The Great Depression, Causes and Extensions: a discussion

I wrote this as a post. for my political discussion group, not as a paper or formal discussion. It seems, however, that politicos are not economists. Nor do they enjoy learning or discussing fiscal or monetary policy. This is a departure from my usual posts. Enjoy.

First of all, let’s look more closely at seashells as currency and Keynesian economics. Keynesian economics for a very long time disregarded monetary policy. Keynesians argued for many years that monetary policy was powerless. So if you are looking for your seashells as currency, you need not look any further than Keynes. (See: Keynesian Economics by Alan S. Blinder) It wasn’t until Milton Friedman (See Milton Friedman) that monetary policy was introduced into Keynesian economics, something that had already been in the Austrian school for many years. Monetarism was anathema to Keynes though no longer.

With respect to Austrian monetary policy, here are some links: Stockman on sound money, click here for The Forgotten Cause of Sound Money, and a critics of Austrian thinking with respect to monetary policy and a comparison of Austrian policy vs. modern monetary policy. Click on the PDF on this article: Austrian Monetary Policy Views: A Short Critique

You’ll notice two things about “Austrian Monetary Policy Views: A Short Critique”, that it was published by the Mises Institute and that it advocates that the Depression was caused by demand shocks rather than, as Stockman points out, an oversupply of inventory, coming hot after WWI and the Roaring Twenties. It also says that the gold standard restricted economic expansion. However, as Stockman points out in his talk at the Mises Institute, after the Civil War, the US had the greatest economics expansion in its history and was on a true gold standard (as opposed to a partial reserve, which we had after FDR.) Part of what extended the Depression was that FDR forbade gold from leaving the country. This effectively shut down trade, which worsened the Depression. It wasn’t until/towards the end of WWII that trade resumed and that the depression ended. You will note that the none of FDRs ad hoc jobs programs affected the jobless rate, or if they did, not by very much. (I’ll come back to this.) It wasn’t until the start of WWII that the unemployment rate lessened due to manufacturing jobs for the war effort. If FDRs policies were so great, then why did it take a World War to do what he could not? Here is another interesting article comparing Austrian Economics with Modern Monetary Theory (See Modern Monetary Theory and Austrian Economics):

“As Wenzel points out, Murray Rothbard—one of the most important Austrian Economists the United States has produced—takes exactly the same position. He says that governments take “control of the money supply” when they find that taxation doesn’t produce enough revenue to cover expenditures. In other words, fiat money is how governments escape revenue constraint.

“Rothbard considers this counterfeiting, which is a moral judgment that depends on the prior conclusion that fiat money isn’t the moral equivalent of real money. Rothbard is entitled to this view—I probably even share it—but that doesn’t change the fact that in our economy today, this “counterfeiting” is the operational truth of our monetary system. We can decry it—but we might as well also try to understand what it means for us.”

Indeed, as I have stated, the problem with fiat money is that eventually it will be so devalued, as we have seen with the Colombian Peso, that it will put a very heavy burden on the economy. And as Zimmerman points out, “Austrian business cycle theory is enjoying a comeback because explanations of the recent recession in the U.S. and the current sluggish recovery often have an Austrian flavor (e.g., Laidler 2003; Eichengreen and Mitchener 2003; Economist 2002; Oppers 2002). In a nutshell, Austrian business cycle theory postulates that “too low” interest rates induced by monetary policy trigger a credit-financed investment boom—possibly reflected by an asset price bubble—which is unsustainable in the long run so that a subsequent recession not only is unavoidable but necessary to correct imbalances between saving and investment (e.g., Shostak 2002).“ (See the above link for references in this quote.)

And we have seen these results not once in the last century but multiple times, and also twice in this current century. We have boom and then bust, bubble and bust, every 15-20 years. Without tight controls on monetary policy, we are doomed to a boom and bust cycle. The reason why I advocate a return to the gold standard is that would automatically put those monetary controls in place without having to resort to a Central Bank and bond buying and selling.
“The Austrian view is based on the idea that government spending tends to distort the economy, in part because—as the MMTers would agree—government spending in our age typically involves monetary expansion.”

Now that I have defined what we are fighting over monetary policy or the lack thereof, and demand side economic vs. supply side economic causations, we can talk about the Great Depression more fully.

