Herbert Hoover, Rugged Individualism
October 22, 1928
…After the war, when the Republican Party assumed administration of the country, we were faced with
the problem of determination of the very nature of our national life. Over 150 years we have builded up
a form of self-government and we had builded up a social system which is peculiarly our own. It differs
fundamentally from all others in the world. It is the American system. It is just as definite and positive a
political and social system as has ever been developed on earth. It is founded upon the conception that
self-government can be preserved only by decentralization of Government in the State and by fixing
local responsibility; but further than this, it is founded upon the social conception that only through
ordered liberty, freedom and equal opportunity to the individual will his initiative and enterprise drive
the march of progress.
During the war we necessarily turned to the Government to solve every difficult economic problem —
the Government having absorbed every energy of our people to war there was no other solution. For
the preservation of the State the Government became a centralized despotism which undertook
responsibilities, assumed powers, exercised rights, and took over the business of citizens. To large
degree we regimented our whole people temporarily into a socialistic state. However justified it was in
time of war if continued in peace time it would destroy not only our system but progress and freedom in
our own country and throughout the world. When the war closed the most vital of all issues was
whether Governments should continue war ownership and operation of many instrumentalities of
production and distribution. We were challenged with the choice of the American system "rugged
individualism" or the choice of a European system of diametrically opposed doctrines — doctrines of
paternalism and state socialism. The acceptance of these ideas meant the destruction of selfgovernment through centralization of government; it meant the undermining of initiative and enterprise
upon which our people have grown to unparalleled greatness.
The Democratic administration cooperated with the Republican Party to demobilize many of her
activities and the Republican Party from the beginning of its period of power resolutely turned its face
away from these ideas and these war practices, back to our fundamental conception of the state and
the rights and responsibilities of the individual. Thereby it restored confidence and hope in the American
people, it freed and stimulated enterprise, it restored the Government to its position as an umpire
instead of a player in the economic game.
…I regret, however, to say that there has been revived in this campaign a proposal which would be a
long step to the abandonment of our American system, to turn to the idea of government in business.
Because we are faced with difficulty and doubt over certain national problems which we are faced —
that is prohibition, farm relief and electrical power — our opponents propose that we must to some
degree thrust government into these businesses and in effect adopt state socialism as a solution.
There is, therefore submitted to the American people the question — Shall we depart from the
American system and start upon a new road. And I wish to emphasize this question on this occasion. I
wish to make clear my position on the principles involved for they go to the very roots of American life
in every act of our Government.
...It is false liberalism that interprets itself into the Government operation of business. The
bureaucratization of our country would poison the very roots of liberalism that is free speech, free
assembly, free press, political equality and equality of opportunity. It is the road, not to more liberty, but
to less liberty.
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…Liberalism is a force truly of the spirit, a force proceeding from the deep realization that economic
freedom cannot be sacrificed if political freedom is to be preserved. Even if governmental conduct of
business could give us more efficiency instead of giving us decreased efficiency, the fundamental
objection to it would remain unaltered and unabated. It would destroy political equality. It would cramp
and cripple mental and spiritual energies of our people. It would dry up the spirit of liberty and progress.
It would extinguish equality of opportunity, and for these reasons fundamentally and primarily it must
be resisted. For a hundred and fifty years liberalism has found its true spirit in the American system, not
in the European systems.
...One of the great problems of government is to determine to what extent the Government itself shall
interfere with commerce and industry and how much it shall leave to individual exertion. It is just as
important that business keep out of government as that government keep out of business. No system is
perfect. We have had abuses in the conduct of business that every good citizen resents. But I insist that
the results show our system better than any other and retains the essentials of freedom.
Questions:
1. In the first paragraph, Hoover talks about the American system of government. Describe his view.
2. How does Hoover feel the war changed government in America?
3. When Hoover talks about “rugged individualism”, what do you think he means?
4. What does Hoover believe will happen if we embrace paternalism, socialism, and the government
operation of business? Do you agree with Hoover? Explain.
5. In the last paragraph, Hoover talks about the “great problem of government”. What is this problem
and what do you think Hoover’s opinion is on this problem or issue?
EVERYBODY’S BUSINESS: The Smoot-Hawley Act Is More Than a Laugh Line
May 10, 2009
By BEN STEIN
FOR the last 23 years or so, complete strangers have come up to me all over this country to ask if there
really was such a thing as the Smoot-Hawley Tariff Act or if I made it up.
