What Caused the Great Depression?

Something interesting I read in Thomas Sowell’s The Housing Boom and Bust: Revised Edition* was about the Great Depression. I remember being taught that excessive borrowing (margin) used to purchase stocks formed a bubble. The bursting of that bubble and the closing of banks(1) caused the Great Depression and that Roosevelt’s New Deal (and World War II) pulled the nation out of that depression.

Sowell makes the case that it was the RESPONSE (government intervention) to the stock market crash that prolonged the depression. Take unemployment for example:

Those who think that the stock market crash in October 1929 is what caused the huge unemployment rates of the 1930s will have a hard time reconciling that belief with the data in that table.

Although the big stock market crash occurred in October 1929, unemployment never reached double digits in any of the next 12 months after that crash. Unemployment peaked at 9 percent, two months after the stock market crashed– and then began drifting generally downward over the next six months, falling to 6.3 percent by June 1930.

This was what happened in the market, before the federal government decided to “do something.”

What the government decided to do in June 1930—against the advice of literally a thousand economists, who took out newspaper ads warning against it—was impose higher tariffs [Smoot-Hawley tariffs], in order to save American jobs by reducing imported goods.

This was the first massive federal intervention to rescue the economy, under President Herbert Hoover, who took pride in being the first President of the United States to intervene to try to get the economy out of an economic downturn.

Within six months after this government intervention, unemployment shot up into double digits—and stayed in double digits in every month throughout the entire remainder of the decade of the 1930s, as the Roosevelt administration expanded federal intervention far beyond what Hoover had started. (2)

In the last chapter of The Housing Boom and Bust: Revised Edition*, Sowell lists several government measures that took place during the depression that he believes helped prolong the depression:

…The biggest of the New Deal interventions was the National Industrial Recovery Act of 1933, which controlled prices and wages in industry. The Agricultural Adjustment Act of 1933 established federal control over prices and output in agriculture. The National Labor Relations Act of 1935 made it mandatory for employers to negotiate wages and working conditions with labor unions. FDR also took the country off the gold standard and issued thousands of executive orders—more than all the subsequent Presidents of the United States in the twentieth century combined.

A paragraph or two later, Sowell writes:

The Roosevelt administration’s rapid succession of sweeping and unpredictable interventions in the economy, interpsersed with anti-business rhetoric, caused even a liberal like John Maynard Keynes to question whether some of the New Deal reforms, includeing some he regarded as “wise and necessary,” might “impede” economic recovery because they could “upset the confidence of the business world and weaken their existing motives to action.”

Of course we’ll never know what would have happened had the government not intervened during the depression (the same way the current administration can’t talk about how many jobs they “saved” with their stimilus bill). But, we do know that government intervention does have consequences and sometimes those consequences are not what we expect.

I’m a newbie when it comes to economics discussions but I’m going to be doing a lot more reading on this topic in the future.

(1) Sowell mentions in his book that a “wholly disproportinate share of those banks that failed then were in states with laws preventing banks from having more than one location,” which increased risk.
(2) A Mind-Changing Page

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4 thoughts on “What Caused the Great Depression?”

  1. Congrats JLP on your journey down the rabbit hole. This is exactly the progression I took as I started with personal finance and soon found myself reading macroeconomics blogs and books.

    I know I have posted his site numerous times here but I strongly recommend that you check out Mish (http://globaleconomicanalysis.blogspot.com/). He provides some great global economic news from an Austrian perspective.


  2. Another great book on how government intervention accelerated the Depression is “The Forgotten Man” by Amity Shlaes.

    It is a huge misconception that the market crash of 1929 started the Depression. The economy and market actually improved considerably in 1930. The market rose 50%, very similar to this rise.

    The government took the wrong lesson from the Depression. They believed it could have all been fixed by increasing the money supply. Ultimately, it was excessive debt peppered with poor government policy. What scares me is we are following the playbook. We haven’t implemented as many tariffs, but Chuck Schumer threatens China all the time.

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