Over
the past several years, the term ‘Great Depression’ has made a
grand re-entry into the American mainstream and has as a consequence become perhaps
one of the most misunderstood terms. We are told it was everything that it
wasn’t and that it wasn’t everything that it was. Like many
important historical events, there is a good bit of revisionist history at
work with regards to those dark 12 years in American history when it seemed
as though there was nothing but despair and governments tripping over
themselves to fix something they didn’t have the tools or the business
monkeying with in the first place. Think of it like a butcher going to work on
the engine of a ’57 Chevy with baseball bat. The results are
predictable.
Unfortunately
for us here the United States, there are so few people alive who actually
experienced the Depression at a time in their lives when they could remember
and understand what was going on. We’ve lost our perspective, and our
experience from the patriarchs of the day, and that is a dangerous
combination. It means we’ll be pitched to and fro in the breeze and
will buy almost anything that comes in a newscast, daily paper, or monthly
magazine. It is really time for a thorough, while brief, reset on what the
Great Depression was – and wasn’t.
The
first really big misunderstanding about the Great Depression is that it
happened because the stock market crashed. You can go into a bookstore and
pick up countless history and economic texts and nearly all of them
promulgate the absolute lie that the stock market crash of 1929 was
responsible for the Depression. I don't think, however, that it is enough to
just call this out as a lie. WHY wasn’t the crash responsible for the
Depression in and of itself?
Contributory
Factors vs. Causes
Many
people often confuse contributory factors for causes. It is certainly true
that a crashing stock market erodes confidence. This is mostly true because
so many people subscribe to another fairy tale – that the stock market is
the economy when it has devolved into little more than a momentum casino for
banks and hedge funds to shave pennies from each other. Another contributory
factor is the idea that a crashing stock market makes people poorer, and thus
gives them less discretionary funds with which to spend. Consider this
– during the past several years, people have gotten hit with two
hammers – a housing crash and a market crash. Yet the spending continues
for the most part. People didn’t stop spending so much because of the
stock market, but rather because they lost their jobs – an important
distinction.
So
the ‘official story’ of the Great Depression is that capitalism
(in the form of the stock market) collapsed of its own weight and that
Hoover, a laissez-faire believer, failed to use the full power of the
government to manage the crisis. Later, FDR came in and, in similar fashion
to today, wielded the power of government to ‘manage’ the crisis.
And where power didn’t exist, it was created – in many cases
outside the Constitution. The obvious takeaway here is that capitalism is a
failure and only naked socialism can save us from the evils of economic
torment. Don’t laugh folks – there are a lot of people who
believe this nonsense. And many of them hold important roles in our
government.
Multiple
Depressions vs. a Single Event?
A
reasonable assessment of the facts surrounding the Great Depression points to
the fact that there were at least three, and possibly four, actual
depression-like events rather than the single event depicted in the
‘official story’. For the purposes of this paper, I am
going to focus on three of these events: a low in the business cycle, global
involvement in the US collapse, and the New Deal.
I
- The Business Cycle – Monetary implications
One
of the biggest facts left out of the official story of the Depression was
that it wasn’t the first. In fact, it takes quite a bit of digging in
the history books to find any mention of previous tragic deflagrations of the
business cycle. I am not going to outline each of them here in the interests
of time, however, I am going to list them: 1819, 1836-37, 1857, 1873,
1893-95, and 1921. I have omitted banking panics such as 1907 since we’re
discussing the business cycle. The very interesting fact about all of these
sharp downturns of the business cycle is that ALL of them coincided with a
complete and utter failure of the management of the money supply by the
government. However, as can easily be inferred by the dates of these crises
and by closer study of the crises themselves, these were all short-lived
events. Most lasted two years with a couple of them lasting 4, but that was
the most. The Great one was three times that long. Was this just because of
monetary errors? Of course not. It was monetary errors compounded by policy
missteps and ill-advised interventions on the part of government. In short,
it wasn’t a failure of capitalism that caused the Depression, it was
the failure to adhere to the free market that caused it – and then
compounded it.