Before we continue, we need to talk about Crony Capitalism for two reasons, because our current economic and monetary policy is geared towards a crony capitalistic view. Stockman talks about this in his Mises Institute talk on sound money. John Carney also discussed it in his article. (Here is another article on the subject: Monetary Theory, Crony Capitalism and the Tea Party.) And because FDR’s policies institutionalized crony capitalism. Just look at the problems with Fannie Mae, another failed and ultimately damaging program that came out of FDR’s ad hoc economic policies.

Also, we need to understand the Austrian monetary policy (See Austrian School of Economics by Peter J. Boettke) : “Money is defined as the commonly accepted medium of exchange. If government policy distorts the monetary unit, exchange is distorted as well. The goal of monetary policy should be to minimize these distortions. Any increase in the money supply not offset by an increase in money demand will lead to an increase in prices. But prices do not adjust instantaneously throughout the economy. Some price adjustments occur faster than others, which means that relative prices change. Each of these changes exerts its influence on the pattern of exchange and production. Money, by its nature, thus cannot be neutral.”

Also, “Perhaps economists should adopt the doctors’ creed: “First do no harm.” The market economy develops out of people’s natural inclination to better their situation and, in so doing, to discover the mutually beneficial exchanges that will accomplish that goal. Adam Smith first systematized this message in The Wealth of Nations. In the twentieth century, economists of the Austrian school of economics were the most uncompromising proponents of this message, not because of a prior ideological commitment, but because of the logic of their arguments.”

(See also Stockman’s The Great Deformation for how the policies of the Great Depression are responsible for the crash of 2008 and also see Piketty’s Capital in the 21st Century for an in-depth look at inequality before and after the Great Depression )

The New Deal shattered the foundation of sound money and created a régime of capricious fiscal and regulatory activism that fueled the growth of state power and crony capitalism which thrives on this power. As I have stated before, FDR shut down world trade and destabilized our monetary régime. The shutting down of trade deepened the depression as well as lengthened it. The great industries of the time, capital goods, autos, steel chemicals, and agriculture, had too much capacity for the domestic market. During WWI and the Roaring Twenties, these industries exported heavily, which was unsustainable. US vendor financed loans to worldwide customers fueled the Roaring Twenties and the prosperity during WWI for the US. Ultimately the customers could not afford to repay those US financed loans. (If the US had forgiven French War debt, not only could WWII have been avoided but also the Depression.) In today’s economic scale, these vendor loans totaled more than $3 trillion dollars.

The stock market crash worsened these problems. Without more funding, which was unavailable, the borrowers defaulted. At this point, what the US needed to do was rejuvenate its foreign customer base. Washington should have canceled the war debts of England and France and should have demanded that France give up its campaign to extract punishing reparations from Germany. Remember, part of the reason for these reparations was to pay off the US. The US should have taken the lead in reestablishing stable foreign exchange markets around a fixed currency and gold conversion to revive confidence in trade.

Add to this fifty percent of the national income went to the top decile, slightly higher than in Europe at the time, as a result of the shocks European capital had already received since 1914, and you have recipe for disaster, massive inequality and the inability for foreign customers to pay their debts. The US, though escaping both WWI and WWII physical destruction, received great shocks from WWI, the Depressio,n and WWII. Both WWI and WWII acted as economic engines of wealth redistribution, compressing income inequality. Also, Roosevelt continuously jacked up the top rate to 94%, further redistributing wealth in the US. The depression continued through WWII, though the jobless rate declined due to wartime jobs.

Unfortunately, Roosevelt inherited a fatal contradiction from Hoover: the gold standard for money but protectionism for trade, the Smoot-Hawley tariff bill.

So when FDR took office on March 4, 1933, he was confronted with a crisis, though it wasn’t the domestic banking crisis sensationalized by the newspapers. The banking crisis was over in a matter of weeks. The $2 billion of currency hoarded flowed back into the banking system, not because of the New Deal, but rather because of a bank-reopening plan that Hoover’s outgoing Treasury Department had designed and stayed on to implement. (The problem with the Bank Holiday program/process and Crony Capitalism is a much longer post for another time. This, however, was rampant in FDR’s administration also was rampant in various state banking policies and action by their governors.)

