The Panic of 1921 looked at least as severe initially as the Wall Street Collapse of 1929, but the former event resolved in under a year and the latter became the biggest catastrophe in American history. What made the Great Depression so much worse, and so much longer? In the first part of this series, I’ll take a look at the early years of the crisis under its first President, Herbert Hoover.
I’ll spoil the surprise now and say there’s no perfect consensus on the main cause of the Depression, though there are some key contributing factors everyone agrees upon. Broadly speaking most theorists of this era can be separated into two main groups, the Keynesians and the Monetarists. The Keynesians thought the Depression was caused by a lack of demand, which would spiral downwards unless the state stepped in with tax cuts and stimulus spending. The Monetarists, a little farther to the right on the economic spectrum, believed that markets would have generally self corrected as long as the Federal Reserve balanced the money supply. Alternative minority theories include the Market Monetarists, who think the Gold Standard caused the crisis, and the Austrian School of Economics, whose adherents believe the Depression was prolonged by excessive state intervention.
Excessive state intervention? Isn’t this Herbert Hoover, the do-nothing president? Well, it turns out this is a bit of a caricature, not least buoyed on by Hoover’s own writings after he left the presidency. Hoover talked that small government talk, but in practice he had a strong streak of technocrat central planner. Far from being a reckless free marketeer, Hoover saw his own philosophy as a “third way” between capitalism and socialism, and worked to intertwine the systems of the state with the movements of the market. During his time in the White House Hoover would unify manufacturers under a nationwide set of standards and establish central agencies to coordinate the moving parts of the economy. And what an economy it was! Those were the years of the Roaring Twenties, of Coolidge Prosperity followed by Hoover Prosperity, of things going up, up, up until . . .
September 1929: The Depression Begins
On Black Friday, 1929, a growing stock bubble finally burst and an economy that had been running red hot finally came raining down. Everyone agrees that the beginning of the Great Depression can’t be directly blamed on Hoover. The commonly agreed upon cause is a glut of irresponsible stock speculation, which Hoover had indeed warned about for years.
However, while the Wall Street crash was the trigger moment for the nationwide crisis, it was far from the first sign of an unstable economy. Running parallel to the urban prosperity of the Roaring 20s was the steady collapse of the farm sector, which suffered from a stubborn post war surplus and tumbling crop prices.
This surplus was actually in part the legacy of Hoover’s previous efforts as U.S. Food Commissioner to encourage Americans to grow in excess for the war effort. It should be said that while Hoover may not have caused the stock bubble, he did sit idly by as the farms veered towards collapse
1929 - Early 1930: Hoover’s First Wave of Federal Initiatives: The Hoover Recovery
When the stock market crashed, however, Hoover reacted immediately, getting major industry heads to agree not to cut wages, passing a tax cut worth $160 million and pushing federal funds into infrastructure projects. He went on to establish the Federal Farm Board, charged with belatedly offering loans to the now destitute farm sector and picking up the slack by buying surplus crops. As for the growing problem of unemployment, Hoover was, and forever continued to be, philosophically opposed to welfare. He did make a vague effort to address joblessness with the President’s Emergency Committee for Unemployment, a bloodless administrative organization that couldn’t actually hand out funds or jobs.
Hoover’s early approach had the beginnings of a Keynesian solution, though Keynes himself was still a minority voice in the world of economics. Keynes would go on in 1936 to author “The General Theory of Employment, Interest and Money,” which would outline a novel model for economic collapse: if unemployment rose, people would have less money to buy things, businesses would predict lower profits and therefore invest less, and the entire process would spiral cyclically downwards. To break this "demand cycle" Keynes advocated cutting taxes, lowering interest rates, running a deficit and raising federal spending to recirculate money for businesses to borrow. Hoover did cut taxes and push federal stimulus spending, though only within the hard limitations of a properly balanced budget. Unfortunately, interest rates were also to remain sky high.
Economic indicators began to trend back up and early press reports praised Hoover’s decisive intervention. For a while it looked like the stock market crash of 1929 might go the way of the Panic of 1921.
