it brought Hitler to power.
Once Hitler had taken power and broken adherence to monetary and fiscal orthodoxy, his Nazi Germany was able to recover.
Overall, the major monetary powers passed up their chances to do something constructive to help the world monetary system recover. In '33, the London Economic Conference collapsed.
Coordinated reflation was the first obvious strategy. Fiscal expansion was the next, but it was not attempted until the end of the decade when the threat of war made governments realize that spending public money to build weapons was important.
Close to bringing up the rear was Britain. It abandoned the gold standard in September '31. The Bank of England did its part, but the government did not.
France, which stuck it out on the gold standard until '37, did worst of all. Blum abandoned the gold standard, but that did not mean substantial expansion. France entered 1938 with its level of industrial production still less than it had been in 1929.
The Great Depression meant that the reaction to it shaped countries’ politics and societies for a long time. Orwell expressed how the system that had produced the Great Depression had failed humanity.
With the coming of the Depression, it was impossible not to conclude that the old order was bankrupt. As it fell, it took representative democracy down with it.
In Scandinavia, social democratic parties would be in power for a half century. In continental Europe, the Depression reinforced reaction and allegiance to the belief that a revolutionary change was needed.
More important than that the United States was going to be a laggard was that the United States learned to spend money and buy things. Roosevelt’s policies worked well enough to gain him majority support.
He was willing to break political norms. He wanted to save what was good about America by throwing overboard everything that he saw as blocking it.
In 1932, Roosevelt broke tradition and flew to Chicago and spoke to the delegates. He pledged a New Deal for the American people.
Franklin Roosevelt meant what he said. In the United States, the Great Depression did not empower reaction but liberal experimentation.
Why did the Great Depression not push the United States to the right? Maybe it was sheer luck because the Republicans were in power, and Roosevelt was center-left.
The elections of the '30s would be different. Congress swung heavily Democratic. Roosevelt had little idea what he was going to do other than that Hoover had gotten everything wrong. He decided to do the opposite. If he was persuaded by a half-plausible thing, he would try to do it.
The First New Deal was made up of many things: a joint government-industry program, the farm sector on the federal dole, a program of building utilities, public works spending, federal regulation of financial markets, insurance for small bank deposits, mortgage relief, unemployment relief, plus promises to lower tariffs, hours, and raise wages.
The devaluation of the dollar and the NIRA of '33 broke the expectations of future deflation. The creation of deposit insurance and the reform of the banking system did make savers trust the banks and began re-expansion. The balance sheet of the rest of the First New Deal wasn't clear. It did not bring complete recovery.
Therefore Roosevelt kept trying and launched a Second New Deal.
His labor secretary, Frances Perkins, had influence on the Second New Deal. The most enduring and powerful thing was the Social Security Act, which provided assistance for widows, orphans, and the disabled, and set up a system of old-age pensions. The Wagner Act of 1935 strengthened the union movement. The programs of the Second New Deal probably did little to cure the Great Depression, but turned the United States into a modest European-style social democracy.
The New Deal Order lasted. Laissez-faire had been a powerful doctrine until the Great Depression.
But after that, it was greatly diminished. The US economy did recover under Roosevelt, albeit incompletely. By 1941, 82% of US households had a radio; 63% had a refrigerator; 55% had a car; and 49% had a vacuum cleaner.
In the '50s, President Eisenhower wrote that laissez-faire was (or ought to be) dead and that attempts to resurrect it were “stupid.”
In 1930, Keynes distracted an audience with a talk on "Economic Possibilities for Our Grandchildren." He said that if the problems of full employment and managing the economy could be solved, what then would be the economic possibilities for humanity?
Keynes’s conclusion was that technology would deliver enough abundance that “the economic problem” would prove not to be “the permanent problem of the human race.” Humankind would face the “real,… permanent problem—how to use… freedom from pressing economic cares… to live wisely and agreeably and well.”
Even in the Great Depression, Keynes saw light at the end of the tunnel.