1929: Then and Now
by Hans F. Sennholz
http://mises.org/story/3672

Early 1955 finds the American public swamped by forecasts of prosperity and boom. Economic advisers to governments, corporations, universities, labor unions and other groups seem to have resolved in unison to assure the people that a depression like that of the 1930s has been banned forever from the American scene. "Americans need not fear a depression," they say. "Our government will carefully watch our economy and interfere when the need arises."

According to these economists, the numerous built-in safety and stabilization devices operated by the federal government — plus its vast powers in the economic sphere — will avert any economic downtrend and assure us continuous prosperity.

This reassurance from the planners of governmental intervention may seem soothing and acceptable to many political leaders and followers. But it is a frightening thing to the economist who recognizes in it the denial of economics and the lessons of economic history.

In studying this problem, we must realize first that a trade cycle with its periods of boom and bust is not one of the characteristics of a free market economy. These extreme fluctuations are, and always were, superimposed by government interference upon the unhampered economy. An economic crisis in some form is inevitable as soon as government or a pressure group with powers of coercion interferes with the smooth operation of the market economy in order to advance its own schemes of "progressive planning."

When government embarks upon a policy of inflation or credit expansion, everything looks fine. Profits increase because prices rise while business costs tend to lag behind for a while. Business begins to expand. The demand for the several factors of production — land, capital and labor — increases.

We witness a period of high employment and high productivity. But the increased demand for these production factors naturally raises their prices, which are business costs. These costs climb until they reach the point where business is no longer profitable. At this point, we enter a period of recession and readjustment. It lasts until the costs have come down and business becomes profitable again.

The subtle instruments of inflation and credit expansion first lead to the "prosperity" side of the trade cycle. The cruder methods of raising costs — by government or by labor unions backed by government — lead directly to readjustment or even to depression.

For example, it is obvious that business must decline when, in utter disregard of productivity and profits, either government or labor unions force costs beyond what the market will bear, or when business taxes are raised, or when any other cost increasing obstacle to production and trade is erected. In each instance, business begins to contract immediately.
How the Depression Started

Let us illustrate this effect on the trade cycle with an analysis of the great depression of the 1930s. It all started with the two big spurts of credit expansion created by the Federal Reserve System in 1924 and 1927. In both years, the Federal Reserve banks bought large amounts of government securities in the open market in order to flood the economy with cheap credit and money and thus to attain prosperity and full employment. The newly created money, which rapidly went into security loans and bank investments in securities, caused the stock market to rise by leaps and bounds.

However, business in general, at that late date, refrained from making full use of the newly created funds because the inflation-induced rise in costs had begun to lead to difficulties in an increasing number of industries. Finally, in October of 1929, after an unprecedented rise in stock prices, the inevitable downward readjustment set in.

The government immediately "came to the rescue" again in an attempt to rectify the damage it had already done. In June of 1930, Congress passed the Smoot-Hawley Tariff Bill which gave high tariff protection to American industries. This eliminated much foreign industrial competition from the American market. Foreigners, who no longer could sell their products and earn American dollars, could no longer buy American products.

The American export industries — especially agriculture, which used to export a large share of its production and which had already been hurt by previous government interference — began to suffer from a rapid decline in prices and from unemployment of capital and labor. All over the world, an irresistible movement to raise tariffs began. This merely accelerated the decline in employment.

In 1933, after an inevitable upswing from extreme panic, the depression was intensified by more governmental intervention in the economy, mainly the National Industrial Recovery Act. This act imposed new internal regimentation and restrictions on imports. It provided for shorter work hours and minimum wages in order to increase purchasing power by increasing payrolls. Naturally, the immense increase in business costs constituted a most successful anti-revival measure. In the South, where the government minimum wage was considerably above the free market wage as determined by labor productivity, about 500,000 Negroes were immediately forced out of work.

In 1935, Congress passed the Wagner Act which led to ugly labor conditions, inflicting heavy losses on business. Through the Undistributed Profits Tax of 1936, Congress again struck at corporate savings and expansion. In 1937, the government policy was directed at restricting, if not destroying, the stock market. And in 1938, the Wage and Hour Act provided for new increases in business costs which severely affected the South and, above all, Puerto Rico where labor productivity was low. Immense unemployment resulted.