The small upwards peak in 1930 represents the short lived “Hoover Recovery.” Does the slight bump in the economy after Hoover implemented a partially Keynesian strategy validate the Keynesians? It can’t be said with any real confidence, given that Hoover never pursued their chief recommendation of intentionally running a deficit, an idea anathema to his somewhat Republican spirit. Either way, the slump was shortly to return with a vengeance.
1930-1931:The Whole World Gets Involved: Smoot-Hawley and the European Situation
One of the most important downstream effects of the 1929 crash was a spike in protectionism throughout Congress. This led to the major legislative milestone of the early Depression: the 1930 Smoot-Hawley Tariff Act. Smoot-Hawley was originally intended to be a belated farm relief package, only to morph on the floors of Congress into the protectionist bill to end all protectionist bills, raising tariffs by 20% to 50% across a vast range of products. Hoover took little leadership during the design of the act and the process was rife with cronyism and lobbyist influence. Literally 1000 economists told Hoover not to sign it; he did anyway, and sparked an extremely poorly timed trade war across the Western world.
Soon a series of crashes across Europe in 1931 set the American economy off again as countless overseas export customers went broke. Some sources I’ve read believe Smoot-Hawley led directly to European banks collapsing; others claim the impact of the act is much more modest. Either way, things were heading back down everywhere and an added layer of trade barriers between interdependent economies was probably not to the greater benefit of the system.
For what it’s worth, Hoover actually did propose, almost exactly a year after the passage of the Smoot-Hawley Tariff Act, a one year nullification of European debts, news which was met with rising optimism and a strengthening stock market. The “Hoover Moratorium,” however, provided only modest relief to the struggling European nations, partially because their economies had already significantly regressed, partially because Britain was reeling from the effects of an overvalued currency and because France refused to give an inch on failing Germany’s war debts. Could a stronger debt relief bill have saved Europe and thus prevented its downstream effects on the United States? This is a huge “what if” that can never be fully answered. Imports and exports between America and Europe during this period dropped by 67%. Unemployment soared on both continents and Hoover continued to refuse to push a national unemployment program or bailout.
If this graph is accurate, Smoot-Hawley didn’t change the trendline much - it had been shooting straight down for at least a year prior. On the other hand, given that other economic indicators were trending back up, it’s plausible that Smoot-Hawley continued to drag trade down during what could otherwise have been a lasting Hoover recovery.
Early 1932: Hoover’s Second Wave of Federal Initiatives: Hoover’s New Deal
Things were looking bleak. Hoover’s Federal Farm Board, while designed with noble intentions, had ended up incentivizing farmers to borrow more money, grow more crops, and then sell anything the market didn’t buy back to the government. Needless to say, this had the opposite of the desired effect of curing the surplus. American farms were reeling and, in the wake of the trade war, American industry was heading down just as fast.
While Hoover had initially hoped to massage the Depression into a natural fix, by 1932 he was convinced stronger action was necessary, and began his second wave of Federal relief programs by launching the Reconstruction Finance Corporation to distribute loans to banks, railroads, municipal governments and agricultural organizations. He went on to pass the Federal Home Loan Bank Act and the Glass Steagall Act, aimed at boosting lending throughout the country, and the Emergency Relief and Construction Act, which siphoned congressional funds for large scale infrastructure projects. Note that these are essentially smaller and less narrowly focused versions of later New Deal programs. At a minimum, there’s a lot there for an expansive-government minded liberal to appreciate.
I often hear the dynamic between Hoover and Roosevelt presented as some kind of face off between reactionary corporate capitalism and progressive populism, but my impression is that Hooverism, as it evolved over time, was less a foil to the New Deal than it was a natural precursor.
Mid 1932: The Revenue Act of 1932: Tightening the Belt Back Up
However, running parallel to these new generous federal programs was the steadily rising threat of a growing deficit. In present day America we’ve been living with a massive deficit pretty much my whole life, so it's almost comical to hear that there was a time people were worried about there being any deficit at all. While people like Keynes counselled that running a deficit was actually desirable, mainstream economics held the opposite - that no, this really was cause for alarm that might discourage foreign investors and devalue the Dollar.