Yes, there really was such a thing. And while it’s been the subject of some controversy for economists
and historians, it also played a special role in my little life. The Smoot-Hawley Tariff Act, sometimes
called Hawley-Smoot, was the subject of a monologue I gave ad lib, just off the top of my head, in the
movie “Ferris Bueller’s Day Off” on Stage 15 at Paramount Studios on or about Nov. 15, 1985. It stayed
in the movie, and when that movie was released in 1986, that scene, my first of any size in any movie,
made me a star — although a star of only cult proportions, unlike, say, a Ronald Reagan. For me, that is
the primary significance of that piece of legislation.
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Otherwise, the Smoot-Hawley Tariff Act of 1930 was a wildly misguided attempt by two Republican
senators, Reed O. Smoot of Utah and Willis C. Hawley of a very different Oregon, and the Republicancontrolled Congress to stimulate domestic production by raising (“raising or lowering ... anyone,
anyone?”) tariffs on many goods from abroad. Signed reluctantly by President Herbert Hoover, who
most certainly did know better, the law did not do much to ameliorate the onrushing Depression, but it
did anger foreign trading partners. They slapped retaliatory tariffs on American-made goods. World
trade slumped.
As the great economist Ludwig von Mises has said, causes and effects in economics are impossible to
connect, so we do not know what effect Smoot-Hawley had on worsening the Depression. In economics,
each case has elements of uniqueness. Economics is not physics, and experiments are impossible to
conduct with enough control to consistently give us predictable results. We do not know at all what
effects Smoot-Hawley, as compared with the collapsing world economy, had on trade.
At the time of its enactment, exports were only about 5 percent of the economic output of the United
States and still outweighed imports. (Even now, exports are a smaller part of output in the United States
than in any other large developed nation.) To say that the act, which applied to a distinct minority of
imports and which raised tariffs generally by only about six percentage points, caused the Depression is
almost comical. It did no good, but compared with the titanic monetary policy disasters of the era, the
effect of Smoot-Hawley was probably very small, or so most mainstream economists believe.
However, a number of well-known people, especially my former colleagues at The Wall Street Journal
editorial page, the late Robert Bartley (a genuinely great guy) and Jude Wanniski, began in the mid1970s to popularize the notion that Smoot-Hawley and not monetary policy mistakes was the real cause
of the Great Depression.
This popularization was a form of intellectual entrepreneurship, in which people carve out an appealing
idea and then try to make capital of it. In this case, the argument actually has some usefulness in
cautioning us against adopting protectionism on a large scale as a way out of our current economic
troubles. That is, while it is a mistaken notion, it still has some beneficial effects. While the proponents
of attributing large effects to Smoot-Hawley are not generally prominent in economics, they are well
known and their views keep us on the straight and narrow about the virtues of free trade. (These, too,
have been seriously questioned in recent years by economists as respected as Paul A. Samuelson, the
Nobel Prize-winning professor emeritus at the Massachusetts Institute of Technology. The Adam Smith
idea that free trade always benefits every nation that practices it is very much in question now.)
Anyway, that’s Smoot-Hawley, or Hawley-Smoot, my main economics lesson of this Sunday.
Questions:
1. What was the basic idea behind the Smoot-Hawley Tariff Act of 1930? What was it supposed to do
and how was it supposed to do it?
2. What is Ben Stein’s opinion regarding the effects of the Smoot-Hawley Tariff Act and it role as a
cause of the Great Depression?
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Franklin D. Roosevelt, Commonwealth Club Address
September 23, 1932
…The issue of government has always been whether individual men and women will have to serve some
system of government or economics, or whether a system of government and economics exists to serve
individual men and women. This question has persistently dominated the discussion of government for
many generations. On questions relating to these things men have differed, and for time immemorial it
is probable that honest men will continue to differ.
…So manifest were the advantages of the machine age, however, that the United States fearlessly,
cheerfully, and, I think, rightly, accepted the bitter with the sweet. It was thought that no price was too
high to pay for the advantages which we could draw from a finished industrial system. This history of the
last half century is accordingly in large measure a history of a group of financial Titans, whose methods
were not scrutinized with too much care, and who were honored in proportion as they produced the
results, irrespective of the means they used.
…Just as freedom to farm has ceased, so also the opportunity in business has narrowed. It still is true
that men can start small enterprises, trusting to native shrewdness and ability to keep abreast of
competitors; but area after area has been pre—empted altogether by the great corporations, and even
in the fields which still have no great concerns, the small man starts under a handicap. The unfeeling
statistics of the past three decades show that the independent businessman is running a losing race.
Perhaps he is forced to the wall; perhaps he cannot command credit; perhaps he is "squeezed out," in
Mr. Wilson’s words, by highly organized corporate competitors, as your corner grocery man can tell you.
