Well, today we're going to talk about the Great Depression and President Herbert Hoover's response to it.
There's a lot of misunderstanding about this and a great many misconceptions, and I'd like to address them in the brief time we have today.
So first, the Great Depression itself. American history textbooks take for granted that the Great Depression was caused by some inherent flaw in the free market and that only wise government management of the economy can steer us clear of similar economic catastrophes in the future.
This is the mainstream view held by everyone from Marxists to run-of-the-mill conservatives.
The market economy, whatever its benefits, is said to be inherently unstable and susceptible to devastating downturns unless properly managed by central planners of one stripe or another.
The business cycle, the boom and bust of prosperity and collapse, is said to be an unavoidable feature of capitalism that can be mitigated by government action but never entirely eliminated.
One major school of economic thought, the so-called Austrian School, named for the country of origin of its principal founders,
rejects this casual mainstream assumption and places the blame for boom and bust elsewhere.
Significantly, it was economists of this school practically alone among economists in the 1920s,
the rest of whom insisted to their later embarrassment that an age of permanent prosperity had arrived.
It was these economists who predicted the Great Depression.
and Depression. And it was his elaborations on this theory that won F. A. Hayek the Nobel Prize in Economics in 1974.
Hayek's Nobel sparked renewed interest in the Austrian theory of the business cycle, as did the bus that followed the dot-com boom of the 1990s,
which was a textbook example of the Austrian theory in action.
There's an article in the Quarterly Journal of Austrian Economics that you can find at mises.org when you go under publications
written by Gene Callahan and Roger Garrison that makes this argument about the dot-com boom and bust.
But the Austrian theory can also shed light on the Great Depression,
specifically one of the most catastrophic and least understood episodes in American economic history.
Now in his classic little essay on economic depressions, their cause and cure,
Murray Rothbard suggested that any theory claiming to account for the business cycle has to be able to reckon with two empirical facts.
First, it has to be able to explain why all of a sudden we should discover that entrepreneurs throughout the economy have made disastrous forecasting errors.
Anticipating consumer demand for some product or service is the quintessential entrepreneurial function.
How should entrepreneurs who have achieved their position, thanks to their previous success at anticipating consumer demand, now commit such egregious errors?
Not all markets are depressed during the bust period, to be sure. Some are flat, some are even counter-cyclical.
But there is a dramatic imbalance toward losses rather than profits. What can account for this sudden cluster of entrepreneurial error?
Second, the theory must explain why economic depressions tend to be considerably worse in so-called producer goods industries like construction, machine tools and raw materials, and relatively mild in consumer goods industries.
American history texts like to claim that so-called underconsumption caused the Great Depression. Americans supposedly could not afford to buy the goods the economy was producing.
Now, if that were true, the downturn should have been worse in consumer goods industries like toothbrushes, hats and magazines than in producer goods industries,
but the Depression was actually at its mildest in consumer goods industries.
Underconsumption theories are unable to account for this consistently observed fact about depressions.
The Austrian explanation, which exonerates capitalism of blame for recessions and depressions,
begins by reminding us of the role that interest rates play in the economy.
Interest rates coordinate production across time.
As people consume less and save more, interest rates come down.
That stands to reason. Thanks to people's additional saving,
the banks now have more funds available to lend and therefore the price of borrowing,
namely the interest rate, comes down. On the other hand,
if people save relatively little, the interest rate remains high,
since in this case the banks have relatively little to lend and the price of borrowing remains high.
Businesses respond to these lower interest rates by taking the opportunity to embark on investment projects
such as building new physical plant or acquiring additional machinery that will increase their productive capacity in the future.
Now notice, when people save more, they reveal a relative decline in their desire to consume in the present.
That's when it makes the most sense for businesses to carry out time-consuming investment projects with an eye to future production.
If, on the other hand, people possess an intense desire to consume in the present,
their relatively low amount of saving and the high interest rates that result convey to business that now would not be a good time to shift resources toward projects intended to increase future production.