The fear of the deficit also meshed nicely with Hoover’s belief, still held deep down somewhere, that a fiscally responsible, balanced government was the cornerstone of the kind of Republican governance he did believe in. Hoover’s solution was to raise taxes across the board with the Revenue Act of 1932. This too was a prelude for Roosevelt’s more expansive progressive tax code by setting a new top tax rate at a walloping 63%. However, Hoover’s poorly thought-out plan managed to make life harder on ordinary people and add the extra weight of corporate taxes on a business sector already struggling to afford employees at all. One modern tax analyst calls the 1932 Act “the largest - and most poorly timed - peacetime tax in American history.” Can’t you just hear the Keynesians howling?
But let me add a disclaimer: a sizable contingent of economists and historians believe that most of what I've covered so far - all this Keynesian focus on controlling demand and spending - is misguided. It’s time to touch on the second school of thought, the Monetarists, who maintain that fiscal policy played a small role in the Depression relative to the true cause: monetary policy.
The Great Contraction: Tight Money and Loose Money
Monetarists would have been likewise dismayed at the era's potent mixture of high taxes and high interest rates. Keynes, however, objected to these practices in the context of a recession, whereas Monetarists tend to disagree with the government meddling in the economy in general. Monetarists shun federal spending solutions along with the demand cycle, and claim that the real problem was simply a shortage in the money supply. In “A Monetary History of the United States,” economists Milton Friedman and Anna Schwartz describe the prosperous 20s as a period where the Fed diligently kept inflation under control by increasing the amount of Dollars in circulation to match rising prices. In late 1928, however, the Federal Reserve shifted leadership and began to pursue a new, tighter monetary policy, supposedly to restrain the "irrational exuberance" of Wall Street. Between 1929 and 1932 the Fed refused to lower interest rates and print more cash during a time when gold hoarding was rising and the nation desperately needed more money flowing through the system. Over the next four years the amount of paper money would dwindle by two thirds in what Friedman and Schwartz have termed “the Great Contraction.”
In the eyes of Friedman and Shwartz, the Federal Reserve also made one further crucial mistake. During recent recessions, the Fed had put limits on how much money people could withdraw. In 1929 there was decidedly no such policy in place. As nervous people began to withdraw their money en masse, the value of the currency dropped as a whole, thus encouraging other people to withdraw quickly as well before their savings became worthless. This created a vicious cycle of bank runs across the country; the Fed sat idly by and refused to offer bail outs as two thirds of American banks went bankrupt.
The fact that this tight money policy was pursued exactly at the start of the Depression and throughout its worst early years makes it seem like an extremely plausible explanatory mechanism. On the other hand, keep in mind that the economy did in fact show signs of improvement on two separate occasions in 1930 and again in 1932 - despite the fact that this tight money policy was still in place.
Furthermore, Friedman and Shwartz have had difficulty connecting policy changes directly to economic outcomes, which they justified with “long and variable lags.” In the words of Friedman himself in a letter to another economist: “Changes in money tend to affect output after something like about six to nine months, and inflation only after another 18 months.” Understandably there has been some skepticism of these lags, which has led in recent years to the growth of a new movement: the Market Monetarists.
Gold Bugs and Gold Bears
Market Monetarists are broadly separated from mainstream followers of Friedman by their claim that markets can react instantly to policy, their belief that the Fed should boost income rather than inflation, and their focus on sweet, sweet gold.
I bring this relatively newer movement up because it gives me a chance to really lay out the case for and against the Gold Standard, which everyone from Fed Chairman Ben Bernarcke on the way down agrees played some relevant role. Before the Great Depression, mainstream economics generally held that economic stability was achieved by maintaining currency stability, commonly by pegging your currency to gold at a fixed ratio. Most modern economists casually disagree with the Gold Standard, but Market Monetarists argue that the system itself was inherently volatile because it subjected a pegged currency to any shocks in the gold market.