Clearly, all this calls for a re—appraisal of values. A mere builder of more industrial plants, a creator of
more railroad systems, an organizer of more corporations, is as likely to be a danger as a help. The day
of the great promoter or the financial Titan, to whom we granted everything if only he would build, or
develop, is over. Our task now is not discovery, or exploitation of natural resources, or necessarily
producing more goods. It is the soberer, less dramatic business of administering resources and plants
already in hand, of seeking to reestablish foreign markets for our surplus production, of meeting the
problem of under consumption, of adjusting production to consumption, of distributing wealth and
products more equitably of adapting existing economic organizations to the service of the people. The
day of enlightened administration has come.
…As I see it, the task of government in its relation to business is to assist the development of an
economic declaration of rights, an economic constitutional order. This is the common task of statesman
and businessman. It is the minimum requirement of a more permanently safe order of things.
…Every man has a right to life; and this means that he has also a right to make a comfortable living. He
may by sloth or crime decline to exercise that right; but it may not be denied him. We have no actual
famine or dearth; our industrial and agricultural mechanism can produce enough and to spare. Our
government formal and informal, political and economic, owes to everyone an avenue to possess
himself of a portion of that plenty sufficient for his needs, through his own work.
Every man has a right to his own property, which means a right to be assured, to the fullest extent
attainable, in the safety of his savings. By no other means can men carry the burdens of those parts of
life which, in the nature of things, afford no chance of labor; childhood, sickness, old age. In all thought
of property, this right is paramount; all other property rights must yield to it. If, in accord with this
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principle, we must restrict the operations of the speculator, the manipulator, even the financier, I
believe we must accept the restriction as needful, not to hamper individualism but to protect it.
These two requirements must be satisfied, in the main, by the individuals who claim and hold control of
the great industrial and financial combinations, which dominate so large a part of our industrial life.
They have undertaken to be not businessmen, but princes —— princes of property. I am not prepared to
say that the system which produces them is wrong. I am very clear that they must fearlessly and
competently assume the responsibility which goes with the power.
Questions:
1. Roosevelt opens his speech with the following statement, “The issue of government has always
been whether individual men and women will have to serve some system of government or
economics, or whether a system of government and economics exists to serve individual men and
women.” What does he mean by this?
2. What does Roosevelt claim has happened to the small businessman? Who has done this to them?
3. What does Roosevelt identify as “the task of government in its relation to business?”
4. What two rights does Roosevelt identify as being necessary for each individual’s declaration of
economic rights. Explain each.
5. Besides the government, who does Roosevelt feel should guarantee the above rights?
AN OPEN LETTER TO PRESIDENT ROOSEVELT
By John Maynard Keynes, New York Times, 1933
Dear Mr. President,
… Now I am not clear, looking back over the last nine months, that the order of urgency between
measures of Recovery and measures of Reform has been duly observed, or that the latter has not
sometimes been mistaken for the former. In particular, I cannot detect any material aid to recovery in
N.I.R.A., though its social gains have been large. The driving force which has been put behind the vast
administrative task set by this Act has seemed to represent a wrong choice in the order of urgencies.
The Act is on the Statute Book; a considerable amount has been done towards implementing it; but it
might be better for the present to allow experience to accumulate before trying to force through all its
details. That is my first reflection--that N.I.R.A., which is essentially Reform and probably impedes
Recovery, has been put across too hastily, in the false guise of being part of the technique of Recovery.
My second reflection relates to the technique of Recovery itself. The object of recovery is to increase
the national output and put more men to work. In the economic system of the modern world, output is
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primarily produced for sale; and the volume of output depends on the amount of purchasing power,
compared with the prime cost of production, which is expected to come n the market. Broadly speaking,
therefore, and increase of output depends on the amount of purchasing power, compared with the
prime cost of production, which is expected to come on the market. Broadly speaking, therefore, an
increase of output cannot occur unless by the operation of one or other of three factors. Individuals
must be induced to spend more out o their existing incomes; or the business world must be induced,
either by increased confidence in the prospects or by a lower rate of interest, to create additional
current incomes in the hands of their employees, which is what happens when either the working or the
fixed capital of the country is being increased; or public authority must be called in aid to create
additional current incomes through the expenditure of borrowed or printed money. In bad times the
first factor cannot be expected to work on a sufficient scale. The second factor will come in as the
second wave of attack on the slump after the tide has been turned by the expenditures of public
authority. It is, therefore, only from the third factor that we can expect the initial major impulse.