So the interest rate ensures a compatible mix of market forces.
If people want to consume now, businesses respond accordingly.
If people want to consume in the future, businesses allocate resources to satisfy that desire as well.
But the interest rate can perform this coordinating function only if it is allowed to fluctuate freely in response to changing conditions.
When the central bank, in the American case the Federal Reserve system, manipulates the interest rate,
It introduces systemic problems of discoordination and miscalculation.
Although it cannot do so directly, the Federal Reserve system has various means at its disposal
to bring about lower interest rates.
When it does so, interest rates are lower not because people have saved more and indicated
a desire to consume less in the present, but instead because they have been forced down
artificially.
They no longer reflect the true state of consumer demand and economic conditions in general.
These artificially low interest rates mislead investors.
The low rates make investment decisions suddenly appear profitable that under normal conditions would be correctly assessed as unprofitable.
As a result, irrational investment decisions are made and investment activity is distorted.
The Federal Reserve's policy of cheap credit misleads businesses into thinking that now is a good time to invest in long-term projects
when in fact the public has given no indication of any intention to postpone present consumption
and free up resources that investors can devote to long-term projects.
The central bank's lowering of the interest rate therefore creates a mismatch of market forces.
Long-term investments that will bear fruit only in the distant future
are encouraged at a time when the public has shown no let-up in its desire to consume in the present.
Resources are therefore being misallocated.
In the short run, the result of the central bank's lowering of interest rates is the apparent prosperity of the boom period.
New construction is everywhere, businesses are expanding their capacity, and people are enjoying a high standard of living.
But the economy is on a sugar high and will inevitably come down.
Since the public has not saved as much as the artificially low interest rate makes entrepreneurs think they have saved,
have been saved. Insufficient resources have been freed up to make all of these new investment projects sustainable.
The complementary goods that businesses need in order to complete these projects turn out to be scarcer and thus more expensive than investors anticipated.
Some of these investments will prove to be unsustainable and will have to be abandoned, with the resources devoted to them having been partially or completely squandered.
The Federal Reserve could simply pump still more credit into the economy to keep the boom going, and indeed it usually does just that.
But at some point, it has to put on the brakes.
The more it inflates, the greater the mismatch between consumer preferences and productive capacity.
As this becomes more apparent, pressure builds for a liquidation of the malinvestments.
If the Fed ignores this pressure and continues inflating the money supply indefinitely, it risks hyperinflation, a galloping inflation so severe as to destroy the currency unit altogether.
The recession or depression is the necessary, if unfortunate, correction process by which the malinvestments of the boom period, having at last been brought to light, are liquidated.
The Central Bank's cheap credit policy encouraged the initiation of countless investment projects that could not be sustained in the long run.
The diversion of resources into unsustainable investments that do not conform with consumer desires and resource availability swiftly ceases as businesses fail and investment projects are abandoned.
We now see how the Austrian theory answers our two original questions.
The cluster of entrepreneurial error occurs because economic actors are misled by the interest rate, an economic indicator that enters into the calculations of all serious entrepreneurs.
And the downturn is heavier in producer goods industries rather than consumer goods industries, because it is that sector in which the artificially low interest rates disproportionately attract investment.
Although this is not the version of the story that Americans get in the standard telling,
these are precisely the events that led up to and caused the Great Depression.
Contrary to popular belief, the 1920s saw a very substantial inflation of the money supply,
which in classic Austrian fashion sowed the seeds of the inevitable collapse.
The extent of that inflation of the money supply was obscured by the relatively stable
This was the stable price level of the 1920s, but that stable price level was the result of increasing productivity, which offset the inflation of the money supply.
Moreover, just as the Austrian theory would lead us to expect, the economic downturn disproportionately hit producer goods industries and not the consumer goods industries that under consumptionist theories would lead us to expect.
