Great Depression presented in my history textbook this semester

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John James replied on Tue, Feb 21 2012 2:26 PM

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I'll come back with some recommendations, but for now, if you can get ahold of a copy of The Politically Incorrect Guide to the Great Depression and the New Deal, you'd be in excellent shape.

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Cari replied on Wed, Feb 22 2012 2:36 PM

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Thanks for the response. I would like to read that book when I get the chance. I doubt I will have the time by this time next week to have done so though.

I want to run by a few conclusions the author came to about New Deal spending to see if they pass the Austrian test!

First, the text correlates the downturn of 1937 with a lessening in government spending less on farm subsidies and the WPA work projects! Here is the passage:

"1937 also witnessed a sharp downturn of the economy. With economic conditions improving in 1936 (due the the Second New Deal programs and redistribution), Roosevelt had reduced federal funding of farm subsidies and WPA work relief. The result was disasterous. As government spending fell, so did business investment, industrial production, and the stock market."

It goes on to talk about Keynes and how he heavily influenced the economic policies of that era.

It then concludes the section with this,

"In April, [FDR] asked Congress for billions more for work relief and farm aid. By the end of the year, the immediate crisis had passed."

You can see what the author has done here. He has confirmed Keynesian economics and admitted it. He correlates a lessening of spending with the 1937 downturn and then correlates the increased spending to the start of the end of the Depression before WWII. On the same page he has a chart with the unemployment figures that show how employment correspondingly went up when the spending went up and how it went down when government spending went down.

This strikes me as a huge "correlation does not equal causation" fallacy.

Am I correct?

How do I address another correlation fallacy expressed in the general sentiment that "it is so obvious that lassaz faire did not work and that government spending did?"

BTW, in the middle of this section, they go back to saying that Hoover all of a sudden was "free-market" again when he rallied against FDR's New Deal in The Challenge to Liberty. This text makes out Hoover to be quite the multiple personality: first he is extremely free-market, then he reluctantly agrees to intervention, and then he is back to Mr. Free Market again. Something does not seem right here.

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Seraphos1 replied on Wed, Feb 22 2012 3:14 PM

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An informal situation like speaking in a class/talking to fellow students lends itself to the notion of keeping it simple. When it comes to the great depression I think the following three straightforward points being made (and then you can go into more detail if people disagree/are more interested):

A) The events of 1920/21. Briefly describe both what happened and the recovery in the absence of a material increase in gov't intervention

B) Hoover was certainly not "Free Market". Discuss the policies enacted during his tenure, this demolishes the mainstream narrative and this fact alone should make many question what they have been led to believe. If this crucial element was downright incorrect/a lie, what else is?

C) Depending on what metric you use, the depression really only ended post WW2 when gov't spending was cut by 30%+. If indeed gov't intervention "solves" recessions/depressions why did the first real instance of gov't intervention in this manner lead to a 15+ year depression? A corellation vs. causation issue is still present here, but it makes people reconsider things, especially when quality of living and growth only picked up AFTER the gov't spending stopped.

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ThatOldGuy replied on Wed, Feb 22 2012 3:45 PM

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With regard to the FDRs recession (1937), I'll leave this here. Important text:

Myth 1: Deficit Spending

That the deficit of 1937 was smaller than that of 1936 is undeniable. In 1937 the deficit stood at $2.2 billion, as compared to a deficit of $4.3 billion in 1936. However, it is also noteworthy that, while the deficit was half as much as that of the previous year, total government outlays decreased from $8.2 billion to only $7.6 billion.[4]

Interestingly, during 1935 — a year considered one of recovery — total government outlays measured $6.4 billion, less than during both 1936 and 1937. In fact, looking back to the years from 1933 to 1935, government spending peaked at $6.5 billion in 1934. It suffices to say that explaining Roosevelt's recession by pointing at a decrease in government spending is severely dishonest.

It is not much more useful to look at deficit spending. True, deficit spending in 1937 was at its lowest since 1933, but it is worth mentioning that in 1938 — the same year as the economy rebounded from the 1937 dip — total government deficit spending amounted to only $89 million.

But wait, if government spending did not decrease by much in 1937, then how did the government avoid large deficits? Government receipts — money received through taxes — increased from $3.9 to $5.4 billion between 1936 and 1937. In other words, high government spending did not result in a high annual deficit because the government collected a far greater amount of tax money that year than in all previous years of the Great Depression. It is unsurprising that in 1938, government receipts increased to $6.75 billion.

Finally, while government spending did decrease between 1936 and 1937, total expenditure in 1937 was still greater than all years prior to 1936. If a contractionary fiscal policy led to a recession in 1937, how did less spending cause recovery only a few years earlier? This inchoate theory does not hold water.

Myth 2: Tight Credit

Blaming cyclical fluctuations on tight monetary policies has been a favorite pastime ever since Milton Friedman and Anna Schwartz's extensive, albeit heavily flawed, monetary history of the Great Depression.[5] Why such a terrible depression in 1929? Restrictive monetary policy![6] Why the recession of 1937? Restrictive monetary policy, of course!