Now there are indications that two technical fallacies may have affected the policy of your
administration. The first relates to the part played in recovery by rising prices. Rising prices are to be
welcomed because they are usually a symptom of rising output and employment. When more
purchasing power is spent, one expects rising output at rising prices. Since there cannot be rising output
without rising prices, it is essential to ensure that the recovery shall not be held back by the insufficiency
of the supply of money to support the increased monetary turn-over. But there is much less to be said in
favour of rising prices, if they are brought about at the expense of rising output. Some debtors may be
helped, but the national recovery as a whole will be retarded. Thus rising prices caused by deliberately
increasing prime costs or by restricting output have a vastly inferior value to rising prices which are the
natural result of an increase in the nation's purchasing power.
… Thus as the prime mover in the first stage of the technique of recovery I lay overwhelming emphasis
on the increase of national purchasing power resulting from governmental expenditure which is
financed by Loans and not by taxing present incomes. Nothing else counts in comparison with this. In a
boom inflation can be caused by allowing unlimited credit to support the excited enthusiasm of business
speculators. But in a slump governmental Loan expenditure is the only sure means of securing quickly a
rising output at rising prices. That is why a war has always caused intense industrial activity. In the past
orthodox finance has regarded a war as the only legitimate excuse for creating employment by
governmental expenditure. You, Mr. President, having cast off such fetters, are free to engage in the
interests of peace and prosperity the technique which hitherto has only been allowed to serve the
purposes of war and destruction.
The set-back which American recovery experienced this autumn was the predictable consequence of the
failure of your administration to organise any material increase in new Loan expenditure during your
first six months of office. The position six months hence will entirely depend on whether you have been
laying the foundations for larger expenditures in the near future.
… The other set of fallacies, of which I fear the influence, arises out of a crude economic doctrine
commonly known as the Quantity Theory of Money. Rising output and rising incomes will suffer a setback sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that
output and income can be raised by increasing the quantity of money. But this is like trying to get fat by
buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most
misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume
of expenditure, which is the operative factor.
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It is an even more foolish application of the same ideas to believe that there is a mathematical relation
between the price of gold and the prices of other things. It is true that the value of the dollar in terms of
foreign currencies will affect the prices of those goods which enter into international trade. In so far as
an over-valuation of the dollar was impeding the freedom of domestic price-raising policies or disturbing
the balance of payments with foreign countries, it was advisable to depreciate it. But exchange
depreciation should follow the success of your domestic price-raising policy as its natural consequence,
and should not be allowed to disturb the whole world by preceding its justification at an entirely
arbitrary pace. This is another example of trying to put on flesh by letting out the belt…
Questions:
1. Looking over Roosevelt’s first nine months in office, what are Keynes two observations (reflections)?


2. What are the two technical fallacies that Keynes believes has affected the policies of Roosevelt’s
administration?


John Maynard Keynes His radical idea that governments should spend money they don't have may
have saved capitalism
By ROBERT B. REICH
Mar. 29, 1999
He hardly seemed cut out to be a workingman's revolutionary. A Cambridge University don with a flair
for making money, a graduate of England's exclusive Eton prep school, a collector of modern art, the
darling of Virginia Woolf and her intellectually avant-garde Bloomsbury Group, the chairman of a lifeinsurance company, later a director of the Bank of England, married to a ballerina, John Maynard
Keynes--tall, charming and self-confident--nonetheless transformed the dismal science into a
revolutionary engine of social progress.
Before Keynes, economists were gloomy naysayers. "Nothing can be done," "Don't interfere," "It will
never work," they intoned with Eeyore-like pessimism. But Keynes was an unswerving optimist. Of
course we can lick unemployment! There's no reason to put up with recessions and depressions! The
"economic problem is not--if we look into the future--the permanent problem of the human race," he
wrote (liberally using italics for emphasis).
Born in Cambridge, England, in 1883, the year Karl Marx died, Keynes probably saved capitalism from
itself and surely kept latter-day Marxists at bay.
7
His father John Neville Keynes was a noted Cambridge economist. His mother Florence Ada Keynes
became mayor of Cambridge. Young John was a brilliant student but didn't immediately aspire to either
academic or public life. He wanted to run a railroad. "It is so easy...and fascinating to master the
principles of these things," he told a friend, with his usual modesty. But no railway came along, and
Keynes ended up taking the civil service exam. His lowest mark was in economics. "I evidently knew
more about Economics than my examiners," he later explained.
