The great Crash of October 1929 did not spell the long-heralded end of Capitalism. Nor, for that matter, did the yawning, decade-long Great Depression, any more than the War to End All Wars (a.k.a. World War I) ended European Civilization. Endism, especially when attached to the sort of nouns we were once prone to capitalize, can become a bad habit when used as anything more than a literary device to call attention to events worthy of it. The Great Depression was certainly worthy of its capital letters; even if nothing exactly ended, plenty changed. But what? And with what, if any relevance for present circumstances?Revisiting the Great Depression has become increasingly popular of late, as a rash of recent books, essays and conferences attests. Some of this searching has confined itself to technical analyses of monetary and fiscal policies. Some of it is partisan, if not more broadly ideological; there are those who see the crisis as a opportunity to stump for big government and those who sound like reincarnated Republicans from New England circa 1934—people who hated Franklin Roosevelt and his “socialist” New Deal more than the Devil himself. And most of it misses the point. How we view the Depression today has much to do with how leaders chose to portray their actions then. Whether we realize it or not, we are still reacting to those portrayals more than we are to the actions themselves. What really changed was the way the world’s elite thought of themselves and their institutions. Above all, what happened in the early 1930s was a loss of trust in authority—a loss of faith that the institutions that ordered society could be counted on to provide stability and prosperity for those willing to work for it. Suffering the most damage was the great, but still relatively new and fragile Western idea that anonymous and uncoordinated exchanges among millions of strangers could be trusted to lead to good outcomes without supervision or filtering. The Rise of Trust
The idea of impersonal social trust was the most dramatic accomplishment of industrial civilization’s rise from the 18th to the early 20th century. The greatest achievement of early modern economic growth was not the Industrial Revolution itself, but the way in which the leading Western economies began to move away from highly parochial, narrow networks of personal exchange and came to rest instead on increasingly complex national and international commercial networks of impersonal exchange. The networks were mediated by competition, but also by an Adam Smithian understanding that strangers’ seeking their own gain amongst each other could lead to universal benefit. Praxis and theory reinforced each other.Of course, only in theory did such impersonal commercial networks exist in a pure form. Everywhere, power and political rent-seeking, or nationalism, or ethnic or religious factionalism, or sheer envy, distorted the workings of this commerce. Nor was the notion entirely new; just as history does not abruptly end, it is a challenge to find real beginnings. Long before even the Romans or the Chinese, human beings had developed complex abstract forms to support ever more elaborate forms of trade and commerce. Nonetheless, Western society did raise the idea of exchange based on impersonal social trust to a new level, inventing legal fictions like the corporation to make use of ever more abstract legal contracts and resting on a foundation of highly abstract finance. This new way of economic thinking supplanted for the better the techniques of cultivation, production and exchange wherein trade was usually limited within or between villages or towns. With the advantages of these new ways, however, came certain vulnerabilities. Money, an item not necessarily intrinsically desirable or usable but serving as a stand-in for the complex wants and valuations of untold individuals, is an unnatural idea that required centuries to take hold. How much more difficult to grasp was a system of international finance founded upon even more complex forms of exchange? Who really understood a process that not only brought items from around the globe into the living rooms of middle-class European families, but so multiplied the possibilities of production that new inventions could be integrated into reliable mechanisms for delivering basic necessities to people from all walks of life? The extent to which people could trust a system they did not understand was necessarily limited, but those limits were often successfully occluded by a wave of civilizational optimism. The rise in Western prosperity and the promise of global participation in this new and abundant world seemed to many proof that petty politics, and especially its ugly handmaiden, war, were the vanishing throwbacks to a less enlightened era. In crude political form, this Whiggish inclination toward progress was encapsulated in the functionalist view retailed by Norman Angell around the turn of the last century, which held that countries that traded with each other would develop economic self-interests too intertwined to justify war. But at a more general level, optimism and trust flowed from a faith that trade, market competition and the gold standard had produced a system of impersonal exchange that made large-scale, uncoordinated actions productive and reliable. The common man did not worry about such high and mighty notions. But to the extent that he moved from trusting the corner grocer to relying on national suppliers, or from worrying about the trustworthiness of individual bankers to trusting a currency or banking system backed by a larger, more diffuse international system (itself held together by gold and by the faith that governments and bankers managed that relationship properly), he served as a brick in the edifice of a new concept of political economy. Political economy was no longer the study of the intersection of power and wealth in any simple sense, but of an intertwined economic system mediated by political agencies and sustained by beliefs about how states should interact with private individuals and each other. The material benefits of this system, unambiguous at the start of the 20th century, quite naturally led to expectations that the progress would continue or even accelerate. These expectations were not unreasonable, perhaps, but they turned out to be unwarranted. And failed expectations produce severe reactions. If markets had come to play a more prominent part in the industrial West, it was not because markets had just been invented. It was because social and political systems had evolved in which powerful elites were willing to