The business cycle theory explains what causes the initial downturn,
but just how long and severe the depression will be depends on the government's response.
If out of a misplaced humanitarianism, or just plain ignorance, the government hinders the liquidation process
by bailing out failing businesses, propping up wages, or artificially stimulating consumption,
the recovery will be much slower and more painful.
For example, government-sponsored emergency loans merely prop up the unsound investment
projects undertaken during the boom and the misdirected resources being squandered on
them and thus only intensify the problem.
Wages and prices must be allowed to fluctuate freely so that labor and capital may be moved
rapidly into lines that make sense in terms of prevailing economic conditions.
The initial downturn of the Great Depression occurred in late 1929, of course, but conditions
These did not reach truly calamitous proportions until 1931, which economist Benjamin Anderson
called the Tragic Year.
Herbert Hoover and Franklin Roosevelt, as we'll see Herbert Hoover later today and Franklin
Roosevelt in a future talk, those presidents and their administrations pursued policies
that prolonged the downturn of 1929 into a depression that plagued the country throughout
about the 1930s and beyond.
The free market therefore is responsible neither for the initial downturn nor for the duration
of the Great Depression.
The culprit in the first case is the Federal Reserve System, a non-market institution created
by active Congress, and in the second case is federal government policy that severely
hampered the economy's ability to recover and adjust.
Unfortunately, the Austrian theory of the business cycle, in spite of winning one of
One of its architects, the Nobel Prize, remains one of the best-kept secrets of economics.
Now what about Herbert Hoover, elected president in 1928, and his response to the Depression?
Well, the version of American history that students learn in school goes something like this.
Herbert Hoover, who had the misfortune of being president during the Great Depression,
was wedded to an old-fashioned philosophy of rugged individualism
that was no longer relevant to the advanced American economy.
When the Depression struck, therefore, Hoover did not take decisive action,
since, as a strict supporter of laissez-faire economics, he believed the government should never interfere in the economy.
Well, this depiction of Hoover, which was fashionable among historians in the decades following Franklin Roosevelt's New Deal,
has more or less been overturned, finally, in recent years.
But while most professional historians have at last come to acknowledge the truth of the matter,
the popular rendition of these events continues to portray Hoover as the laissez-faire stooge
who could have helped people during a time of great deprivation, but callously allowed them to suffer.
Well, first things first, did Hoover in fact believe in the unhampered market economy?
Not at all, and he made this point clear time and again during his tenure as Secretary of Commerce throughout the 1920s.
The United States, in the words of Hoover, had abandoned the laissez-faire of the 18th century,
and he said new emphasis had been placed on, in his words, social and economic justice, and he went on to add,
We have learned that the impulse to production can only be maintained at a high pitch
if there is a fair division of the product by certain restrictions on the strong and the dominant.
Absolutely free competition, according to Hoover, yielded economic chaos
and needed to be replaced by some form of voluntary economic planning.
Hoover possessed the typical progressive confidence in the ability of various classes of experts
to plan the economy scientifically, and more efficiently than could the aggregate of individuals and their own plans that comprised the unhampered market.
But Hoover did not think the Federal Government should be the primary player in accomplishing this regulation and economic planning,
since he believed that government power was difficult to control once unleashed, burdened the private economy, and undermined incentives to produce and innovate.
The federal government should instead serve as the great coordinator of the various lesser organizations.
In addition to local government, Hoover made specific mention of the chambers of commerce, trade associations, labor unions, bankers, farmers and propaganda associations.
Hoover looked to this kind of government-business cooperation to deal with issues ranging from unemployment to housing, industrial waste and foreign trade.
In normal circumstances, the Great Depression was an exception, as we'll see, the Federal Government would be confined to this coordinating role.
The trade associations of which Hoover spoke were voluntary organizations of firms in a particular industry.
Hundreds of them had been organized by the 1920s that were thought to serve a variety of useful social and economic purposes.