Keynes was posted to the India Office, but the civil service proved deadly dull, and he soon left. He
lectured at Cambridge, edited an influential journal, socialized with his Bloomsbury friends, surrounded
himself with artists and writers and led an altogether dilettantish life until Archduke Francis Ferdinand of
Austria was assassinated in Sarajevo and Europe was plunged into World War I. Keynes was called to
Britain's Treasury to work on overseas finances, where he quickly shone. Even his artistic tastes came in
handy. He figured a way to balance the French accounts by having Britain's National Gallery buy
paintings by Manet, Corot and Delacroix at bargain prices.
His first brush with fame came soon after the war, when he was selected to be a delegate to the Paris
Peace Conference of 1918-19. The young Keynes held his tongue as Woodrow Wilson, David Lloyd
George and Georges Clemenceau imposed vindictive war reparations on Germany. But he let out a roar
when he returned to England, immediately writing a short book, The Economic Consequences of the
Peace.
The Germans, he wrote acerbically, could not possibly pay what the victors were demanding. Calling
Wilson a "blind, deaf Don Quixote" and Clemenceau a xenophobe with "one illusion--France, and one
disillusion--mankind" (and only at the last moment scratching the purple prose he had reserved for Lloyd
George: "this goat-footed bard, this half-human visitor to our age from the hag-ridden magic and
enchanted woods of Celtic antiquity"), an outraged Keynes prophesied that the reparations would keep
Germany impoverished and ultimately threaten all Europe.
His little book sold 84,000 copies, caused a huge stir and made Keynes an instant celebrity. But its real
import was to be felt decades later, after the end of World War II. Instead of repeating the mistake
made almost three decades before, the U.S. and Britain bore in mind Keynes' earlier admonition. The
surest pathway to a lasting peace, they then understood, was to help the vanquished rebuild. Public
investing on a grand scale would create trading partners that could turn around and buy the victors'
exports, and also build solid middle-class democracies in Germany, Italy and Japan.
Yet Keynes' largest influence came from a convoluted, badly organized and in places nearly
incomprehensible tome published in 1936, during the depths of the Great Depression. It was called The
General Theory of Employment, Interest and Money.
Keynes' basic idea was simple. In order to keep people fully employed, governments have to run deficits
when the economy is slowing. That's because the private sector won't invest enough. As their markets
become saturated, businesses reduce their investments, setting in motion a dangerous cycle: less
investment, fewer jobs, less consumption and even less reason for business to invest. The economy may
reach perfect balance, but at a cost of high unemployment and social misery. Better for governments to
avoid the pain in the first place by taking up the slack.
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The notion that government deficits are good has an odd ring these days. For most of the past two
decades, America's biggest worry has been inflation brought on by excessive demand. Inflation soared
into double digits in the 1970s, budget deficits ballooned in the '80s, and now a Democratic President
congratulates himself for a budget surplus that he wants to use to pay down the debt. But some 60
years ago, when 1 out of 4 adults couldn't find work, the problem was lack of demand.
Even then, Keynes had a hard sell. Most economists of the era rejected his idea and favored balanced
budgets. Most politicians didn't understand his idea to begin with. "Practical men, who believe
themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct
economist," Keynes wrote. In the 1932 presidential election, Franklin D. Roosevelt had blasted Herbert
Hoover for running a deficit, and dutifully promised he would balance the budget if elected. Keynes' visit
to the White House two years later to urge F.D.R. to do more deficit spending wasn't exactly a blazing
success. "He left a whole rigmarole of figures," a bewildered F.D.R. complained to Labor Secretary
Frances Perkins. "He must be a mathematician rather than a political economist." Keynes was equally
underwhelmed, telling Perkins that he had "supposed the President was more literate, economically
speaking."
As the Depression wore on, Roosevelt tried public works, farm subsidies and other devices to restart the
economy, but he never completely gave up trying to balance the budget. In 1938 the Depression
deepened. Reluctantly, F.D.R. embraced the only new idea he hadn't yet tried, that of the bewildering
British "mathematician." As the President explained in a fireside chat, "We suffer primarily from a failure
of consumer demand because of a lack of buying power." It was therefore up to the government to
"create an economic upturn" by making "additions to the purchasing power of the nation."
Yet not until the U.S. entered World War II did F.D.R. try Keynes' idea on a scale necessary to pull the
nation out of the doldrums--and Roosevelt, of course, had little choice. The big surprise was just how
productive America could be when given the chance. Between 1939 and 1944 (the peak of wartime
production), the nation's output almost doubled, and unemployment plummeted--from more than 17%
to just over 1%.
Never before had an economic theory been so dramatically tested. Even granted the special
circumstances of war mobilization, it seemed to work exactly as Keynes predicted. The grand
experiment even won over many Republicans. America's Employment Act of 1946--the year Keynes
died--codified the new wisdom, making it "the continuing policy and responsibility of the Federal
Government ...to promote maximum employment, production, and purchasing power."
