Lessons of depression
“Sir” Alan Greenspan, the chairman of the Federal Reserve, allowed the stock market bubble to inflate because he thought he could control its aftermath. This view derives from a belief that the depression of the 1930s was not caused by the preceding speculative boom but was the result of poor policies by the government and central bank. Following the continuing rout in the stock market and signs that the US economic recovery is petering out, we have reached the point when this historical thesis is about to be severely tested.
In a recently published book, Rethinking the Great Depression, economic historian Gene Smiley catalogues the errors of both the Federal Reserve and federal government during the 1930s. In July 1931, the Fed raised interest rates in order to fulfill its obligations under the gold standard (despite the fact that Britain had already abandoned it). Five years later, prompted by fears of inflation, the Fed doubled the reserve requirements of its member banks. Both of these actions were followed by a severe contraction of the money supply, which induced a further collapse of the stock market and economy.
The failures of the federal government during this period were more various. After the October crash of 1929, President Hoover urged companies to maintain wages, which resulted in falling profits and investment during the early years of the depression. Hoover also signed the Smoot-Hawley tariff bill which led to a reduction in world trade. The actions of Hoover’s successor, Franklin Roosevelt, were even more destructive to the business environment. During his first administration, Roosevelt created the National Recovery Administration which was mandated to control production through the creation of industry cartels. The NRA had the effect of discouraging business spending.
Once the failure of his initial policies became manifest, Roosevelt changed tack; declaring war on big business and its leaders, the “economic royalists” in his phrase. In 1936, a tax on undistributed corporate profits was introduced in order to make big corporations more accountable to their shareholders. The effect was to further discourage investment. According to Smiley, between 1930 and 1940, net private investment amounted to minus $3 billion.
The problem with this interpretation of history is that it ignores the relationship between the boom of the 1920s and the ensuing bust. The roaring twenties had been a period of rapid business investment, accompanied by an overvalued stock market…