The authoritative text on this theory is Scott Sumners’ “The Midas Paradox: Financial Market, Government Policy Shocks and The Great Depression,” which modifies the Great Contraction to focus on the money supply relative to changes in public and private hoarding of gold, rather than overall prices. Sumners points out that in 1929 the world’s three largest economies, Britain, France and the United States, were all pursuing restrictive monetary policy while at the same time allowing large exports (outflows) of gold, thus rising the global “gold reserve ratio,” or the ratio of gold to cash. In this model, this deflationary pressure on the international economy is what made the 1929 Wall Street Crash so long lasting and severe, relative to the brief crashes of 1887 or 1921.
The above graphs plot the tightly woven relationship between the gold reserve ratio and plummeting industrial production, used as a proxy for a healthy economy. While central banking policy initiated the rise in the ratio in 1929, throughout the following years the shifts in industrial production corresponded with spikes in private gold hoarding, which came in waves as people lost trust in the failing banks. Market Monetarists point to the immediate bounce back in our economy following FDR’s decision to forcefully collect gold from Americans, effectively outlawing the main source of hoarding and restoring the Federal Reserve’s gold inflows.
The above graph helpfully draws a line showing how Britain’s departure from the gold standard triggered what seems like an immediate worsening of major indicators in the US, while employment bounced right back when the United States made its own switch off of gold.
Is there a smoking gun proving that gold was the decisive factor in the end of the Depression? Famous (Keynesian) economist Paul Krugman has used the below graph to extend the Gold Standard theory across the developed world, arguing that the world’s largest economies began their respective recoveries in the exact same order in which they left gold.
The few goldbugs still remaining, usually proponents of the laissez faire Austrian School of Economics, counter that this isn’t the whole picture. Countries which switched off the gold standard did find their debts a little easier to pay and did receive a short term boost, but often nothing lasting. Two of those five countries in the above graph actually switched off of gold long after Krugman claimed, as he himself has admitted, making any hard claims connecting de-golding and recovery on a global scale a little dubious. Indeed, our own brief recovery following FDR’s Gold Reserve Act was short lived and quickly descended right back into the Depression (Sumners’ in Midas’ Paradox responds by claiming this could have been avoided if not for the New Deal artificially constraining natural labor markets). A clean look at the effects of de-golding in the United States is also a challenge because Roosevelt would shortly return to an effective peg only a year after the Gold Reserve Act, one which would harden at Bretton Woods and last until Richard Nixon.
Perhaps the gold standard isn’t an economic lightswitch flipping nations from collapse into recovery, but this doesn’t mean it had no relevant constraining effect in the United States, as tempered by other contemporary factors. I also appreciate this framework because it is the first I’ve seen to account for the strange periods of slight recovery and downturn, though I lack the economic knowledge to say whether this shows greater accuracy on the part of the Market Monetarists or simply my uniformed expectation that there should be straightforward answers to be found. I discussed this theory with a friend who is an economist and he offered the analogy of thinking of gold hoarding as any other form of speculation. Speculation in any asset can cause bubbles and instability, whether that asset is oil, tech, or housing securities. Because gold was so closely tied with our currency, gold hoarding effectively acted as the default focus of speculation for during this time, inevitably influencing our overall monetary stability.
Where does all this Gold Speculation Converge?
Bitter debate aside, there does seem to be agreement across these different schools that the interwar gold exchange standard was uniquely volatile for several reasons. Starting in the 1870s, most western countries had directly pegged their currency to gold, only to temporarily abandon the peg during the first World War. After the war, instead of returning to the direct peg, many nations pegged their currency first to the British Sterling or the American Dollar, which were then in turn pegged to gold. However, Britain returned to its Gold Standard at the pre-war price, not taking into account the effects of inflation. Adherents from all economic schools, including Keynes as well as important Austrian economists like Ludwig Von Mises, believed the post war gold exchange standard was inherently deflationary with its layers of paper money stacked on top of an overvalued British peg.