Ellis Hawley is one of the most important scholars of this phenomenon and he says,
As guild-like collectivities led by enlightened and public-spirited men, these cooperative institutions could develop codes of ethical behavior,
desirable patterns of social obligation, and the harmonious productivity of which an integrated and purposeful commonwealth was capable.
These associations were urged to adopt codes of so-called fair competition governing their industry that would limit each firm's liberty to some degree in order to stabilize the industry as a whole.
Henry S. Dennison, president of Dennison Manufacturing Company, called for exactly that and he said,
We must manage ourselves if we are to gain on the past. No laissez-faire, no unchanneled and unimpeded course of nature, no invisible hand will do it for us. We now find ourselves in a period of growing social self-control.
Denison's comments were typical of what people were hearing from business leaders in the early 20th century.
One trade association executive condemned the businessman who operated his business,
quote, in entire disregard of the effects on his competitor and the rest of the industry.
Another businessman complained, quote, our profits are absolutely unprotected.
The American Bottlers of Carbonated Beverages declared,
My desire shall not be to undersell my fellow bottlers, but to contend with them for first place in the quality of my products and the service I render my patrons.
Business magazines consistently echoed this kind of talk.
In the 1920s the Federal Trade Commission, or FTC, held conferences with various industries in order to identify competitive practices
that the bulk of existing firms considered unfair.
So-called Group 1 rules governed practices forbidden by the antitrust laws.
More interesting though were the Group 2 rules, which dealt with practices that were not strictly illegal,
but that many firms in an industry simply agreed were unfair.
The FTC expected the trade associations to police their own firms,
but in many cases the associations issued formal complaints with the FTC
The FTC sometimes issued cease-and-desist orders against offending firms.
I might note as an aside that in a study for the George Washington Law Review,
two scholars concluded that businesses at the time,
quote, were all too prone to regard as unfair competition
almost any kind of active competition that discommoded them,
particularly if it related to price.
related to price.
So here was an example of the much touted government business cooperation of the 1920s.
Fair competition codes hampered newcomers to an industry.
Established firms enjoy many advantages including name recognition and public trust.
If newer firms are to have any success against them,
they need to be able to compete in particularly vigorous and innovative ways.
But if competitive methods become fairly standardized through the kinds of agreements established during the 1920s,
explains law professor Butler Schaeffer, and the newer firm is required to adhere to the same patterns as the established firm,
the newcomer will find itself at an even greater disadvantage.
It will have been deprived of the means of offering the necessary inducements to attract customers away from the established firms.
For all their pleasant rhetoric, therefore, these schemes amounted to conspiracies within many American industries to prop up prices and to suppress competition.
Although historians, who in all other situations are willing to ascribe the basest motives to businessmen, have typically been rather indulgent in their treatment of these codes.
The medieval scholastics criticized the guilds of their day for doing exactly this.
Now the same mentality had overtaken the American business community.
Adam Smith's observation in the 18th century is apropos.
He said people of the same trade seldom meet together even for merriment and diversion,
but the conversation ends in a conspiracy against the public or in some contrivance to raise prices.
Now it's true that Hoover did not envision compelling businesses to comply with these schemes.
These agreements would be essentially voluntary.
But for all Hoover's protestations to the contrary, journalist John T. Flynn could see where the system of voluntary, so called, restraints on business was bound to lead to the government's use of force against firms that refused to comply with the regulations and requirements dreamed up by industry leaders.
Flynn said that trade associations, and these are Flynn's words,
are harassed by the unwillingness of those rebellious and adventurous spirits who refuse to accept their rule.
They are forever running into the disturbing fact that while a trade may, after a fashion, rule itself,
it cannot rule some other trade which is in collision with it.
It is this very weakness which sends trade associations to Congress and the legislatures every year
with appeals to the government to join them in some program of regulation.
But the practice of regulating others is habit-forming. It is a mania.