The 1937 recession came with a contraction in the money supply. The reasons for this contraction is that the Federal Reserve raised the reserve ratio in the previous months.[7]However, his explanation of the contraction is unsatisfying, because the volume of loans made and securities sold continued to rise despite the increase in the required reserve ratio. It was only after the initial fall in the stock market that bank lending began to tighten.[8]

A more plausible explanation behind the contraction of the money supply is a tightening in lending and a decrease in borrowing due to an increase in entrepreneurial uncertainty, given the drop in the stock market's value and the growing disproportion between real wages and productivity. The fall in the supply of money was a result of the 1937 recession, not vice versa.[9]

If anything, a loose monetary policy preceding the recession was more at fault than the Federal Reserve's ineffective attempt to lower excess reserves by raising the reserve ratio.

Causes of Roosevelt's Recession of 1937

If it was not tight credit or low government spending, then what caused the 1937 downturn? Three main factors stand out:

1. An inflow of gold from Europe and an artificial increase in the dollar-gold exchange ratio caused inflation.

2. Meanwhile, government's union and wage policies maintained high real wages in the face of stagnating productivity.

3. Finally, heavy government regulation made the stock market extremely volatile and susceptible to otherwise minor changes.

The years 1933–1936 saw an expansionary monetary policy pushed by the Federal Reserve and the federal government.[10] Within that time period, the stock of money increased by 46% and the general price level by 31%.[11] While the Federal Reserve's rediscount rate remained at 3.5% for the majority of that time,[12] the greatest monetary inflation came as a result of the inflow of gold from Europe.

Regime uncertainty in Europe, largely as a result of the rise of Adolph Hitler in Germany, caused an influx of gold into the United States. In 1934, the government increased the price of gold from $20.67 to $35 per ounce. Banks holding this increased stock of gold were therefore keen on exchanging it for dollars, leading to a substantial increase in the money base.[13]

We know from Austrian business-cycle theory that increases in the supply of money will lead to shifts in the structure of production.[14] This means that there will be a shift toward the production of capital goods, as they seem advantageous while the interest rate — the cost to borrow capital — is low.[15] This occurs because lower interest rates imply that the share of profits made from investments in capital goods will increase, given that thecost of borrowing the necessary capital is decreased.[16]

The result is widespread malinvestment, as the decrease in the rate of interest was not preceded by a necessary increase in the volume of voluntary savings. Such was the result of the artificial increase in the price of gold in 1934. It comes as little surprise that between 1935 and 1936 there was a sudden illusionary boom in productivity.[17]

Although real wages decreased at first, by 1937 they rose by 11.6%. It is no mere coincidence that around that time the Supreme Court upheld the Social Security Act, the Wagner Act, and the National Labor Relations Act of 1935. The result of these decisions was an increase in the power of unions to coerce firms to raise wages and benefits.[18] Fringe benefits — supplements to standard wages — rose from 1.4% in 1935 to 4.2% in 1937. Accounting for the majority of the rise in cost of supplements was the required employers' contributions toward social insurance, which by 1938 rose from 25 to 71% of the total cost of the supplements.

It is also important to consider Friedrich Hayek's "Ricardo Effect" theory. This is the tendency for entrepreneurs to replace labor with capital-goods while the productive structure lengthens due to increases in real wages.[20] The period between 1935 and 1936, as previously explained, saw an economic boom, a lengthening of the productive structure. But union activity largely disallowed entrepreneurs from replacing labor with capital goods, while real wages were rising astronomically.[21]

All that was necessary was a catalyst to bring about a slowing in the pace of credit expansion. This was provided by the stock market. Heavy regulation in the years leading up to 1937, including heavy taxes and legal impediments on inside trading, reduced incentives to invest in the market.

The result was a stock market in which a large proportion of shares were held by a relatively small pool of investors. This naturally "thinned" the markets, meaning that minor changes relating to buying and selling could reflect dramatically on the prices of individual stocks.[22]Regime uncertainty caused by increasing tax rates and several Supreme Court's decisions led to volatile fluctuations in the stock market, as investors moved to sell their shares.

The sudden drop in value of aggregate stock indexes led to more widespread uncertainty, causing a decrease in the volume of lending. This catalyzed a contraction in the credit markets. The widespread malinvestments which occurred in 1935 and 1936 began to reveal themselves. The 1937–1938 period, known as "Roosevelt's Recession," was therefore a necessary readjustment period after the boom of the period 1935–1936.

More roundabout methods of production, or more capital-intensive entrepreneurial activities, were found to be less profitable than was earlier believed. Moreover, marginal profitability was undercut by the high cost of wages. The predictable result was an incredible drop in productivity and a rise in unemployment.

It is evident that the recession of 1937 was not a product of low government deficit spending or contractionary fiscal policy on the part of the Federal Reserve. It was, instead, a product of expansionary monetary policy and heavy government regulation.