Eric Rauchway on the Great Depression and the New Deal 12/01/2008

Banks are profit-seeking firms, not social agencies, so government cannot expect them to lend recapitalization funds if they lack good investments or if creditworthy borrowers are scarce; both in the 1930s (RFC/Jesse Jones) and today (Paulson/TARP) the constraint was a shortage of qualified borrowers, not bank timidity.

“banks are interested in profits. They're not social agencies... if you don't think you have something good to invest in, you're not going to invest. And if people don't want to borrow, they're not going to borrow if they're worried they're not going to be able to pay it back.”

The agricultural sector had long lobbied for an equivalent of the protective tariff—price supports for farmers comparable to the protection manufacturers received—which they finally obtained through the AAA, which taxed processing to limit production and support prices.

“forever uh farmers have been lobbying to get some kind of equivalent of the protective tariff, something that would produce for them the same kind of price supports that the protective tariff produces for manufacturers. Uh they finally get this uh in the form of the Agricultural Adjustment Administration”

Americans' attitudes toward debt flipped after WWI, doubling household debt over the 1920s as installment credit (e.g., GMAC financing cars sold on novelty rather than need) gave rise to modern consumer culture where people bought because they could get credit, not because they had money.

“you had a doubling of household debt uh after World War I... This is when you see GMAC set up shop... you have uh the beginnings of our modern consumer culture, where people are buying things because they want them and not because they have the money, but because they can get the credit.”

New Deal bureaucracies suffered from a logistics problem of assembling many bureaucrats on the fly in an emergency—e.g., the AAA couldn't get cotton-subsidy forms out fast enough, leaving an unwanted crop in the ground and forcing destruction of crops and slaughter of pigs that the program had meant to prevent from being produced.

“This this turns up with the AAA where they can't get the necessary forms out, you know, for cotton subsidies quick enough and they end up with a cotton crop in the ground that they didn't want”

The lasting phase of the New Deal operated on the principle of 'countervailing power'—rather than the federal government directly setting prices and wages, it enabled organized groups to bargain for themselves (Wagner Act for unions), made regions self-sufficient (TVA electrifying the South), and gave workers security (Social Security), so that the government's role became enabling people to act for themselves rather than acting for them.

“the policies that are adopted under the heading of countervailing power. And the idea is, as with the Wagner Act, is that instead of having the federal government do something, you're going to make sure that some organization of people can strike a bargain for themselves.”

The New Deal's signal achievement and legacy was demonstrating—against contemporary alternatives of Soviet communism and European fascism, with Hitler's tenure almost exactly coterminous with Roosevelt's—that a nation could reckon with the Depression's crisis without throwing democracy and capitalism overboard, preserving a recognizably capitalist, liberty-respecting, democratic order.

“the idea that you could reckon with the crisis of the depression without throwing democracy and capitalism overboard is is probably the New Deal's signal achievement and legacy for the rest of the world.”

Keynes argued in The Economic Consequences of the Peace that the pre-WWI world was an economic utopia in which goods, capital, and people moved freely—lifting Malthusian fetters on growth—and that the Versailles Treaty's failure to reconstruct Europe would produce a depression in which desperate men would overthrow civilization, a prediction that proved largely accurate.

“Keynes says, 'What's not in the treaty is any attempt to reconstruct Europe'... one of the results... are going to be a depression in which men in their desperation will overthrow civilization, which turns out to be a pretty good prediction.”

The New Deal was not a coherent program springing from Roosevelt's mind but emerged from conflict among president, Congress, and courts; it can only be defined in retrospect as what survived after certain experiments failed or proved politically untenable, with the survivors partly shaped by the obstacles they had to circumvent.

“the New Deal is not something that springs from the brain of Franklin Roosevelt... You can only say what the New Deal looks like in retrospect and it's only because certain experiments have failed, certain things have been found to be politically untenable and what's left over is what you have”

World War II irreparably confounds any verdict on what caused recovery: the apparent effectiveness of monetary policy is entangled with capital fleeing Hitler, and the Keynesian deficit experiment was never run because spending was redirected to war preparedness, so with only one data point and the war looming over everything, causal claims about the 1930s inevitably collapse into ex post storytelling.

“There's very little you can say about the '30s that doesn't have the specter of the war looming over it... Suppose they had gone on to run bigger deficits, would they have been able to uh cure the depression by following straightforwardly Keynesian policies? Well, we don't know because we don't get to see to run that experiment because they end up preparing for war instead.”

Unions help those who are unionized but, by raising wages above market levels, make it harder for others to find work—embodying the Depression-era dilemma where high wages support purchasing power but low wages encourage employers to hire the unemployed; the resolution is to attend to quantities (employment) as the sign of recovery, not just prices (wages).