Let’s
look at the causality of how monetary policy impacts, and as some would
argue, even creates the business cycle. The cycle begins with a bolus of
fresh money into the system. This oversupply of money drives down interest
rates in the market place and causes businesses to undertake capital spending
projects. Many businesses improperly interpret the bolus of fresh money and
its effects as an increase in aggregate demand. Thus many of these capital
spending projects are foolish in nature. I am sure it won’t take much
intellectual gymnastics to figure out what some of today’s foolish
endeavors happen to be. As this move continues, business costs begin to
rise due to the oversupply of money. This is further proof that inflation is
a monetary event not an economic one. As cost increases persist, the monetary
authorities begin to worry about inflation. Remember, their job is to manage
inflationary expectations within a fiat system. So they turn off the pump, or
even reverse it. As a result the ‘boom’, which was never real to
begin with, comes crashing down once the supports are knocked out from under
it. The business cycle bottoms and it starts all over again. This sequence of
events was precisely played out during the latter part of the 1920’s.
Austrian economist Murray Rothbard estimated that
the money supply ballooned by around 60% between 1921 and 1929. There is a
good deal of evidence that suggests the main reason the USFed
kept the heel to the steel so long on monetary expansion in the 1920s was to
enable the Bank of England to maintain low post WWI interest rates. Remember
the fact that our USFed is beholden to the British
by virtue of its owners.
The
roaring 20s were just that – roaring. And nobody was paying any
attention either. One of the biggest problems with advancements in technology
– even then – is that they assist in masking the effects of
monetary inflation. As such the 1920s saw a period of relatively stable
prices for goods. The inflation made it into rampant asset speculation. Sound
familiar?? As has been the case in so many subsequent boom cycles, the USFed has telegraphed its actions with regard to taking
the punch bowl out the back door. By 1928, interest rates on the short end
had begun to increase. Between January 1928 and August 1929, the discount
rate was increased 4 times from 3.5% to 6%. It gets better. For the next
three years into the depths of the first leg of the crisis in 1932, the USFed allowed the money supply to shrink by 30%.
Let’s
keep score here. In the 1920s the Fed allowed the money supply to rise by
over 60%, then allowed it to crash by 30% in the
three years following August 1929.
Looking back in history, this has been the pattern of every boom-bust. Overissuance followed by contraction. The sad thing is
that ending the USFed probably wouldn’t make
too much of a difference – if only in this regard. Our government has
shown complete ineptitude and an inclination to corruption as well when it
comes to regulating the money supply. The one thing that would result in an
ending of the USFed, at least in theory, is greater
accountability. As an interesting aside, the St. Louis Fed in its most recent
bimonthly ‘Review’ features an article that argues
what a great creation the central bank is, and how it is directly accountable
to the people. It is so biased as to be almost entertaining.
Friedman
and Schwartz argued a ‘seismic incompetence’ by the USFed. It is my humble opinion, however, that these
events constitute a self-inflicted wound. Why say such a thing? Look at the
results; they are undeniable. A massive consolidation as the elite snapped up
paper assets at fire sale prices and the unmistakable intrusion of government
into the social and economic fabric of this nation, and a calling in of a
fiat money’s only competition are three salient examples. Now take a
look at the crisis of 2008 and ask yourself the same questions. Look at what
has happened since. Government has gotten larger, and more intertwined with banks
and in the regulation of everyone’s business. These are the events and
facts. Draw your own conclusions.
II
– Global Involvement and Resultant Disintegration
Unlike
today, where collapses can happen across the globe in mere hours, the initial
shocks of the Great Depression were limited to the United States. Ironically,
had policy mistakes not been made at numerous times, the Great Depression
would never have been great at all. It would have been just a footnote, like
the aforementioned periods of economic duress. I mentioned previously that it
is my opinion, based on the preponderance of the evidence, that the USFed precipitated the economic crash intentionally.
However, what is certainly open to much speculation is the influence the
central bank had on subsequent policy decisions. I am not going to go there
since politics is not my field. What I will say in post-mortem fashion is
that there were gross gaffes made that took a pinhole in the proverbial dyke
and ran a train through it.
First
lets look at unemployment.