The real crisis was the shutdown of world trade and the chaos in the monetary system and foreign exchange markets. The last hope for reversing this breakdown was the London Economic Conference in June, which Hoover had organized but which FDR had refused to cooperate in the planning and the meetings. FDR personally torpedoed the London Conference, basically striking down the international gold standard. FDR had decided that economic stimulus was the only way out of the crisis. This, by the way, was not prompted by Keynes. FDR had only met Keynes once and found that his economic ideas for the country were unintelligible. So, no, Keynesian economics was not a factor in the New Deal.

The New Deal had nothing to do with modern Keynesian theories of countercyclical demand management. And, if you have not noticed, the giant stimulus of 2008 and beyond, TARP and QEs, though good for the stock market, hasn’t done much for the overall economy, no matter what Krugman thinks. It isn’t until 8 years after the 2008 crisis that we are finally seeing the economy starting to rebound.

FDR, after begging Carter Glass to become his secretary of the treasury, ignored all his advice, ignored the advice of his budget director Lewis Douglas, and defied all of his advisors including his chief of his brain trust, Raymond Moley, and instead produced a set of policies with little rime (Old English spelling) or reason. Some of the programs of the New Deal provided relief and a safety net but most either retarded recovery or were abandoned before they could do lasting harm. A few of them, such as industrial union legislation, universal social insurance, Fannie Mae, bank deposit insurance and farm price supports, cast a debilitating shadow on the future. Just look at the troubles we had had with Fannie Mae. And Social Security is no longer an insurance program for financial disasters both locally and globally but rather has become a government sponsored retirement program without any sort of income requirement threshold to receive it. Not only are multi-millionaires and billionaires eligible for Social Security but they have the same income cap as the working poor.

(See Five Reasons Why Social Security Retirement Program Needs To Live Long And Prosper by John Wasik for some ideas about why Social Security is a good program and what will have to be done to fix it. I like the original idea of Social Security, as an insurance, and do not like it as a retirement program. However, Wasik does make some excellent arguments pro. Personally, if Social Security had remained a national insurance, I would have liked that better. Not only would it still have provided a safety net but at a fraction of the cost of our current retirement program. And don’t forget, Nixon signed two very large and dangerous cost of living adjustments for social security.)

The long lasting impact from FDR’s hundred days wasn’t the bank holiday, the national treasury act, the farm adjustment act, the Tennessee Valley Authority or the public works administration, but rather from FDR’s April 1933 ordering confiscating gold. (A side note, antique gold coins were exempt from this order but some people turned them in anyway thus making those that did not a tidy sum.) The Thomas Amendment gave him open-ended authority to reduce the gold content of a dollar effectively trashing our nation’s currency. This introduced a process of monetary deformation that eventually culminated in Nixon’s 1973 suspension the convertibility of the dollar into gold, thus breaking up Bretton Woods, at Camp David, Greenspan’s panic at the time of the 1998 Long-Term Capital Management crisis and the final destruction of monetary integrity and financial discipline during the BlackBerry Panic of 2008.

It is interesting to note that Nixon pressured Arthur Burn, the Fed Chairman, to overheat the economy on his run-up to the 1972 elections.

This was a break with the past; the dollar’s gold content had been set at $20.67 per ounce in 1932 and had never been changed. There had been zero domestic inflation for a century and the dollar’s gold value had never varied in international commerce except during times of war. (And remember the economic expansion following the Civil War!)

The Thomas Amendment had destroyed this rock-solid monetary foundation and instead permitted the president to cut the dollar’s gold content by up to 50 percent. It was a complete reversal of FDR’s campaign pledges to preserve “sound money at all hazards” and contradicted the pro-gold standard views of his party. The function of gold was financial discipline and that was lost.

Then, after his first hundred days, FDR headed off to vacation on Vincent, Astor’s yacht sending Moley as his personal emissary to the London Conference, the last hope for retaining open international trading and monetary order. Most of the assembled financial officials, including Cordell Hull, a former Democratic senator from TN, now Secretary of State, and the conference’s presiding officer, came to an agreement. The main goal of the Conference was to roll back the protectionist trade barriers, which came about from Smoot-Hawley, and to stabilize exchange rates.

After Moley arrived in London, the US delegation, Great Britain, and the French-led gold bloc nations had all managed to find common ground. The center of it was repegging the dollar to the pound exchange rate to about 20 percent below the old parity. From that point on, the French franc and other major currency would be fixed to the dollar.