And so the Federal Government did, for the next quarter-century. As the U.S. economy boomed, the
government became the nation's economic manager and the President its Manager in Chief. It became
accepted wisdom that government could "fine-tune" the economy, pushing the twin accelerators of
fiscal and monetary policy in order to avoid slowdowns, and applying the brakes when necessary to
avoid overheating. In 1964 Lyndon Johnson cut taxes to expand purchasing power and boost
employment. "We are all Keynesians now," Richard Nixon famously proclaimed. Americans still take for
granted that Washington has responsibility for steering the economy clear of the shoals, although it's
now Federal Reserve Chairman Alan Greenspan rather than the President who carries most of the
responsibility.
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Keynes had no patience with economic theorists who assumed that everything would work out in the
long run. "This long run is a misleading guide to current affairs," he wrote early in his career. "In the long
run we are all dead."
Were Keynes alive today he would surely admire the vigor of the U.S. economy, but he would also notice
that some 40% of the global economy is in recession and much of the rest is slowing down: Japan, flat
on its back; Southeast Asia, far poorer than it was just two years ago; Brazil, teetering; Germany,
burdened by double-digit unemployment and an economic slowdown; and declining prices worldwide
for oil and raw materials.
In light of all this, Keynes would be mystified that the International Monetary Fund is requiring troubled
Third World nations to raise taxes and slash spending, that "euro" membership demands budget
austerity, and that a U.S. President wants to hold on to budget surpluses. You can bet Keynes wouldn't
be silent. Dapper and distinguished as he was, he'd enter the fray with both fists and a mighty roar.
Questions:
1. What was Keynes’ analysis of the Paris Peace Conference?
2. What was the basic ides of Keynes General Theory of Employment, Interest and Money?
3. Did Franklin Roosevelt’s New Deal initiative fully embrace Keynesian Economic theory? Explain.
4. What made Keynes’ economic theory different from the mainstream economic theories of his day?
The Great Depression: An Overview by David C. Wheelock
David C. Wheelock is an assistant vice president and economist at the Federal Reserve Bank of St. Louis.
Why should students learn about the Great Depression? Our grandparents and great-grandparents lived
through these tough times, but you may think that you should focus on more recent episodes in
American life. In this essay, I hope to convince you that the Great Depression is worthy of your interest
and deserves attention in economics, social studies and history courses.
One reason to study the Great Depression is that it was by far the worst economic catastrophe of the
20th century and, perhaps, the worst in our nation’s history. Between 1929 and 1933, the quantity of
goods and services produced in the United States fell by one-third, the unemployment rate soared to
25 percent of the labor force, the stock market lost 80 percent of its value and some 7,000 banks failed.
At the store, the price of chicken fell from 38 cents a pound to 12 cents, the price of eggs dropped from
50 cents a dozen to just over 13 cents, and the price of gasoline fell from 10 cents a gallon to less than a
nickel. Still, many families went hungry, and few could afford to own a car.
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Another reason to study the Great Depression is that the sheer magnitude of the economic collapse—
and the fact that it involved every aspect of our economy and every region of our country—makes this
event a great vehicle for teaching important economic concepts. You can learn about inflation and
deflation, Gross Domestic Product (GDP), and unemployment by comparing the Depression with more
recent experiences. Further, the Great Depression shows the important roles that money, banks and the
stock market play in our economy.
A third reason to study the Great Depression is that it dramatically changed the role of government,
especially the federal government, in our nation’s economy. Before the Great Depression, federal
government spending accounted for less than 3 percent of GDP. By 1939, federal outlays exceeded 10
percent of GDP.1 (At present, federal spending accounts for about 20 percent of GDP.) The Great
Depression also brought us the Federal Deposit Insurance Corp. (FDIC), regulation of securities markets,
the birth of the Social Security System and the first national minimum wage.
What Caused the Great Depression?
Economists continue to study the Great Depression because they still disagree on what caused it. Many
theories have been advanced over the years, but there remains no single, universally agreed-upon
explanation as to why the Depression happened or why the economy eventually recovered.
The 1929 stock market crash often comes to mind first when people think about the Great Depression.
The crash destroyed considerable wealth. Perhaps even more important, the crash sparked doubts
about the health of the economy, which led consumers and firms to pull back on their spending,
especially on big-ticket items like cars and appliances. However, as big as it was, the stock market crash
alone did not cause the Great Depression.
Some economists point a finger at protectionist trade policies and the collapse of international trade.
