With the nation in the grips of a failing economy, the Obama administration is prepared to step up the government’s fight against a possible Great Depression II. The types of solutions that the government is considering, however, are the exact same mistakes that caused and worsened the first Great Depression, when Herbert Hoover and Franklin Roosevelt turned an acute recession into a chronic depression. The popular history of the Great Depression goes as follows: the Roaring Twenties were a period of unrestricted laissez-faire capitalism, which naturally became unbalanced, and the unwise policies of quiescent Hoover caused the system to fail and created a massive depression. The depression was solved by Roosevelt’s policies of government intervention into the economy and the onset of World War II.

Thankfully, most of that tale is completely false.

The Roaring Twenties was not a period of unrestricted, laissez-faire capitalism, mainly because the Federal Reserve and other central banks around the world poured in tons of easy credit. Much like the current crisis, when any central bank expands credit (lowers the interest rate), it causes disturbances for investors who then misallocate capital into unprofitable investments or malinvestments. The malinvestments usually occur in the stock and real estate market, and would not have been undertaken if it were not for the interest rate expansion. When the central bank attempts to slow the pace of the credit expansion, like the Federal Reserve did in 1928, the bubble bursts and causes a stock market crash, a decline in real estate prices and a general financial panic. Artificial credit expansion throughout the Roaring Twenties led to phony prosperity not as a result of laissez-faire capitalism, but rather because of government interference into the market.

Elected in 1928, Herbert Hoover and his policies were the most interventionist in U.S. history. His program to end the Depression included keeping food prices and wages artificially high, propping up weak firms, constructing massive public works (ever heard of the Hoover Dam?), implementing monetary expansion and enforcing protectionism as evidenced by the Smoot-Hawley Tariff Act. These types of policies have become standard procedure by the federal government during recessions, so this has become what people view as laissez-faire capitalism. But the free-market position on recessions is to stop inflating the bubble by raising interests, decreasing the size of government and allowing malinvestments to become liquidated. Only by following this path will the recession be eliminated and not just papered over.

Comparable in size to the stock market crash of 1929 and the resulting monetary contraction, the 1839-43 Depression also saw a rise in consumption (21 percent) and Gross National Product (16 percent). In the 1839-43 Depression, there was no “federal response” and the economy healed much faster. But during the 1929-33 contraction, with Herbert Hoover’s proto-New Deal policies in place, there was a decrease in consumption (-19 percent) and GNP (-30 percent).

Franklin Roosevelt merely expanded the Hoover playbook and with similar results. FDR not only failed to solve the Great Depression, he also doubled the public debt. In 1932, FDR inherited an unemployment rate of 25 percent — in 1938, it was still 19 percent. His plans never worked at solving the crisis for a simple reason: government cannot produce new resources; they can only employ resources that are already produced. By taxing and spending, the government shifts resources from private usage to public usage. All that the New Deal programs accomplished was a shift of resources from one group of taxpayers to another.

The last aspect of the Great Depression Myth is the belief that World War II “got us out of it.” This makes even less sense than believing in the success of the New Deal — at least New Deal programs did not destroy resources. When we built massive fleets and sent them into the middle of the Pacific to get destroyed, as we did in World War II, we did not create jobs. This was an economic waste, with labor and material being employed for purposes other than usage by the general public. We are now worse off because that steel and electronic equipment is at the bottom of the ocean and not part of trains, radios or consumer goods.

The Depression ended because of the destruction of most of the world’s industrial base, a repeal of most New Deal-era programs and a return to normal production following the war. Recessions cannot be cured or fought, but are just the result of an earlier phase of malinvestments that need to be liquidated.

So now we are left with the unfortunate situation where the federal government is determined to stop the Second Great Depression by repeating the same interventionist mistakes that they committed in the 1930s. But perhaps this time we can convince them to allow the market to heal itself, and not begin a decade long economic slump.

Vincent Patsy can be reached at vapatsy@umich.edu.

Leave a comment

Your email address will not be published. Required fields are marked *