In 1939, after more than nine years of governmental planning for full employment, more than nine million Americans, or 16.7 per cent of the labor force, were still out of work. During these years, unemployment never declined below the six million mark.
War and Inflation

Relief finally came to the suffering nation during World War II through the unprecedented monetary depreciation which eased the burden of business costs that had been created by governmental policies for maintaining high wages and prices. Thus the evil of depression and chronic unemployment was replaced by the evil of mammoth inflation.

Again, booms and busts do not lie in the nature of a free economy. If the government refrains even now from further inflating the money supply, erecting new obstacles to international trade, enacting new National Industrial Recovery acts, imposing new taxes, raising minimum wages above the height of the market, enacting new Wagner acts and Wage and Hour acts and otherwise interfering with the smooth operation of the market economy, 1929–1939 will not happen again. There would doubtless have to be some readjustments, but there could be no depression like that of the thirties.

But can we assume that government will henceforth refrain from interfering with the economy? Indeed not! Most planner-economists want our government "to carefully watch our economy and interfere when the need arises." They advocate the continuous expansion of government power in economic life and a further increase in the number of "built-in safety and stabilization devices operated by the federal government."

And the ever-growing powers of government hover over our economy, to be applied at the discretion of "economic stabilizers and mobilizers." This knowledge and the remembrance of the misery of the great depression should indeed give us cause for alarm.

What are the plans of our economic planners in Washington and in the headquarters of our labor unions? This is the ultimate question which the prognosticator must endeavor to answer. Obviously, the question is political and cannot be answered through economic reasoning. We must know the political and economic ideologies prevailing in public opinion, and the ideas, notions and intentions of their spokesmen. We can only guess from their ideologies what their future actions may be, and then explain the economic effects of such political intervention.
Policies of the Present Administration

It is our assumption, based on the understanding of contemporary political conditions, that the present administration will continue to conduct "moderately progressive policies." This means that the administration will limit its interference with the market economy to those measures which are merely moderately harmful. In this case there is hope that the market economy will quickly overcome their effects through its tremendous ability of adaptation and recuperation.

Let us therefore assume that the Eisenhower progressive policies will include no new obstacles to international trade, no new NRA, no new taxes or tax increases, no raising of minimum wages above the height of the market, and finally, no additional Wagner acts and Wage and Hour acts.

In that case, many causes of economic decline would be eliminated. But one formidable cause would remain in the armory of the current government's moderate progressivism — the policy of inflation and credit expansion.

Even moderate progressivism seems to mean continuous inflation. Contrary to the president's foremost campaign plank — the promise of a balanced budget — the present administration is spending on a chronic deficit basis. The fiscal year 1955–56 is planned to be the 23rd deficit year in the past 26. In the fiscal year ending June 1953, the federal government's deficit amounted to $9.4 billion. In the following year it was $3.3 billion. For the current year which ends in June 1955, the Treasury's deficit is estimated to be $4.7 billion.

If we add to these figures the minimum deficit of $3 billion as estimated by the Secretary of the Treasury for the 1955–56 fiscal year, we arrive at a total of more than $20 billion during the four years of Eisenhower's presidency.

After 25 years of almost uninterrupted deficit spending, there is widespread public acceptance of this feature of progressivism. But the economic scientist cannot conveniently wink away the effects of Treasury deficits in his analysis of present economic conditions. He must take into consideration the fact that our politicians cease to see anything frightening in a $20 billion deficit and that even this administration, which was pledged to cope with this feature of progressivism, has itself finally abandoned hope and has embraced the evil which it set out to eliminate.
Inevitable Results of Deficit Spending

Accepting, as we must, our government's obsession with deficit spending, let us briefly analyze its economic consequences.

They are twofold. First, inflation and credit expansion transfer wealth and purchasing power from the pockets of all creditors to those of all debtors. If you have saved a thousand dollars and the government depreciates them by 10 percent, you lose 10 percent of your purchasing power; you are poorer by 10 percent, due to inflation by government. If you have loaned out your money — as in a savings account, a life insurance policy, or a government or industrial bond — you must lose when the government depreciates your dollar claims.

