For a century, economists and historians have debated those questions, without arriving at conclusive answers. They’ve also asked these kinds of questions: When did the Great Depression end? If the stock market crash caused it, was it the only cause? If the stock market crash didn’t cause it, what might have been the cause or causes? Could the Great Depression have been avoided?
While few definitive explanations have emerged, some hypotheses seem generally to be more plausible than others, e.g., it is now widely accepted that the stock market crash did not cause the Great Depression, but rather was a reflection of a nervousness or an awareness of some troubling economic trend in the making. The stock market functions primarily as a barometer of investor psychology. Stock prices go up when people have optimistic expectations. Stock prices go down when people have grim forebodings.
Another generally endorsed hypothesis is that, whatever the cause or causes of the Great Depression may have been, the depression didn’t have to be great. It could have been merely an ordinary depression, not a great one.
The Depression went from being merely a depression to being the Great Depression because of government intervention in the economy. Economies organically seek equilibrium. An event or situation, like a depression, which takes an economy out of equilibrium, will trigger the economy to rearrange itself in order to work its way back to equilibrium. When governments take action to fix ailing economies, these actions, despite their good intentions, get in the way of the natural process of returning to equilibrium.
The reader will be aware of President Roosevelt’s New Deal programs, a mixture of massive government spending, massive tax increases, and massive increases in government debt. While intended as a way to help the economy, FDR’s New Deal prevented the economy’s mechanisms from automatically compensating for any deviations from equilibrium and from thereby bringing the economy back to balance, as historian Ben Shapiro writes:
According to Professors Harold Cole and Lee Ohanian of UCLA’s Department of Economics, FDR’s policies prolonged the depression by at least seven years.
FDR tried and abandoned different strategies in quick succession. But all of his strategies shared a common element: the assumption that the government should intervene in the economy, rather than stand back and let the economy sort itself out. At one point Roosevelt persuaded many manufacturing companies to give their workers an outrageous 25% raise; in return, those companies were given permission to raise their prices substantially. Here was the core of the problem: the government should have no say in how much people are paid; it should have no say in which prices manufacturers charge for their products. The catastrophic results of FDR’s wage and prices controls were predictable, as Shapiro explains:
Not surprisingly, wages were 25 percent above market level, but unemployment was also 25 percent higher than it should have been. Demand stalled because of artificial boosts in prices.
Professor Ohanian clarifies why wage and price controls lead only to more problems:
High wages and high prices in an economic slump run contrary to everything we know about market forces in economic downturns, as we’ve seen in the past several years, salaries and prices fall when unemployment is high. By artificially inflating both, the New Deal policies short-circuited the market's self-correcting forces.
Likewise, Professor Cole describes how the economy’s self-correcting mechanisms are stymied when the government tries to correct the problems:
President Roosevelt believed that excessive competition was responsible for the Depression by reducing prices and wages, and by extension reducing employment and demand for goods and services. So he came up with a recovery package that would be unimaginable today, allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies.
What drove FDR’s economic decision-making? Henry Morgenthau was one of FDR’s close personal friends; Morgenthau became friends with Roosevelt long before either of them entered politics, and twenty years before Roosevelt became president. Not only was Morgenthau Roosevelt’s friend until the latter died in 1945, he was also appointed by Roosevelt to a series of government positions, culminating in his appointment as Secretary of the Treasury by Roosevelt. He remained in that post for over a decade during Roosevelt’s presidency.
Despite good political and personal relationships with Roosevelt, Morgenthau described FDR as essentially uninformed about economics. During one of his political campaigns, FDR bragged about his education, saying “I took economics courses in college for four years.” The registrar at Harvard, however, revealed this to be untrue.
Accounts provided by a number of Roosevelt’s friends and appointees confirm that he often chose arbitrary numbers and used them to set economic policy, as Ben Shapiro reports:
FDR’s own economic ignorance is legendary. According to historian Amity Shlaes, FDR used to tinker with the price of gold arbitrarily. At one point, he raised the price of gold by 21 cents because he said it was a “lucky number, because it’s three times seven.” Henry Morgenthau, part of FDR’s brain trust, said later, “If anybody knew how we really set the gold price through a combination of lucky numbers, etc., I think they would be frightened.”
It remains plausible that there were few or no coherent systematic underpinnings for FDR’s economic policies, and that those policies did more harm than good, preventing what would have been a small depression from self-correcting. The New Deal policies made a short-term depression into the Great Depression, causing it to last longer and have more extreme impacts than it otherwise would have had, as Shapiro describes:
FDR’s policies greatly lengthened the Depression and made it far worse than it otherwise had to be.
It may be taken as an axiom that government actions in the economy — regulating, taxing, creating a national debt — prevent the economy’s own organic self-correcting mechanisms from doing what they do best: keeping the economy at a prosperous equilibrium point.