As soon as men find themselves in a game, they begin to invent rules for that game,
and the more extensive and complicated the rules become.
At first they depend upon a certain spiritual pressure operating through the law of honor to support the rules.
But very soon they seek more effective means of getting the rules obeyed.
This involves a kind of force.
So Hoover's support for these fair competition schemes reveals his lack of confidence in the unhampered market,
and thus his refusal to adopt the strict laissez-faire position falsely ascribed to him.
So the president who first tackled the Great Depression was therefore not inclined to trust the free market.
When the Depression hit, Hoover certainly did not sit back and do nothing.
He called on business leaders, first of all, to refrain from cutting wages and he did this both in meetings at the White House in November 1929 and in follow-up meetings in the ensuing months.
Although the issue of wages was the most pressing, Hoover also called upon business to continue making purchases of raw materials and above all to continue construction and maintenance work.
What Mr. Hoover is really trying to do, the Nation magazine wrote in a November 1929 editorial,
apparently without knowing it, is to create a supreme council of national economy in the United States,
and it will be interesting to see how far he can go in our topsy-turvy capitalist economy.
He is right in wanting a planned economy.
Leo Wolman of the Amalgamated Clothing Workers of America, who is himself an economist of sorts,
scientists described the Hoover conferences as a supreme economic council or Americanized
gauss plan.
Now, no doubt Hoover would have protested such characterizations, but they reveal how
significant many observers considered these early presidential interventions.
Hoover's high-wage policy seems reasonable enough to a casual observer.
Who wouldn't want high wages after all, and wouldn't they stimulate the economy too?
But the idea was in fact terribly ill conceived.
Since an artificial boom had distorted the economy's capital structure, wage adjustments
were essential if the downturn was to be brought to an end.
The necessary readjustments required flexible wage rates in order to direct labor out of
areas in which the boom had created unsustainable expansion and into areas that central bank
distortions had served to deprive of sufficient labor.
Many artificially imposed wage rigidities could only prolong the economy's adjustment process and the suffering that accompanied it.
Hoover believed, wrongly, that reductions in wage rates would harm the economy by depriving wage earners of sufficient purchasing power to buy the goods that businesses were producing.
This is a very common argument and a superficially plausible one, but it is a fallacy.
For our purposes, we may at least note that the Depression actually came in the midst of a dramatic upward trend in the share of national income devoted to wages and salaries and a corresponding downward trend in the share going to interest and dividends and entrepreneurial income.
In other words, the data shows exactly the opposite of what would need to have happened in order to validate the underconsumption theory of Hoover and of amateur economists then and now.
If depressions are caused by insufficient consumer purchasing power, how do we account for a Great Depression that occurred at a time when that purchasing power was at a high point?
While the underconsumptionist explanation for unemployment has declined in respectability in recent decades, it has never gone away entirely.
Now, one of the, in my opinion, most important works of economic history to be published in the late 20th century
is a book called Out of Work by Ohio University economist Richard veteran Lowell Galloway.
And they take on this under-consumptionist explanation.
And they show in this book that wages, a sort of common sense idea, are at cost of doing business
and that artificially increasing wage rates beyond the level prevailing on the market
will simply create unemployment as businesses begin to demand less labor and or to substitute capital for the overpriced labor.
By the way, one economist put it,
an unemployed laborer has no purchasing power at all, however high may be the wage rate he would get if he had a job.
Pretty relevant point, I think.
Now, what this means in short is that Hoover's demand for high wages, even in depressed economic conditions, he's calling for high wages,
undoubtedly worsened rather than improve the situation.
Lyle Robbins, who was an economist, said,
Another critic put it this way,
Its effect would be, rather, to make unemployment complete rather than partial.
Although Hoover did not force business to abide by his high-wage policy, the president's
appeal nevertheless had substantial impact.
