Some of the most important lessons can be learned by studying history - that's why I have always enjoyed it. This is especially true for economics. If we want to understand how to deal with our current economic problems, let us look to the past and learn from the mistakes of those before us. The Great Depression is naturally a time that most economists like to point to, as a lesson. Being the most severe and long lasting recession in U.S. history, there is definitely a lot we can learn from it. While most of us studied The Depression in school, it seems that the general public does not have a firm understanding of it. Much of what we do understand is based off of myths and fallacies. I want to approach this subject from an Austrian economics view, a more free-market perspective, in order to dispute some of the misconceptions of the Depression Era.
Consider the common teachings on the Great Depression. We have all been told that it was started by the stock market crash of 1929. Stocks were being bid up higher and higher, until it was realized that the stocks were over-valued. People began to sell. Stock prices dropped. The people who hadn't sold realized their stocks were worthless, causing a rush on the banks. But the banks were broke too, and suddenly the entire country was poor.
Then we were told of how we escaped the Depression. The FDIC was created, the government began guaranteeing people's bank savings. This was part of the Glass-Stegal Act, which also prevented the banks from investing people's savings. All of this was meant to gain back the saver's faith in the banking system, and stabilize the economy. Then we look to monetary policy. The Federal Reserve began buying up treasury securities (although they temporarily sold them, running a contractionary policy, and worsening the Depression), increasing the money supply, and expanding the supply of credit, in hopes of increasing economic activity. Finally, we are taught that the long Depression ended with World War II. As unemployment dropped to nearly nothing, and GDP grew exponentially, it was clear that the Depression was over - or so they say.
Now, let's look at this from a different, and in my opinion more logical, point of view. We know that the Great Depression started with the crash of '29. But what caused the crash? Markets have natural positive and negative shocks, but they don't just crash spontaneously. It's given that stocks were tremendously overvalued, and eventually the bubble burst. But a free-market economist would tell you that a market should not naturally be that far out of equilibrium. The only way for stocks to be so overvalued, is if the market was tampered with.
We know about the bust, what about the boom? Today, it is known as the Roaring Twenties. It was a time when GDP and prosperity rose exponentially. How did this all come about, we wonder. First, we should look to the creation of the Federal Reserve in 1913. As a young entity, the Fed would prove to make several mistakes. The first of which came in the early 1920s, when the Bank of England, wanting to keep its artificially high-valued currency, asked the U.S. to devalue the dollar. We agreed, mainly in order to help farmers increase their exports. The Fed expanded the credit supply through an increase in the money supply by about 60%. Prior to this, the country had also seen excessive spending to finance World War I.
This expansion in credit was created out of thin air. There was no real wealth being added to society, so there was no real increase in the supply of credit. It was a mythical credit expansion based off of the Fed's expansionary policies and the government's printing of money. The excess spending added no real wealth. In fact, the spending for WWI only destroyed, not created, wealth. But as the credit market was manipulated, people believed the expansion to be real and increased their spending during the Roaring Twenties. Since this false wealth could not continue forever, it had to leave the economy in some form - either through inflation or devalued capital. Think of the stock crash as the devaluing of capital. The stocks that had risen in price, had not risen in value. As people realized this, it created a run on the stock, then a run on the banks. Benjamin Strong, Governor of the Federal Reserve Bank of New York from 1914 to 1928, put it like this - "Very few people indeed realized that we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis."
Critics of Austrian economics often argue that it offers no solutions. I would disagree. While it may not offer the same crowd pleasing, slogan solutions that Keynesian economics does, it offers more practical and logical solutions. Instead of looking at the busts, we should look at preventing artificial economic booms. It is important to understand that credit cannot be truly expanded at the snap of the Fed's fingers. The government cannot add wealth to the country with the push of a button. Solution: stop manipulating the markets.
The commonly understood solutions to the Depression seem fallacious. The Glass-Stegal Act, while probably necessary only because of the prior harmful government interference, may have done more harm than good. As stated, it prevented banks from investing people's savings. This may sound good, however, it can be viewed as a prevention of real credit expansion. Banks are able to create money, by putting people's savings to economic use until the people need those savings. They lend the money to a corporation, through stocks, the corporation then uses that money for further investment. The bank gets the return on the investment, and is then able to loan out more money. This differs from the false credit expansion created by the Federal Reserve, because the corporation was able to add real value to the economy through the extra money available for investment. Unfortunately, this aspect of the Glass-Stegal Act remained in effect until 1999, so we will never know the economic growth that was potentially lost.
One aspect of Glass-Stegal that remains in place is the FDIC. The FDIC has helped people keep their faith in the banks, but is this such a great thing? The fact is, when you put your money in a bank, there is some risk involved, however slight it may be. Banks make money by loaning out and investing our savings. There is a chance, when you put money in a bank, that you will never see it again. Once again, it's not high risk, but there is a risk that should be accounted for. The FDIC manipulates with the market by taking away that risk. Falsely taking it away, that is. The FDIC can only protect your savings as long as the government can afford it. If the banks went broke, and everyone demanded payment from the FDIC, I doubt they would be able to pay off the entire country. Banks are not meant to be 100% safe, nor should they be considered so.
Possibly the most irritating myth of the Great Depression is that we escaped it through WWII. While it is true that unemployment went down and GDP rose during WWII, this says nothing about the quality of life. Of course unemployment was down, the men were overseas fighting a war. Back home, many basic necessities were rationed. That doesn't sound like prosperity to me. This is a perfect example of why unemployment rates are not always a good economic indicator. If you go by unemployment rates, might as well have locked everyone in jail, and considered the Depression over.
Truly, the Depression did not end until after WWII. At this time, government spending was finally cut. Thanks to Keynesian economics, we were able to end the Great Depression, only a couple of decades after it began.
Being one of the worst crises in American history, the Great Depression should be an important point of study. Unfortunately, most of us only understand generalities of the time period. "The stock market crash of 1929 led to the Great Depression." This tells us very little, and isn't helping us learn from the mistakes of our past. The free market approach is almost an untold story, in education. It is my hope that this perspective will be given a chance. After all, as evidenced by the latest recession, we haven't learned that much from Keynes.
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