However, FDR was incommunicado during the hours when the global consensus to fix the international financial system gelled and then flickered. Alone on Astor’s yacht, the Mourmahal, the president had the advice of only his wealthy dilettante friend Vincent Astor and Louis House, his butler and glorified White House “secretary.”

When Moley finally found a navy ship to track down the Nourmahal and deliver a radio message outlining the London agreement, FDR, Howe, and Astor gathered around a kerosene lamp on the deck. They scribbled out a handwritten response and dispatched it back to the London via the Navy. Roosevelt’s message was among the most intemperate, incoherent, and bombastic communiqués ever publicly issued by a US president. It killed the monetary stabilization agreement on the spot and locked the world into a destructive economic nationalism that eventually led to war.

(See FDR: Sowing the Seeds of Chaos for a more detailed account of FDR’s vacation on the Astor’s yacht and the crony capitalistic consequences.)

“When the Conference opened on June 12, 1933, all attention rested on the tripartite currency discussions happening outside the Conference. The big issue was the exchange rate of the dollar against foreign currencies such as the British pound and French franc. Many in the U.S. favored devaluation of the dollar to improve the U.S. trade position; France and Britain wanted to stabilize the dollar rate; i.e. fix it at a relatively high value.

U.S. Secretary of State Cordell Hull led the American delegation to the Conference. The President ordered Hull not to enter into any discussions regarding currency stabilization. However, by the time the Conference gathered, President Roosevelt had changed his mind, supporting currency manipulation to raise prices, and had American banking experts O.M.W. Sprague and James Paul Warburg conduct currency stabilization talks with their British and French counterparts.[6] By June 15, Sprague, Warburg, Montagu Norman of the Bank of England, and Clement Moret of the Bank of France had drafted a plan for temporary stabilization.

“Word of this plan leaked out. The reaction in the U.S. was negative: the dollar rose against foreign currencies, threatening U.S. exports, and stock and commodity markets were depressed.

“Although Roosevelt was considering shifting his policy to a new median dollar-pound rate, he eventually decided not to enter into any commitment, even a tentative one.

“On June 17, fearing the British and the French would seek to control their own exchange rates, Roosevelt rejected the agreement, in spite of his negotiators’ pleas that the plan was only a temporary device full of escape clauses.

On June 30, Roosevelt went further: in an interview with four reporters, he openly criticized stabilization. Then on July 3, he issued a message to the Conference condemning its efforts at stabilization when “broader problems” existed, and asserting that the exchange rate of a nation’s currency was less important than other economic values.

Roosevelt’s rejection of the agreement gathered an overwhelmingly negative response from the British, the French, and internationalists in the United States. British Prime Minister Ramsay Macdonald feared “Roosevelt’s actions would destroy the Conference” and Georges Bonnet, rapporteur of the French Monetary Commission, is said to have “exploded.”

“Critics see nationalism as a key factor in Roosevelt’s decision.[10] But John Maynard Keynes hailed FDR’s decision as “magnificently right”, and Irving Fisher wrote FDR that his message “makes me the happiest of men.”[11]” (See Roosevelt’s Rejection for the above quote and more on the London Conference).

For another look at this disaster, this time on the pro side, see How FDR wrecked the London Economic Conference and Saved the World.

FDR’s mishmash of economic and disastrous monetary policies extended the Great Depression. The proof is very simple. As I stated above, none of FDR’s job programs worked. This chart shows incredibly high unemployment rates during FDR’s work programs. It also shows large swings in unemployment indicating that there were truly no structural changes in the job market but just WPA Band-Aids. The jobless rate did come down during the US lead up to the war, starting around 1940, as wartime manufacturing created jobs. See Unemployment Rate from 1929 to 2005 And stayed down after the war when the trade resumed. The New Deal did nothing significant to fix the unemployment landscape and the structural problems facing the US.

Average rate of unemployment
in 1929: 3.2%
in 1930: 8.9%
in 1931: 16.3%
in 1932: 24.1%
in 1933: 24.9%
in 1934: 21.7%
in 1935: 20.1%
in 1936: 16.9%
in 1937: 14.3%
in 1938: 19.0%
in 1939: 17.2%

(From Historical Statistics of the United States: Millennial Edition, ed. Susan Carter, Scott Sigmund Gartner, Michael Haines, Alan Olmsted, Richard Sutch and Gavin Wright (Cambridge: Cambridge University Press, 2006),, accessed 5 January 2009.)