The Smoot-Hawley tariff of 1930 dramatically increased the cost of imported goods and led to
retaliatory actions by the United States’ major trading partners. The Great Depression was a worldwide
phenomenon, and the collapse of international trade was even greater than the collapse of world
output of goods and services. Still, like the stock market crash, protectionist trade policies alone did not
cause the Great Depression.
Other experts offer different explanations for the Great Depression. Some historians have called the
Depression an inevitable failure of capitalism. Others blame the Depression on the “excesses” of the
1920s: excessive production of commodities, excessive building, excessive financial speculation or an
excessively skewed distribution of income and wealth. None of these explanations has held up very well
over time. One explanation that has stood the test of time focuses on the collapse of the U.S. banking
system and resulting contraction of the nation’s money stock. Economists Milton Friedman and Anna
Schwartz make a strong case that a falling money stock caused the sharp decline in output and prices in
the economy.2
As the money stock fell, spending on goods and services declined, which in turn caused firms to cut
prices and output and to lay off workers. The resulting decline in incomes made it harder for borrowers
to repay loans. Defaults and bankruptcies soared, creating a vicious spiral in which more banks failed,
the money stock contracted further, and output, prices and employment continued to decline.3
Money, Banking and Deflation
Money makes the economy function. Money evolved thousands of years ago because barter—the direct
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trading of goods or services for other goods or services—simply didn’t work. A modern economy could
not function without money, and economies tend to break down when the quantity or value of money
changes suddenly or dramatically. Print too much money, and its value declines—that is, prices rise
(inflation). Shrink the money stock, on the other hand, and the value of money rises—that is, prices fall
(deflation).
In modern economies, bank deposits—not coins or currency—comprise the lion’s share of the money
stock. Bank deposits are created when banks make loans, and deposits contract when customers repay
loans. The amount of loans that banks can make, and hence the quantity of deposits that are created, is
determined partly by regulations on the amount of reserves that banks must hold against their deposits
and partly by the business judgment of bankers.
In the United States, bank reserves consist of the cash that banks hold in their vaults and the deposits
they keep at Federal Reserve banks. Reserves earn little or no interest, so banks don’t like to hold too
much of them. On the other hand, if banks hold too few reserves, they risk getting caught short in the
event of unexpected deposit withdrawals.
In the 1930s, the United States was on the gold standard, meaning that the U.S. government would
exchange dollars for gold at a fixed price. Commercial banks, as well as Federal Reserve banks, held a
portion of their reserves in the form of gold coin and bullion, as required by law.
An increase in gold reserves, which might come from domestic mining or inflows of gold from abroad,
would enable banks to increase their lending and, as a result, would tend to inflate the money stock. A
decrease in reserves, on the other hand, would tend to contract the money stock. For example, large
withdrawals of cash or gold from banks could reduce bank reserves to the point that banks would have
to contract their outstanding loans, which would further reduce deposits and shrink the money stock.
The money stock fell during the Great Depression primarily because of banking panics. Banking systems
rely on the confidence of depositors that they will be able to access their funds in banks whenever they
need them. If that confidence is shaken—perhaps by the failure of an important bank or large
commercial firm—people will rush to withdraw their deposits to avoid losing their funds if their own
bank fails.
Because banks hold only a fraction of the value of their customers’ deposits in the form of reserves, a
sudden, unexpected attempt to convert deposits into cash can leave banks short of reserves. Ordinarily,
banks can borrow extra reserves from other banks or from the Federal Reserve. However, borrowing
from other banks becomes extremely expensive or even impossible when depositors make demands on
all banks. During the Great Depression, many banks could not or would not borrow from the Federal
Reserve because they either lacked acceptable collateral or did not belong to the Federal Reserve
System.4
Starting in 1930, a series of banking panics rocked the U.S. financial system. As depositors pulled funds
out of banks, banks lost reserves and had to contract their loans and deposits, which reduced the
nation’s money stock. The monetary contraction, as well as the financial chaos associated with the
failure of large numbers of banks, caused the economy to collapse.
Less money and increased borrowing costs reduced spending on goods and services, which caused firms
to cut back on production, cut prices and lay off workers. Falling prices and incomes, in turn, led to even
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more economic distress. Deflation increased the real burden of debt and left many firms and households
with too little income to repay their loans. Bankruptcies and defaults increased, which caused thousands
of banks to fail. In each year from 1930 to 1933, more than 1,000 U.S. banks closed.
Banking panics are pretty much a thing of the past, thanks to federal deposit insurance. Widespread
failures of banks and savings institutions during the 1980s did not cause depositors to panic, which
limited withdrawals from the banking system and prevented serious reverberations throughout the
economy.