All this was compounded by the “beggar thy neighbor” process by which countries would one by one devalue their currency to make their war debts easier to pay off and their exports cheaper. This in turn put any country still on Gold at a competitive disadvantage by leaving them with a higher valued currency, more expensive exports, and (if they were debt holders) decreasing the value of the debt payments they received. The extent of the impact the gold exchange standard had on the Great Depression is difficult to measure, but there is consensus that it was one relevant factor.
Late 1932: Roosevelt Enters the Fray
Whether or not the Gold Standard is as important as Market Monetarists claim, understanding its role is important for grasping one of the last pieces in the puzzle of Hoover’s presidency. Once again economic indicators had begun to trend slightly back up in the summer of 1932 following Hoover's second series of federal relief initiatives. Unfortunately, they fell hard right before Roosevelt’s election (possibly because it was clear he would win and the markets reacted badly.) Hoover tried to launch into action a third and final time with a bold bank relief plan, but his time was done. Franklin Delano Roosevelt was President elect and Hoover was to sit out his remaining days in office powerless, his congress unwilling to commit to legislation that the incoming president might disagree with (shortly after FDR was inaugurated he passed a bank relief plan quite similar to the one Hoover proposed).
Scott Sumner suggests that part of why the interim between Roosevelt’s election and inauguration was so bad was because no one knew whether or not he would switch off the Gold Standard. Everyone knew where Hoover stood; he quite explicitly said “we have gold because we cannot trust governments.” But Roosevelt refused to comment either way from the day he was elected to the day he was inaugurated, and the confusion made investors skittish, which may have caused a prolonged devaluation of the Dollar - as opposed to a sudden but brief devaluation which would follow a clear announcement that the US was leaving the Gold Standard. The ensuing months of sluggish investment, combined with Congress’ refusal to work with Hoover, may have prevented what could have been one last chance at a recovery in Hoover’s final months.
A Primer on the Case Against State Intervention
I don’t want to get too deep on this subject, because any charitable and thorough analysis of state intervention in the Depression will have to include the New Deal, and I have considerably more research I need to do before I am prepared to tackle that challenge. But let me add a few points here. As I have attempted to demonstrate, Hoover never really took a hands-off approach to the free market; in fact he oversaw the most protectionist administration in American history.
That’s the beauty of Hooverism, really, whether you’re a right wing free marketer or a left wing social democrat, everyone can find something to complain about.
A relevant contingent of Austrian School economists and Monetarists overlap in believing that Hoover’s Federal initiatives actually made things worse through his “high wage, high tariff and high tax policies.” These theorists point directly to Smoot-Hawley, of course, but they also tend to emphasize the impact of his interventions on the labor market. Remember how one of Hoover’s first actions was to gather industry leaders and make them commit to keeping wages at their current level? Some Austrian economists, led by Murray Rothbard, argue that because consumers were spending far less money, the decision to keep wages artificially high necessarily led to companies having less funds available - and laying off workers to make up the difference. Scott Sumners agrees with this and points out that no such rule had been established during the 1921 panic, wages had dipped slightly, the economy recovered and wages were restored. Note that while there were two periods in the early depression where some economic indicators trended up, employment basically only ever went straight down.
In the above graph wages are for some reason inverted, so what the figure actually shows is that boosts in wages coincide with a decrease in industrial production. I found this in Sumner’s own book, so let me offer a graph from a reputable outside source that demonstrates the same dynamic. The below figure, in contrast, shows composite wages un-inverted, starkly displaying the inverse relationship between rising wages and waning industrial production.
Opponents of state intervention go on to extend this “wage theory” all the way through the Thirties, claiming that every time the labor market began to climb back up it received a shock from a New Deal labor initiative that brought it right back down. A real analysis of the impact of state intervention will have to wait till next time, when I have a broader timeline of data to work from. Either way, I’m heartened to see a (any) point of convergence between the old school and the new school.
So Where Do We Stand Now?
This slightly hideous graph attempts to collect everything we’ve looked at so far in one place, from the Hoover Recovery to Smoot-Hawley to the Great Contraction and the departure from the Gold Standard.