Granted, the methodologies were much different in the 1930s than they are
today, but I am quite certain the numbers were much less maligned in those
days. 1929 unemployment averaged a mere 3.2%, a figure that rose to a
recessionary 8.9% in 1930. Oddly enough, calling 8.9% unemployment ‘recessionary’ was not my label, but
the labeling of the economists of the day. Contrast that with today’s
metrics and the outright refusal to admit the continuing contraction in
today’s economy.
Unemployment
would peak at the now-famous 25% level in 1933. Much of this increase was
blamed on the free market and its advocate, Herbert Hoover. However, a more
in-depth and complete study of the policies Hoover endorsed and championed
demonstrated that he wasn’t the free-market advocate he claimed to be.
In fact, Hoover’s running mate John Nance Garner asserted that Hoover
was ‘leading the country down the path towards socialism!’
Franklin Roosevelt of all people also rang the bell of Hoover’s
socialist tendencies – and both were absolutely right. The true irony
here is that FDR ended up being the one who would lead America perhaps the
furthest down the path to socialism with the myriad programs enacted during
his tenure, almost all of which put the destinies of the people in the hands
of central planners.
In
my opinion, Hoover’s biggest mistake was his enactment of the
Smoot-Hawley Tariff Act. This one is actually in the history books, but it is
always portrayed positively, when in fact it was almost singlehandedly
responsible for passing the banner from the first phase of the crisis –
that of America – to the rest of the world.
Smoot-Hawley was piggybacked right on top of Fordney-McCumber;
another tariff act passed in 1922 that had devastated US agriculture.
Smooth-Hawley was a protectionist bill at the time when it was least needed
and it ended up triggering an international trade war. It essentially closed
the border to foreign goods. Tariffs on agricultural goods were raised from
an average of 20% to 34% and from 50% to 60% on wool and wool products. 887
tariffs were increased as a result of Smoot-Hawley and the list of dutiable
goods increased to over 3,000. The biggest gaffe of Smooth-Hawley is that
many of the tariffs were stated as an absolute amount as opposed to being a percentage
of the price. As prices cratered as the USFed’s
consolidative deflation kicked in, the flow of foreign products nearly
stopped, as it no longer made sense for foreigners to export goods to
America. Thousands went home jobless from the steel, paint, and clothing
industries alone.
It
was evident that the thinking behind Smoot-Hawley was to force Americans to
buy products made at home, which would stimulate aggregate demand, thereby
solving the unemployment problems. Unfortunately, the trade dynamics at the
time dictated the other half of that equation. Foreigners with no place to
export to won’t have the disposable income to purchase our
exports. In a world where countries produce based on competitive and
comparative advantages, a healthy trade environment is essential to the
success of everyone. Societies that have not designed themselves to be
self-sufficient can’t suddenly become so with the stroke of a
politician’s pen. And that is what Smooth-Hawley tried to do –
and it helped to take an American problem and make it a global one. Put
another way, Smoot-Hawley was to the 1930s what the repeal of Glass-Steagall has been to the first part of this new century.
Foreigners reacted in predictable fashion; they cut off the United States
from the trade picture, refusing to purchase American goods. With trade
sufficiently disrupted, the surpluses and shortages of goods around the globe
worsened, and the economic calamity that had hit the US became a global
problem.
The
US agriculture industry in particular was devastated, losing around one-third
of its market almost overnight. Food prices collapsed and the dominoes
starting falling. 9,000 bank failures, mostly ones that held farm loans,
rocked the financial sector between 1930 and 1933. Here is another point
where facts diverge from populist historical opinion. The banks failures are
today blamed on the stock market crash, and in effect, the failure of
capitalism, when it was government intervention that was
directly responsible for those failures. The stock market, which at that time
was a better reflector of policy and the economy, peaked at DOW 381 in 1929,
crashed to 198 in 1930, then rallied up to 294 by April 1930. The DOW would begin
to fail again as Smoot-Hawley made its way through the legislative process.
The bill would be signed, the bank failures would begin, the economy would
tank due to a collapse in aggregate demand (which was exacerbated by a
deflationary stance by the USFed), and the DOW
would crater at 41 – a 90% loss two years later. As a side note, it
would take 25 years for the DOW to reach 381 again. Feeling good about DOW
14,000 again anytime soon?
