The Super Summary of World History (58 page)

When the money supply gets tight and loans are hard to obtain businesses stagnate and often stop hiring or start laying workers off to save money. Fewer employed people results in other businesses selling fewer items and they start to lay off workers. This cycle, if continued, can trigger a depression and destroy an economy. When the money supply is easy and loans are easy to obtain businesses may borrow to expand and hire more workers. More employed people means more goods are sold. If many people try to buy the same items the prices will increase under the rules of supply and demand. If these prices continue to rise they can cause runaway inflation which can also destroy an economy. It is a tricky balancing act to keep economies on track.

Prior to the advent of the central bank concept, financial markets set the interest rates banks could charge for loans without government interference. Coupled with the gold standard, the market handled the variables of money supply, monetary value, and the interest rates charged for loans very well before the depression. During the Great Depression, nations went off the gold standard and began economic manipulation, eliminating the free market financial mechanisms setting interest rates and other monetary variables. This was a major and permanent change in the financial world.

Tariffs

Tariffs are critical to international trade.
tariffs
are a financial charge placed on goods coming in from foreign nations, thus making foreign-made goods more expensive. The international community knows that if one nation raises tariffs the nations negatively impacted will also raise tariffs. In practice, England might raise tariffs 10 percent on cars from the United States, and in response the United States will raise tariffs on English tea by 15 percent. Then England will retaliate for that US move, and back and forth it goes until both nations price themselves out of the markets for tea and cars. In
1930
, the Congress of the United States passed very high tariffs on goods from other nations in the
Smoot
Hawley
Tariff
Act
. This could not have come at a worse time. The world’s nations responded by rising their tariffs and international trade began to implode, especially for exports from the United States. Fewer export goods sold because the overseas price took buyers out of the market. This tariff act, along with retaliatory acts passed by other nations, prolonged and increased the severity of the depression and made the disaster truly global.

The
Contraction
Starts

By 1929 in the United States businesses faced new problems getting loans because the money supply was shrinking. Tariffs were going up and decreasing trade. The same was happening around the world. In essence, business was shutting down, markets were contracting, the economies of the world were starting to collapse, and business investment was falling precipitously. Somehow, this economic earthquake remained silent until
October
25,
1929
.

In
October
of
1929,
all illusions came to an abrupt end. The
US
Stock
Market
crashed
. Billions were lost on the New York Stock Exchange in just one day. Industrial stocks peaked at a high of 452 in 1929, but by 1932 industrial stocks were at 58. By 1932 in the US 23 million were out of work. The 1929 crash started a panic and millions of institutions and individuals began selling stock causing a continuing and precipitous market decline. Many paper millionaires, because of their extensive stock holdings, found themselves paupers within a few days. Some large banks failed because they held substantial stock investments. The panic spread to the middle class who owned few stocks but kept savings accounts in local banks. A bank does not keep enough money on hand to pay all its depositors their money at the same time. Banks loan out the deposited money, retaining only a small amount in demand deposits to pay the few customers coming into the bank on a normal day wanting cash. Because of the stock market crash thousands of depositors descended on banks demanding their money. The banks could not pay; consequently,
banks
began
to
fail
by
the
hundreds
all
over
the
nation
. When the local banks failed
they
took
the
depositor’s
money
with
them
into
default
causing people all over the United States to lose their life’s savings. As a result, fewer people put money into banks resulting in more money going out of circulation (and under mattresses) further decreasing the money supply and making money harder to obtain. As
fear
of the economic future took hold fewer people purchased items not absolutely needed, the business community suffered a greater slowdown, and more people experienced layoffs. Therefore, the descending economic spiral began and would not stop.

The economic crash became worldwide. American loans to Europe, previously easily extended, were now called. The American banks needed that money, but the European nations could not pay. The chaos in the world economy caused even more trouble, and as manufacturing declined more people were laid off, and with more layoffs fewer goods were bought (people without work stop buying) causing more layoffs. Things began to look very bleak.
This
was
a
downward
spiral
that
fed
on
itself
. Stopping this cycle became the major focus of economists all over the planet, but classical economic theories of the 1920s seemed unable to explain it. Unfortunately, governments were already trying to “solve” the crisis.

