Econ 101: The Great Depression

     Some in the media try claim that we are in the beginnings of a recession in an attempt to make the case for larger government intervention in the economy. It is instructive to consider an era when there was a truly severe economic downturn, the Great Depression, in order to give some perspective to our current situation and whether government action is likely to help or hinder things.

Great Depression by the Numbers

     Economic growth: The Great Depression was a period of decline that involved not just the economy of the United States but that of the entire world. The economy began to falter in 1929. When it hit bottom in 1933, world production had fallen by one-half, with the United States economy declining by 29 percent.

     Unemployment: U.S. unemployment rates rose to a peak of 24.75 percent in 1933. The rate was still at 20 percent in 1935 and only fell to 14.2 percent by 1937. Then it rose again, hitting 18.9 percent in 1938 and was above 17 percent in 1939.

     Financial Sector: The Dow Jones Industrial Average fell from a peak of 381.17 in October of 1929 to a low of 41.22 on July 8, 1932, a decline of 85 percent. The Dow did not return to its peak for more than 22 years. On Dec. 11, 1930, the fourth-largest bank in New York, Bank of United States, closed its doors. From 1929 through 1933, about 10,000 out of the 25,000 banks in the United States disappeared.

That Was Then …Let’s Not Repeat It

     These numbers are so far afield from what we are experiencing today that it is difficult to comprehend their magnitude.

     As of this writing the Dow is at 12,700, down 11 percent from its peak of 14,280.

     Unemployment stands at 4.9 percent despite the sub-prime loan crisis. Some banks are struggling, but not failing. And GDP rose by .6 percent in the last quarter.

     Yet the economy is the No. 1 issue mentioned by voters looking toward the presidential election. The expectation is that each candidate must have a plan to “rescue the economy.”

     If we understood what caused the Great Depression and why it lasted so long, we might temper our demands for government intervention.

     In “America’s Great Depression,” Murray Rothbard explained the beginnings of the Depression as the inflationary monetary policy of the newly formed Federal Reserve – which was masked by the large increases in productivity that were occurring due to the tax cuts of the 1920s.

     Milton Friedman and Anna Schwartz and argued in their famous treatise, “A Monetary History of the United States,” that the failure of the newly formed Fed to offset the massive decline in the money supply was a primary reason for the depth and length of the Great Depression.

     Deposits and currency in the hands of the public fell by more than one-third from 1929 to 1933, with the Federal Reserve doing little to stem the tide. In fact, when Britain abandoned the gold standard in September of 1931, the Federal Reserve actually raised the discount rate, the rate that it charges member banks to borrow. The proper action of the Federal Reserve would have been to purchase bonds, thus increasing the reserves of banks and the money supply.

     One of the major causes of the Depression was Congress’s passage of the Smoot-Hawley Tariff, which was signed into law on June 17, 1930. Smoot-Hawley placed tariffs on more than 20,000 imported goods. It halted the recovery from the 1929 downturn and resulted in retaliatory tariffs from U.S. trading partners and a decline in U.S. imports and exports of more than 50 percent.

     American agricultural products were particularly hard-hit by retaliatory tariffs. Farm prices fell, with a bushel of wheat falling from $1 in 1929 to 30 cents by 1932. Some economists believe that the effect of Smoot-Hawley actually began earlier, since some foreign governments retaliated when the bill passed the House in May of 1929.

     Tax policy during the Depression kept the economy from recovering as well. President Hoover persuaded Congress to enact the Revenue Act of 1932, which raised income taxes across the board. The top marginal rate rose to 63 percent from 24 percent, with the estate tax doubling and corporate income taxes rising by 15 percent. Roosevelt continued in this fashion, raising the top marginal income tax rate first to 70 percent and eventually to 90 percent.

     Today’s candidates for the presidency are calling for tariffs on Chinese goods, repeal of the North American Free Trade Agreement, and raising income tax rates on the highest earners. These, along with unstable monetary policy, are policies that contributed to the Great Depression. Perhaps we should realize that our current situation is far from an economic disaster – but repeating old policies of inflation, trade barriers, and tax hikes are capable of leading us in that direction.

Dr. Gary L. Wolfram, a Business & Media Institute adviser, is the George Munson Professor of political economy at Hillsdale College in Hillsdale, Mich.