Not only did business leaders want to please the president, but in some cases they actually
believed that high wages were necessary for their own prosperity.
Many contemporary observers commented on the extent of business cooperation with Hoover's
request.
In early 1930, for example, Businessweek published an article called
This Time They Did Not Cut Wages. Late that year, economist Carter Goodrich observed
at a meeting of the American Economic Association,
it seems highly probable that the year 1930 will also show an increase rather than a decrease in the rates of real wages.
Leo Wallman said it was impossible to cite any similarly severe depression
in which what he called the wages of prosperity were maintained for so long.
Something called the Alexander Hamilton Institute observed in 1931 that,
quote, the efforts to maintain wage scales have been an important factor in prolonging the business depression.
In 1930, ignoring the all but unanimous advice of economists, Hoover signed the Smoot-Hawley Tariff,
which raised tariffs an average of 59% on more than 25,000 items.
Among other things, the tariff damaged the American export sector when other countries retaliated by making it difficult, if not impossible, for Americans to sell their goods abroad.
But another aspect of the tariff, overlooked in nearly every major study of the Hoover years, was at least as important the contribution the President thought it could make to his high-wage policy.
As veteran Galloway point out, tariffs insulate the owners of both labor and capital resources from foreign competition, allowing them higher prices for their output and, in the case of labor, higher wages.
and higher wages.
Veteran Galloway go on to suggest that the unemployment rate
would have been 3.8% lower by 1932 in the absence of these tariff increases,
making the tariff responsible for about 20% of the increase in unemployment since 1929.
Overall, Veteran Galloway conclude that Hoover's high-wage policy accounts for 77%
of the observed increase in unemployment from 1929 to 1931.
The high-wage policy by no means exhausted Hoover's anti-depression program.
Public works expenditures also increased dramatically under Hoover,
with more money devoted to them in Hoover's four years than during the previous two decades.
Substantial tax hikes were also introduced, as federal levies were imposed on countless products and services,
Mises, and income tax rates approached World War I levels. Hoover's interventions to prop
up farm prices at a time of general deprivation were a forerunner of Franklin Roosevelt's.
Hoover also signed the Norris LaGuardia Act on behalf of organized labor. There's more
on that in my forthcoming book. He established the Reconstruction Finance Corporation, which
extended low-interest loans to businesses in trouble and extended credit to the states
in order to fund public works projects.
So how in the world did Herbert Hoover get the reputation as a believer in laissez-faire
when he was actually responsible for the greatest peacetime expansion of the federal government
in American history to that point?
It may have had to do with his hesitation to institute direct federal relief programs
preferring to lend money to the states for relief instead, or with his failure to spend
still more money on public works programs.
But the answer may also involve Hoover's opposition to Franklin Roosevelt's New Deal of the 1930s.
Hoover did not reject the New Deal, root and branch, nor could he if he wanted to be consistent
since so much of the New Deal grew out of his own programs.
Rexford Tugwell, who was an important economic advisor to FDR, Franklin Roosevelt, later
said most of what Hoover began would be taken over by Roosevelt and then called the New
Deal.
Hoover merely rejected the lengths to which FDR's interventions went, making his difference
with FDR one of degree, not of kind.
But historians have never been particularly good at drawing such distinctions, and thus
was born the myth of the laissez-faire Hoover.
Now even those who concede that Hoover was far from passive in the midst of the Depression,
these folks will typically conclude that even so, he still didn't do enough to address
against the country's economic woes.
But Hoover's much more interventionist successor, Franklin Roosevelt, oversaw continuing double-digit
unemployment and similarly dreadful statistics.
Moreover, the Depression that hit the country in 1920, which was in some ways worse than
the Great Depression, was entirely over by 1921, when the country was once again setting
production records.
All President Warren Harding had done was cut government expenditures, the very opposite
of the advice Keynesian economists gave presidents throughout the 20th century.
Dare we propose that Hoover, instead of doing too little, did too much?