Through researching the roller coaster ride of these early years of the Depression, I haven’t really emerged with a clear idea of how concretely Hoover’s policies affected things one way or the other. He tried cutting taxes; he tried raising taxes. He tried raising tariffs on Europe; he tried bailing out Europe’s war debts. He tried delegating authority to the states; he tried directly addressing the crisis through Federal initiatives. I get an impression of him just bouncing back and forth between different policy prescriptions; there isn’t a great sense of harmony to the ideas he tried. With regards to his greatest efforts in creating central agencies to boost spending and infrastructure, I have trouble parsing out their exact impact. Does the fact that things improved briefly after each set of Federal measures indicate that they were successful? Does the short lived nature of these recoveries suggest a failure of sustainability in Hoover’s programs, or is this just a symptom of the deeper economic instability of the time?
Hoover certainly shoulders the blame for signing Smoot-Hawley, and probably for ignoring the farm surplus until it was out of control, and then fixing it by paying farmers to produce even more surplus. He made silly fiscal choices by raising taxes during a recession, but at least it was what most smart people at the time counselled him to do. If you accept the Monetarist take on the Depression, it’s possible Hoover had relatively little control over the situation at all, outside of his nomination of a Federal Reserve chairman with restrictive monetary policy. As for the most consistent complaint I hear about Hoover - that he refused to address unemployment head on - the number of relevant theorists who claim his labor market interventions worsened employment make me skeptical that a more involved approach would have been an obvious win.
To summarize what we’ve covered above, here is a breakdown of the main ideas proposed as causes of the Depression, divided by their adherents:
Factors that Everyone Agrees on
1: Endemic agricultural surplus caused American Farms to collapse.
2: The Smoot-Hawley Tariff Act and the Western trade war put enormous strain on American manufacturers and exporters.
2: The interwar gold exchange standard contributed to overall economic instability in this time period because it layered multiple currencies on top of an artificially high peg. This was probably made worse by the process by which countries one by one left the Gold Standard and caused economic pain to everyone who remained tied to gold.
Keynesians and Monetarists:
The problems of the Great Depression in some way stemmed from the lack of money circulating through the economy, and the central state’s refusal to make up that difference. The problem was further compounded by high interest rates and taxes.
Keynesians only:
The ur-cause of the depression was the government’s refusal to run a deficit, keep taxes low, ramp up spending and thus break the ever downward spiral of demand.
Monetarists only:
The Great Contraction was the real driver behind the depression, and could have been fixed by pumping liquidity up and balancing the money supply.
Market Monetarists:
The primary exacerbating factor in this balancing of the money supply was our adherence to the gold standard and its susceptibility to shocks from public and private hoarding.
The Austrian School of Economics:
The causes of the Depression lie in the state’s refusal to let the free market self correct through a combination of protectionism and labor policies.
Austrians and Monetarists:
Keeping wages artificially high while the rest of the economy suffered prevented what could have been a quicker recovery if we had allowed wages to be elastic and bounce in response to the boom and bust.
Any hard conclusions (if there are any to be had) will also have to wait till next time. At this point, three years into the Depression, I don’t have a great sense of whether any of these theories are on the nose. I know that Keynes and Friedman dominate the majority of the debate, and both of their theories sound reasonable and grounded to me. But there’s a significant amount of daylight between the two - enough daylight that both neoliberals and social democrats can find lots of mainstream experts to validate their beliefs. Furthermore, in a few years the new President Roosevelt would employ strategies from both schools - he left the gold standard, cut interest rates, ran a deficit, used the government as a spending machine and instructed the Federal Reserve to pump more money into the economy - and the Depression continued for seven years after. I understand the Keynesian explanation for why the New Deal didn’t fix the Great Depression is that Roosevelt didn’t go far enough, didn’t spend enough money on the economy. This sounds . . . well, it sounds a little like Keynes is trying to sell me a used car, but then again, I’m not a brilliant, genre defining economist so I’ll stay open-minded to this perspective. I look forward to completing the story. Until next time.
Comments, perspectives and nuggets of wisdom are warmly welcomed. I’ve also been a little disappointed at the lack of publicly available well sourced graphs and figures. I would appreciate anyone directing me towards reputable resources for Part 2.