“unions help the people who are unionized and they make it harder by definition they they try to raise wages higher than they otherwise would be, which is problematic for the people who are trying to find work.”

Robert Barro's analysis of rare economic disasters shows that because such events come along only once or twice a century, it is inherently difficult to generalize from them, leading inevitably to ex post storytelling that both economists and historians are prone to.

“We had Robert Barro on on EconTalk uh months back where he talked about disasters... when these things come along once or twice a century, it's it's tough to generalize obviously, and it's inevitably leads to expose storytelling”

Roosevelt was not a Keynesian: he reluctantly accepted relief on the view that a dole was un-American, then in 1937 cut WPA employment seeing recovery (Keynes warned this was an 'error of optimism'), triggering the 1937-38 downturn; even when New Dealers deliberately ran a 1938 deficit it was far too small to produce the appropriate Keynesian effect.

“in 1937, he begins cutting back on WPA employees because he sees the economy recovering... Keynes says, 'This is an error of optimism.'... even when they do, and they deliberately run a budget deficit then in in '38, it's not nearly as big as it ought to be to have the appropriate Keynesian effect.”

World War I was a watershed that flipped the US from the world's great borrower to the world's great creditor, so after the war every belligerent nation owed money largely to the United States while having little productive capacity left to repay it, creating a structurally disadvantageous global debt configuration.

“before World War I, the United States is the world's great borrower. After World War I, the United States is the world's great creditor. So, there's this almost overnight switch in who's at the center of the world's lending and borrowing network.”

Social Security in the 1930s was trivial as a recovery policy—a very small number of people collected very small amounts, mostly symbolic—but it was significant as a reform policy designed to make future downturns less severe, only later growing into a major program.

“Social Security in the 30s was trivial. It became an important social program ultimately... a very very very small number of people collected a very very small amount of money and it was mostly symbolic”

Roosevelt's bank holiday allowed federal auditors to certify sound banks (which proved to be the vast majority) and shutter the rest, which restored confidence, brought deposits flooding back, halted the cascade of bank failures, and set the country on the road to federal deposit insurance (the FDIC), created initially against Roosevelt's own judgment.

“this is has the salutary effect of restoring confidence in the American banking system. And deposits do in fact immediately start coming back into American banks. So this kind of stops the uh the cascade of bank failures in its tracks.”

The Great Depression was a great spur to government data collection, creating the beginnings of the modern enterprise of economic data gathering—which has been both a boon and a bane to good economic policy.

“the Great Depression was a great spur to the collection of data, which created the beginnings of our modern um enterprises of of data collection at the governmental level, which have been both a boon and a bane”

The New Deal was not strongly redistributionist in its tax structure: about half of federal revenue came from regressive excise (sales) taxes (over half in 1933, dwindling through the decade), while individual income taxes were only about 20%—the genuinely redistributive tax schedule waited for the war.

“it's about half from excise taxes... It's a highly regressive form of taxation. Um you know, individual income taxes are around 20% of the federal revenue. So, it's not um there's not a hugely redistributionist program going on here with the tax code”

A Bretton-Woods-style settlement and a Marshall-Plan-equivalent after WWI might have averted the Great Depression and possibly WWII, but while economically plausible on Keynes's own terms, its political plausibility was nil because there were too many dead Frenchmen and Englishmen to generate sympathy for aiding Germany.

“what would have happened had there been um a Bretton Woods settlement and a Marshall Plan after World War I or the equivalent?... the answer might be yes. I don't know if anyone's actually run the numbers... and the political plausibility of it is nil.”

The Federal Reserve's deliberate effort to curb stock-market speculation by raising interest rates—starting in 1928—made US investment more attractive than overseas, reducing capital exports and causing countries dependent on American money (especially Germany) to suffer even before the 1929 crash.

“they raise interest rates. And they do this uh actually first in in '28... This is when you raise rates in the US, all of a sudden uh it becomes more attractive to invest in the US than overseas. Uh capital export falls and countries that depend on money coming out of the United States uh begin to suffer already even before the crash.”

Going off the gold standard and devaluing the dollar to $35/ounce drew foreign deposits into US banks and, combined with FDIC-restored domestic deposits and RFC recapitalization, increased the high-powered money supply enough that some economists argue these monetary measures alone could have produced recovery—though later inflows owed more to capital fleeing Nazi Europe than to devaluation, confounding the verdict.

“the United States going off the gold standard, which probably turns out to be a very good thing in the long run as well... the argument is that that that alone uh is is is enough uh fuel to the recovery fire”

The National Recovery Administration was a failure both in principle—trying to raise prices and wages simultaneously, which cannot produce recovery—and in practice, because assembling cartel boards on a crash basis in an emergency rarely produced consumer or labor representation or even written codes; it collapsed by late 1934 and was ruled unconstitutional in 1935.