tolerate institutions that diffused economic power and weakened the state at the expense of private enterprise. This was the core meaning of liberalism in its original formulation. Whether these elites had done so grudgingly (because of the pressures of a more powerful citizenry) or willingly (out of conviction in the rightness of freer trade) was less important than the simple fact that it is easier to support a system when you are doing well and can anticipate doing even better. And despite the many imperfections and injustices of the Western capitalist system, greater numbers of people in all walks of life were markedly better off than at any time in human history. But that simple progressive narrative stuttered badly as the 20th century proceeded. Its first decade witnessed considerable financial instability. And we certainly would interpret the years from 1914 to 1929 as having been among the most turbulent in Western history had no Great Depression followed to make them seem settled by comparison. The War to End All Wars devastated Europe and left the major powers much poorer and weaker than before. European optimism dimmed as the era of the long peace ended in the trenches of Verdun and the Somme. Not so on the other side of the Atlantic (or at least not in the same way). The United States was a beneficiary of Europe’s nadir, moving from a net debtor to a net creditor nation. Moreover, having played a major role in deciding the war’s outcome but without having suffered as much from it, the United States emerged as the leading economic and political power of the day. Of course, America was not without its challenges: A severe depression in 1920 saw industrial production fall by about 25 percent; the Bureau of Labor’s wholesale price index fell by about 46 percent from 1920–21; unemployment rose from about 560,000 in 1918 to five million in 1921. Nonetheless, this severe contraction was short-lived and recovery was swift beginning in 1922. The Federal Reserve, having opened its doors only in 1913, fueled the recovery with easy credit and the purchase of government securities. In addition, proposals by President Harding to substantially roll back taxes on the wealthy, which the Wilson Administration had raised to fund the war, were eventually enacted during the Coolidge Administration. The roaring boom that followed from 1923 to 1929 was one of the most sustained and impressive in U.S. history. This was truly a golden age, with sharply rising GDP, vastly increased investment, stable commodity prices, rising real wages, modest unemployment, a booming stock market and important technological advances. New products like cars, trucks, radios and other household appliances spread throughout the general population. Credit innovations (especially the spread of payment on the installment plan) led to expanding household consumption. The ability to borrow and increase consumption in an orderly fashion seemed to belie standard intuitions about avoiding debt or constraining purchases to one’s current level of income. The idea of buying capital goods with money one did not yet possess quickly morphed from being seen as evidence of imprudence to being well within the range of proper bourgeois behavior. At the same time, Federal, state and local governments used growing incomes to fund public infrastructure. The 1920s saw a vast expansion in electrification, highway construction and telephone lines. The stock market, following a slump in 1921, experienced a remarkable run-up, with the Standard and Poor’s Index nearly quintupling from its 1921 low to a high in September 1929. This, too, was jointly bolstered by the optimism surrounding overall economic prospects as well as new opportunities for buying stocks on margin. It is not accurate, however, to say that Americans threw caution to the wind. The requirements for buying stocks on margin rose dramatically in 1929, for example. Nonetheless, this did not seem to dampen substantially the demand for stocks. The Crash of 1929, the subsequent economic slump and, particularly, the duration of the Depression took most contemporaries completely by surprise. Indeed, the uniquely severe catastrophe of the 1930s is so unusual that modern analysts should be cautious in drawing lessons from it. But first, this is what happened, in strictly economic terms. Following the September 1929 stock market peak, the Dow Jones fell 17 percent within a month. A misleading initial recovery was followed in October by the great Crash and continuing steady declines until the market had lost some 89 percent of its value at its 1932 bottom. Disaster on Wall Street translated directly and quickly into disaster on Main Street. Within the first year industrial output fell 12 percent from its 1929 peak, fell another 21 percent in 1930, and in total fell by almost 50 percent from 1929 to 1932. GNP contracted by a third in three years. Unemployment hit a high of some 25 percent. Though the timing abroad was slightly different, much of Western Europe was also hit hard. Most of the West suffered through the worst global economic downturn in the modern industrial era, as did most economies outside but linked to the West through colonial relationships. Narratives of the Fall
The economic dimensions of the Great Depression are not disputed, but they alone do not tell a complete story. The politics of the era—not least FDR’s invention of the media presidency—took on a life of its own and colored everything that came after. Indeed, even today there remains a striking contrast between the popular view of Depression-era political economy and the consensus view of professional economists and specialists in economic history. There has been a wide gap between the reality of the economic policies pursued by two American Presidents and the way those policies were sold to the public ever since. This complicates mightily any attempt to draw lessons for our own time.Conventional wisdom tends to treat President Hoover as a clueless advocate of laissez faire who refused to stimulate the economy in the dramatic downturn. Franklin Roosevelt, on the other hand, was the heroic leader who both saved the day and transformed the American economy through his promotion of the New Deal. Conventional wisdom is still very much with us. Thus Adam Cohen in the July 6, 2009 issue of Time: Hoover believed in small government and letting the free market operate. . . . Even as the U.S. endured the worst depression in history, Hoover argued that the answers lay in unfettered capitalism and private charity. . . . Roosevelt, by contrast, insisted that . . . government had to step in.