Recovery
The monetary hemorrhage experienced during the Great Depression finally ended when President
Franklin D. Roosevelt declared a national bank holiday just one day after he took office in March 1933.
Roosevelt ordered all banks closed, including the Federal Reserve banks. He permitted them to reopen
only after each bank received a government license. Meanwhile, the federal government set up a
temporary system of federal deposit insurance and followed up a year later by creating the Federal
Deposit Insurance Corporation (FDIC) and a permanent deposit insurance system.
Roosevelt’s policies restored confidence in the banking system, and money poured back into the banks.
The money stock began to expand, which fueled increased spending and production as well as rising
prices. Economic recovery was slow, but at least the bottom had been reached and the corner turned.
History books often credit Roosevelt’s New Deal for leading the economic recovery from the Great
Depression. Under the New Deal, the government put in place many programs of relief and recovery
that employed thousands of people and made direct cash grants or loans to individuals, firms and local
governments. However, at least in the first few years of the New Deal, federal government spending did
not increase substantially.
Furthermore, some aspects of the New Deal may even have hampered recovery. For example, some
economists believe that the National Recovery Act (NRA) may have slowed the recovery by encouraging
the formation of industrial cartels, which limited competition and may have discouraged employment.
Others note that some New Deal agricultural programs perversely discouraged production and reduced
the demand for farm labor. Still, by restoring confidence in the financial system and in the U.S. economy
as a whole, Roosevelt’s policies undoubtedly did much to spark the economic recovery.
Could It Happen Again?
That’s the big question. As economists have learned more and more about the importance of monetary
and banking forces in both the contraction and recovery phases of the Great Depression, they have
recognized the importance of sound macroeconomic policies in ensuring a strong economy. The Great
Depression was not a failure of capitalism or of markets, but rather a result of misguided government
policies—specifically, the Federal Reserve allowing the money stock to collapse as panics engulfed the
banking system. If the Fed had stepped up to the plate and ensured that banks had ample reserves to
meet their customers’ withdrawal demands, the money stock would not have declined, and the
economy probably would not have sharply contracted.
Although the Fed could not by law directly lend to banks that did not belong to the Federal Reserve
Introduction System, the Fed could have purchased securities in the open market and flooded the
banking system with reserves. Since the Great Depression, the Federal Reserve has responded faster to
shocks that have threatened the banking and payments system.
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The Great Depression also demonstrated the importance of price stability. Deflation was an important
cause of falling incomes and financial distress, as households and firms found it increasingly difficult to
repay debts. Because debt contracts almost always specify repayment of a fixed-dollar sum, deflation
increases the real cost of a given nominal debt.
Thus, deflation often leads to increases in loan defaults and bankruptcies, which in turn raise the
number of bank failures and produces further declines in income, output and employment. Price
stability is now widely accepted as the paramount goal for monetary policy because fluctuations in the
price level—whether deflation or inflation—can cause financial instability and hinder economic growth.
It is unlikely that doctors will ever find a cure for the common cold. Similarly, it is unlikely that
economists will ever find a remedy for the negative effects of the business cycle. From time to time,
shocks will hit the economy and will cause output and employment to fluctuate. However, the Great
Depression has taught us that sound economic policies will help ensure that ordinary fluctuations in
output and employment do not grow into major economic catastrophes.
1 In 1929, federal outlays totaled $3.1 billion (Economic Report of the President); GDP totaled $108.1 billion
(Gordon, Macroeconomics).
2 Milton Friedman and Anna J. Schwartz. A Monetary History of the United States, 1867-1960. Princeton: Princeton
University Press, 1963.
3 Federal Reserve Chairman Ben Bernanke wrote an important article showing that banking panics contributed to
the nation’s economic collapse not only by reducing the money stock, but also by increasing the costs of
borrowing and lending. Ben S. Bernanke. “Nonmonetary Effects of the Financial Crisis in Propagation of
the Great Depression,” American Economic Review, June 1983, v. 73, iss. 3, pp. 257-76.
4 Before 1980, only banks that were members of the Federal Reserve System could borrow directly from Federal
Reserve banks.
Questions:
1. Why does Wheelock believe that students should learn about the Great Depression?
2. What are some of the theories and or factors proposed by economists as causes of the Great
Depression?
3. Regarding falling money stock (contraction of money supply), deflation, and bank panics, how does
Wheelock portray the sequence of occurrence?
4. What actions by the Roosevelt administration does Wheelock identify as stopping the “monetary
hemorrhage” and restoring faith in the banking system?
5. What does Wheelock identify as the primary cause of the Great Depression? How does he believe
the federal government could have responded to avoid the Depression?
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