(NB: rate of unemployment decreases at the start of WWII in Europe. See the above link for the unemployment rate in % from 1929 to after WWII.)

I do like the fact that the WPA gave us nice national parks and lots of great art, but the WPA did nothing substantial or structural to fix the lack of jobs. As I have said in the past, infrastructure is important. However, we got more infrastructure from WWI and WWII than from the New Deal.

And if FDR’s policies were so great in combating the Great Depression, why did the depression last through WWII? (See Piketty.) It wasn’t till toward the end of WWII that the GDP started to gain some traction.

The New Deal did seem to do something, very slowly and extremely unevenly, for the GDP, though it never reached the 1929 levels of $103.6 billion until WWII, and it wasn’t until 1943 that the GDP started making headway. This slow growth seen in the New Deal era was the result of supply dwindling, manufacturings was slowing coming back to replenish the void in supply, and not the policies of the New Deal. If the GDP growth had been due to the New Deal, then unemployment rate would have kept pace with the GDP instead of bouncing around above 14%, and hitting a local maxima in 1938.

But notice that growth exploded after the war with the resumption of trade and unemployment went down to below 3%. At best, the New Deal helped out slightly, giving some relief to out of work artists and laborers, but real recovery began with our manufacturing boom at the start of WWII and didn’t surge until towards the end of WWII when trade resumed.

One might even say that during the lead up to the US involvement in WWII is when the economy started to recover. That is, economic recovery started in 1936, during Hilter’s re-militarization of Germany. Remember, 1936 was Göring’s guns or butter speech urging German’s get behind the build up of the German War machine. As Europe recovered due to the militarization of Germany, that set the stage for a US recovery. Again, this has nothing to do with the New Deal. As you can see below, there is a dramatic increase in the GDP at the start of WWII in Europe in 1939.

The Economy During the Great Depression

US Gross Domestic Product (current dollars)
The Great Crash, 1929-1933
in 1929: $103.6 billion
in 1930: $91.2
in 1931: $76.5
in 1932: $58.7
in 1933: $56.4

New Deal Recovery and Recession, 1934-39 (meager growth.)
in 1934: $66.0 billion
in 1935: $73.3
in 1936: $83.8
in 1937: $91.9
in 1938: $86.1
in 1939: $92.2

Mobilization for WWII, 1940-1945
in 1940: $101.4 billion
in 1941: $126.7
in 1942: $161.9
in 1943: $198.6
in 1944: $219.8
in 1945: $223.1

FDR’s policies were at best nothing more than temporary relief programs, and at worst disasters for future generations, e.g. Fannie Mae, an out of control and warped SSI. Without WWII we’d still be in a depression. One might be tempted say that FDR got us out of the depression because his presidency was from March 4, 1933 – April 12, 1945 and that the Depression ended in 1945, but that doesn’t fit the facts above. Or one might say that FDR’s ad hoc programs put some people back to work, gave us some nifty buildings and national parks and beautiful art, and maybe grew the GDP slowly and erratically, though I think it was the consumption of surplus in supply that caused the GDP to slowly increase. However, if FDR had not torpedoed the London Conference, I think that the depression would have ended much more quickly, probably sometime in the mid thirties. And today, we would not have half the fiscal and monetary problems we currently have.

So many of our current economic problems originated with FDR.

Currently, our overextended and bastardization of Keynesian Economics isn’t working as expected.

‘”Investors are increasingly forced to seek alternative asset classes to insulate themselves in this war on cash. Simply put, very few asset classes can act effectively as an alternative safe haven,” said Joe Roseman, an investor formerly of hedge fund firm Moore Capital, whose 2012 book argued that extraordinary monetary policy would drive investors to silver, wine, art and gold or, as he termed it, SWAG.

‘This, of course, is not what policy makers have in mind. A principal aim of first quantitative easing and now negative interest rates is to drive money into financial assets, making money cheaper and easier to borrow and, hopefully, enticing companies to invest and expand.

‘Yet, as we’ve already seen, negative interest and very low interest rates have driven money into collectibles and other assets which buyers hope will retain value. See this Reuters story detailing the move towards alternative assets in places like Sweden, where prices for things like mid-century furniture have been exploding.’

(See link for the full story on the War on Cash.)

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