Many
historians accurately point out that it was likely the trade war that started
with the signing of Smoot-Hawley that eventually precipitated WWII.
I’ll cite the old economic axiom: When goods don't flow freely across
borders, armies will. If you are feeling shivers up and down your spine right
now – you should be. The environment in place today is eerily similar
to that of the late 1920s and I am not even talking about the stock market.
We’re hearing about potential trade wars over currency valuations, we
are seeing foolish legislation fly through Congress on a regular basis, and
we are seeing the USFed, in the middle of it all,
as usual, rigging the system for its owners. Just like 1929, little has
changed. Sure, the names, faces, and places have changed, but the song
remains the same. Truly, there is nothing new under the sun.
III.
The New Deal
Franklin
Roosevelt rode into Washington on a political white horse in 1933,
capitalizing in a huge way on the mistakes of his predecessor. He rode into
town on the platform of reducing government spending by 25%, a balanced Federal
budget, and a gold currency that would be defended at all costs. That was the
platform. Also on the platform was the removal of the Federal government from
all issues that would be better handled by private enterprises and the ending
of the disastrous and terribly inefficient Hoover farm subsidies.
You can do the research for yourself; this is what FDR promised when he ran
for President. It all sounded very good. We got none of it and the mistakes
and fiscal folly continued.
FDR’s
first act, which would strike fear in the hearts of every American with a
dollar to his name, came before his seat in the oval office was warm. On
March 6, 1933, FDR declared a bank holiday that would last 9 days. Friedman
and Schwartz also argued that the bank holiday was essentially a waste of
time since it did nothing to correct the mischief of the USFed
or reverse Smoot-Hawley. All the banking holiday did was deprive
depositors of their funds and sow the seeds of further distrust – now
directed at the new administration. 5,000 of the banks that closed their
doors on March 6, 1933 did not re-open nine days later and of those 5,000,
40% of them never opened their doors again. Can you say consolidation?
Later
that same year, Congress gave FDR the power to seize private gold and then
fix the value thereof. The US was now well on its way to divorcing itself of
the gold standard. This is where I must call into question the influence of
the USFed and international bankers on US policy.
Cui bono is clear in this case: the moneychangers. The Fed should have been
abolished for its malfeasance in 1929, yet, essentially, it was handed more
power when the private gold was called in. Sure, the USA would not totally
leave the gold standard until 1971, but the die was cast - under a President who
ran on the platform that such an event would never happen on his watch. This
is not intended to be a hit piece of FDR; I am just stating the facts and
events that took place. Senator Carter Glass summed it up in early 1933: “It’s dishonor, sir. This great government, strong in
gold, is breaking its promises to pay gold to widows and orphans to whom it
has sold government bonds with a pledge to pay gold coin of the present
standard of value. It is breaking its promise to redeem its paper money in
gold coin of the present standard of value. It’s dishonor, sir.”
The
hits continued to roll throughout the 1930s. In the first year of the New
Deal, the proposed budget was $10 billion, on revenues of just $3 billion. So
much for the cut in government spending. Between 1933 and 1936, government
expenditures increased 83%, with government debt increasing by an amazing
73%. Seriously, does ANY of this sound familiar?
In 1935, we got Social Security, and it now hangs around the neck of America
like a millstone. Three years later we would get the minimum wage law, which
would ensure that more Americans would remain unemployed. Remember, absent
Fed mischief and felonious behavior, your dollar would be a stable store of
wealth and we would not need minimum wage laws, and increases of the same, to
‘keep up’.
Mainstream
economists will be quick to extoll the virtues of both Social Security and
minimum wage laws. In reality, the former told Americans that they could let
up their guard – the government had their backs covered, while the
latter ensured that many of them had no back to cover. The minimum wage law
priced (and continues to) out the members of society at the bottom of the
experience scales. Namely, teens, young entrants into the workforce, and the
uneducated. It does this by saying that a firm must pay a wage that is
above equilibrium in order to have the privilege of that person’s time.