Hoover
and
Roosevelt—The
Twins
of
Economic
Failure

Governments around the world responded poorly to the crisis. In America, President
Herbert
Hoover
began lobbying businesses to
maintain
high
wages
. He was certain if wages remained high people would keep buying, the national economy would right itself, and things would be fine. As the downward trend continued Hoover instituted government work programs and
raised
taxes
to pay for them. President Hoover tried many things to overcome the Depression that no president before him dared attempt. In fact, his intervention into the economic system was unmatched until his successor took office. When Hoover lost the presidency to Franklin D. Roosevelt the new administration went far beyond what Hoover tried, but the focus of the effort was fundamentally the same. Under Roosevelt the Congress instituted massive work programs, tried to control wages and prices, tried to prop up farm-produce prices, supported union organization of labor in large industries, and
raised
taxes
far more than Hoover’s administration to support new and larger government programs. Roosevelt created regulatory programs stifling competition in an attempt to raise prices because competition kept them down. The National Recovery Act, a centerpiece of Roosevelt’s economic plan, created business cartels with fixed prices and criminal prosecution for anyone trying to undercut the set price. The US Supreme Court ruled the act unconstitutional. An enraged Roosevelt moved to “pack” the Supreme Court with additional justices favoring his programs.
[200]
The Court converted under this pressure, approving New Deal legislation even if it breached Constitutional standards.

Roosevelt fought to end the Depression and tried everything his economic advisors—mostly university professors—could think up. Experimentation with everything became acceptable because of the national emergency. If a program failed they would try something else, but everything they tried involved deep government interference with the capitalist market economy. Most of the interference came under the philosophic heading of
corporatism
, or
tripartite
control. Corporatism means government combined with big business to create cartel like situations limiting competition and imposing price controls. Under a typical tripartite scheme government, big business, and big unions join together to decide production levels, wages, prices, and regulatory oversight routines. With both corporatism and tripartite concepts the government has the ultimate say so, and it can enforce the decisions of the group with government power. These concepts were implemented in the Great Depression, WWI and WWII, although less effectively in the US than in the nations of Europe. Both ideas, like socialism, destroy the free market.

Strangely, if Hoover and Roosevelt had
done
nothing
the Depression in the United States may have ended in a year to perhaps three years. Today there is little doubt that government interference with the market economy prolonged and deepened the Great Depression.
[201]
Sharp downturns occurred in previous years under various presidents, but the government sat still allowing the recessions to run their course. Usually, they cut taxes and just rode out the problem for a few months. From 1854 to 1919, the
average
downturn
was
over
in
17
to
24
months
(see stlouisfed.org). From 1873 to 1879 a severe panic hit the nation; however, the government allowed the economy to punish marginal businesses, and the recovery, although delayed, was very robust. In 1920 through 1921 another panic hit and unemployment reached a high of 11.7 percent, but the government, under President Coolidge and Treasury Secretary Mellon, remained aloof and the adjustment was swift. Unemployment fell to 2.4 percent in 1923. After World War I bigger government was the rule, and some intellectuals (university professors) thought the government could solve the economic hardships, overturn the rules of classical economics, and build a bright tomorrow. They were very wrong. Nearly everything the government did under Hoover and Roosevelt was wrongheaded and backfired in ways beyond imagination. Huge voting majorities continued to back Roosevelt and the Democrats because they were “doing something” about the Depression. Roosevelt’s propaganda was excellent, and the public failed to understand the harm done by its well-meaning, but economically ignorant, government leaders.

By the mid to late1920s America increased production by 24 percent and real income grew by 2.1 percent; that is real prosperity. The next ten years stood in stark contrast to the prosperous 1920s. Even after the 1930s and 1940s America’s problems continued, and the nation’s return to true prosperity occurred in the 1950s.
[202]

A few statistics should help focus the issue:

1929
          Unemployment           
3.3%

1930                           "                  8.9

1933
                           "                  
24.9
(Roosevelt takes office in March)

1935              Unemployment         20.1%

1937                           "                  
14.3

1938
                           "                  
19.0
(5 years in office)

1941                           "                  9.9 (8 years in office)
[203]

Clearly, the chart shows FDR’s New Deal did not solve America’s economic problems until after 1941.

By interfering with the economy, the government destroyed the economy’s ability to adjust. Wages, for example, must be allowed to
fall
along with prices in economic downturns (classical economics—see Economic Theory below). This allows businesses to maintain their employment levels even though their goods are selling for less, otherwise (if wages stay artificially high) employers must lay off employees as earnings fall. The result of Hoover’s high wage policies was more jobless people. Raising taxes took money away from consumers who would normally spend the funds for goods, and businesses who could have maintained higher employment levels. The drop in consumer spending, in part because of high taxes, severely affected the business community. High taxes rob funds from private enterprise normally used to create jobs and additional goods. Lowering taxes during economic downturns increases funds available for consumers and businesses. Raising taxes as Hoover and Roosevelt did was the worst possible economic move.