“leaving aside the central planning part, they're trying to raise prices and wages at the same time. This is going to get you nowhere in terms of a recovery policy... it's a just an enormous failure both in principle and in practice.”

Tariffs rose around the world throughout the 1920s, and the League of Nations' attempts to secure agreement to keep tariffs down failed, with the US raising emergency tariffs in 1921, extending the schedule via Fordney-McCumber in 1922, and culminating in the Smoot-Hawley Act of 1930, which provoked retaliatory tariffs abroad.

“these come in in 1921 and then they're made more permanent and the schedule of tariffs is extended in 1922 with the Fordney-McCumber Act. And then... the Smoot-Hawley Act... Which is 1930... And greeted by the rest of the world with their own tariffs in response.”

The Depression's banking collapse was self-reinforcing: with no deposit insurance and depleted state and private relief, the unemployed drew down savings and pressured banks; as foreign, stock, and municipal debts defaulted, banks weakened, and once their distress became visible, runs ensued—a cascade with no institutional brake under Hoover.

“as soon as it becomes clear that the banks are under pressure, of course, you get runs on banks. And you begin to have banks going under. And, uh, so, the banking system begins to collapse under Hoover.”

Borrowing is not inherently irresponsible—only borrowing you can't pay back is; the stock market run-up of the 1920s likely gave people the confidence they could meet debt obligations, paralleling late-1990s consumers who borrowed against paper wealth to smooth consumption.

“In and of itself, borrowing is not irresponsible. It's borrowing that you can't pay back.”

After WWI the US erected high tariffs and immigration barriers, so foreign nations could neither sell goods to nor emigrate to the US, leaving them dependent on continued American lending to service debts and rebuild—a closed-off system that placed sustained strain on European economies.

“with new tariffs raised after the war, with new barriers to immigration raised after the war in the United States, there's very little foreign competition... you have this kind of world system where nobody can sell to the United States.”

Hoover was not a laissez-faire ideologue—he increased federal spending, tried to coordinate businessmen to prevent wage cuts, and created the RFC—but this is distinct from being a proto-New Dealer; his anti-collapse efforts were limited by his discomfort with anything resembling nationalization and by a federal government too small to counter the Depression's severity.

“Hoover was not a laissez-faire guy. That's not the same as saying he's a proto New Dealer.”

The contraction of the money supply during the Depression was the fault of the Federal Reserve, not Hoover.

“We have the contraction of the money supply, which you can't really put at his feet. No, I mean that's the other thing is that you know, Hoover's not at fault for that either. The Federal Reserve is... at fault for that.”

Hoover's attempt to prevent wage cuts by coordinating employers was ineffective because firms simply laid people off instead—keeping the same wages but reducing headcount, so the stream of money to the economy still fell—and would have been ill-advised even if effective, since keeping wages high blocked the labor-market readjustment that falling wages would have produced.

“they get immediately get around it by simply laying people off. So, they're paying the same wages, but they're hiring fewer people. So, you're not actually keeping the stream of money going out to the economy”

The stock market crash transmitted to the real economy through an uncertainty mechanism: because 1920s borrowing depended on the perception that times were improving (with the stock market as the index of that), the crash triggered an immediate collapse in consumer spending and borrowing, visible in plummeting new automobile registrations through 1930.

“the sudden cutting off of consumer uh borrowing and buying immediately after the crash is a reaction to the stock market's failure... Then you you have an immediate transfer via this uh uncertainty mechanism to what we we call the real economy right now.”

Private-sector unionization fell steadily (almost monotonically) from about 1955 to under 10% of the private workforce today, so the 'golden era' of unionization lasted only about 20 years; its decline owed mainly to private forces—chiefly the shift of the economy away from manufacturing—rather than explicit government action.

“Union is unionization in the private sector I think fell has fallen almost monotonically meaning steadily from about 1955 to the present... it's down to about uh it's under 10% of the private sector workforce today. So this this golden era of unionization lasts about 20 years.”

By any measure of unemployment, conditions were improving through the 1930s but had not fully recovered by the end of the decade, and it is impossible to know what direction the Roosevelt administration would have taken absent the war's pull toward military armaments.

“no matter which measure you use, things are getting better in the '30s. They haven't gotten better by the end of the '30s.”

National wage-setting programs like the WPA struggled because of wide regional variation in what constitutes a living wage; the WPA's crude regional wage schedule overpaid relative to private markets in some places (notably the South) and underpaid in others, illustrating central planning's difficulty in getting local details right.

“Part of the WPA's problem is trying to set a wage... they end up with a sort of regional schedule of wages... It's very hard, uh, you know, as we know with central planning to get these kinds of details right.”