Simply put, if a worker can’t produce the value of the cost of his
employment, then that job will not be filled. By artificially raising the bar
constantly (primarily due to the above-captioned inflationary shenanigans of
the USFed), more of these people are never hired,
and instead rely on government assistance to survive.
The
AAA (Agricultural Adjustment Act) put a tax on food processors and the
revenue from that program was used to destroy crops and cattle. See, there
was a surplus as a result of Smoot-Hawley, so instead of solving the problem
by abolishing the miscarriage of economics that was the law, the government
taxed another area, then used the tax revenue to pay farmers to pour milk
down the drain. It is kind of similar to the example of corn-based ethanol
where the government taxes gasoline, then uses some of that revenue to burn
up the food supply while corn prices hit record highs. I know it isn’t
a perfect example, but it requires the same amount of insanity to justify.
Had
enough yet? I’ve got just one more – the National Recovery
Administration (NRA), brought into existence by the National Industrial
Recovery Act, passed in July of 1933. Again, and I don’t care if I
sound like a broken record – does ANY of this sound familiar? Under
this law, many industrial businesses were forced into what might easily be
considered cartels. The NRA was funded by taxes on the industries it
regulated and it in many ways nearly dictated how they went about doing
business. Here’s the kicker; in the months leading up to the passage of
NIRA, there were signs that the economy might be finally on the verge of
recovery. Factory employment had increased by 23% since its bottom, and
payrolls were also on the rise. The NIRA was passed and work hours were cut,
wages capriciously increased or decreased, and the full regulatory burdens of
this new overlord of American industry were placed squarely on companies that
were just starting to get a steady footing. The results were predicable and it would be absolutely obtuse of anyone to
even suggest otherwise. Six months after the law was passed, industrial
production had already dropped 25%. In fact, during the NRA’s entire
existence, industrial production NEVER got as high as it had in the months
before the passage of that bill in July of 1933.
I
could spend another 5 pages and 5,000 words detailing the rest of the New
Deal, the various agencies, Acts, and actions that put a boot on the throat
of the American economy. But I think you get the point. In 1933, British
‘economist’ John Maynard Keynes would strut into the history
books with what is really nothing more than a bunch of gobbledygook that
would justify the preposterous and underhanded actions of Hoover, Roosevelt,
and the USFed. His ‘work’ was called
‘The Means to Prosperity’, which when compared with the content,
was an oxymoron of dictionary example quality.
As
a footnote, many of the New Deal programs like the NRA and AAA, among others,
were stomped by the Supreme Court in 1935 and 1936 as being unconstitutional.
The economy would undergo some recovery from late 1935 through early 1937
before crashing again as the supports were blown out from under it by the
Court. Oddly enough, revisionist historians blame the Supreme Court for the
final leg of the Great Depression, when again it was government interference
that set the stage for that portion of the collapse as well. Unfortunately,
the government still wasn’t finished perpetuating the Depression and
the Wagner Act (better known as the Labor Relations Act) was passed in 1935
after the voidance of the NIRA. This essentially resulted in organized labor
kicking off an orgy of organizing activity from strikes to boycotts, to
seizures of plants and violence. Just what the fledgling economic recovery
needed. I am not against organized labor in principle, but again, the
consequences of the mere timing of this action couldn’t have been that
hard to fathom.
Conclusions
I
am hopeful that I have established beyond reasonable doubt in this paper that
monetary policy, and more importantly, the execution and timing of monetary
policy, have a direct effect on the business cycle. The 21st century tendency
towards booms and busts is a direct result of the mismanagement of both the
currency and the supply thereof. As a corollary, mismanagement of the
business environment by government can have consequences that are just as
tragic as I discussed with regard to Smoot-Hawley, NIRA, AAA, and eventually
the Wagner Act. We had two leaders and complicit Congresses in the 1930s that
acted like proverbial bulls in the china shop. We had a central bank that was
managing things for the benefit of those who own it,
and what was even worse – we had a country that was very literally demanding
all of the above. And I will say it one more time for posterity – does
any of this sound familiar?
Until Next Time,
Andrew W. Sutton, MBA
Chief Market Strategist
Sutton &
Associates, LLC
Interested in what is going on in the markets and
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