But this aspect of inflation is mild indeed when compared with its other offspring, the periods of boom and bust. As discussed above, the readjustment comes with the inevitability of an economic law once our monetary planners have embarked upon the road of inflation and credit expansion. There is no escape.

But as certain as there must be a readjustment, just as determined are our planners to stave off the day of reckoning. And it is true that this can be done — temporarily. The consequences of policies of inflation and credit expansion, as far as the trade cycle is concerned, can temporarily be postponed through an intensification and acceleration of the depreciation process.

That is to say, our monetary planners can temporarily avert the inevitable decline and readjustment through an intensified operation of the printing presses. As all political parties are dead set against any economic readjustment, they are all ready and determined to resort to this tasty but tragic medicine in case the boom economy should taper off during their tenure of office.

During the last two years, the Republican administration has given the people a full dose of this anti-readjustment medicine. When economic activity began to decline, it twice lowered the legal reserve requirements of all member banks and thus created with the stroke of a pen more than $10 billion in new potential bank credit. Twice within two years it lowered the discount rates of the Federal Reserve banks and thus made credit cheaper.

Interest rates on the capital and money markets are now about as low as they can be kept, barring their complete abolition. Commercial papers and bankers' acceptances are traded at 1.25 percent per annum, federal funds often at less than 0.5 percent. This is credit expansion.

Thus, through an acceleration of the depreciation process, readjustment can be averted temporarily — perhaps for five, perhaps for ten or fifteen years. But it must come to an end.

Of course, the very government that inflates and depreciates the dollar will oppose and fight various symptoms of its own policy. Government officials will fight valiantly against the inevitable rise in commodity and stock prices caused by the acts of the monetary officials of government! They will clamp down on the stock market; but, of course, not on the Treasury or Federal Reserve officials.

In order to "fight inflation," they will raise margin requirements to 75 percent or even 100 percent; of course, they will not abandon their own policies of inflation. In the later phases of inflation, we must even be prepared for price controls, wage controls and other vain measures to be enforced by government and its stabilizers in order to "fight inflation."

The final question which the economist who analyzes present conditions must endeavor to answer is: If it is possible temporarily to postpone the readjustment consequences of inflation and credit expansion policies through an intensification and acceleration of the depreciation process, why then did the accelerated policies conducted during the 1930s fail to have this postponing effect?

The answer has already been indicated above. The numerous progressive burdens and obstacles imposed upon business, such as the Smoot-Hawley Tariff Act, the National Industrial Recovery Act, the Undistributed Profits Tax, the Wagner Act and the Wage and Hour Act, nullified any stimulation conceivable, even that provided by accelerated inflation.

Barring other interventionist measures, accelerated inflation quickly shows its effects. It accelerates the rise of commodity prices while it temporarily lowers business costs, especially real wages, and thus brings about a desired goal — full employment. This is especially true today when the government has at its disposal a multiplicity of lending agencies through which new money and credit is channeled directly into all branches of the economy. These agencies are willing and ready, if the monetary authorities should deem it necessary, even to distribute free money and credit to all applicants.

This is the difference between 1929–1939 and today. Barring radical "progressive" measures, an accelerated inflation and credit expansion will continue to work for some time into the coming years. It will postpone temporarily the inevitable decline and readjustment, up to the point of total destruction of the currency. That is the end of the road on which we are traveling.

If we continue, the final crash in 1965 or 1975 will make the one of 1929 look insignificant and innocuous. It will be a terrible awakening for millions of Americans.



One final warning, reluctantly given: We may not even be fortunate enough to have any market readjustment at some time in the future. Instead, spurred on by people who have lost all sense of economic reality, the government may take complete control of the economy. Then, true enough, there will be no depression and unemployment in the accepted sense; but the alternative is not pleasant to contemplate.

The American people can turn back from this folly any time they are willing to assume responsibility for their own affairs in a market economy, rather than to surrender their freedoms and responsibilities to Washington and a controlled economy.