There is little corroboration in the historical record for this simplistic storyline. Hoover did not advocate “do-nothing” policies. Indeed, many of his interventions—for example, his attempts to balance the budget by raising taxes in 1932, and strengthening support for the gold standard—worsened the economy for reasons orthodox theory would have predicted. On the other hand, Hoover initiated the Reconstruction Finance Corporation to support failed banks, to fund public works, subsidize state relief and otherwise engage in policies that presaged the widely praised interventions of the Roosevelt era.Conversely, Roosevelt’s interventions were neither as thorough nor as systematically revolutionary as they have often been portrayed. Economic historians stress that it was in the realm of monetary and not fiscal policy that FDR had the most success. Indeed, they have established that most of what both Presidents did in fiscal policy had little impact on the Depression one way or another. The current Chair of the Council of Economic Advisors, Christina Romer, wrote in her widely cited article, “What Ended the Great Depression?” (1992), that “unusual fiscal policy contributed almost nothing to the recovery from the Great Depression.” The consensus view is that FDR’s policy success was the abandonment of the gold standard in 1933. Though there is still a lively popular debate about the “true” cause of the Great Depression, there is nonetheless a strong expert consensus—one that includes current Federal Reserve Chairman Ben Bernanke, as it happens. This consensus holds that a series of mistakes by the Federal Reserve were responsible for turning what was a bad downturn into an unprecedented catastrophe. Specialists agree, for example, that the Fed’s focus on curbing speculation in the stock market by restricting lending—as well as its unwillingness to extend liquidity and expand the money supply in the face of a collapsing economy and a wave of bank panics in the early 1930s—deeply aggravated the severity and extent of the downturn. Allan Meltzer has added that the Fed’s failure to expand the money supply stemmed from an inability to distinguish between real and nominal interest rates. (In a period of rapidly increasing deflation, even “low” nominal rates could be tantamount to extremely high real rates.) Worse still was the Fed’s decision to raise interest rates in 1931 for fear that not doing so would undermine the integrity of the gold standard. Experts disagree about other matters. They differ over the effects of Roosevelt’s various fiscal measures and about how much of a role adherence to the gold standard contributed to both the remote and proximate causes of the crisis. To most non-expert observers, these differences seem like finer points in an arcane theological discussion. In a way they are—not because they are unimportant but because they are so limited in scope. Given the importance of financial and monetary policy in causing and aggravating the Great Depression, it is striking how much attention has been paid to the regulatory and fiscal dimensions of economic policy. But even more striking is the lack of fit between any narrowly economic understanding of the Depression and Western policy more generally. One is struck, for example, by the prevalence of policies that aggravated the Depression without aligning in any way with Keynesian or other views about how to fight recession. What is one to make of the widespread popularity of protectionism and high tariffs throughout the Western world? Nationalist policies of every stripe, whether in the form of cartelization of industry in the United States or of more widespread regulation and control in Europe, especially in Germany, were not natural accompaniments to any neutral, technocratic view of recovery. And why would a policy oriented toward stimulus and expansion include rising tax rates throughout the Western world, with the United States, in particular, reversing the trends of the 1920s and raising top rates from a 1929 low of 24 percent to a top rate of 79 percent in the late 1930s, and then 94 percent during the War? Above all, FDR’s worst policies were animated by a desire to repress business, by distrust of competition and a general disdain for the market. Those were, of course, precisely the qualities that made his policies extremely popular. FDR’s economic policies scored mixed successes at best, but his political strategy succeeded by any measure long before U.S. entry into World War II, and subsequent generations have not ceased to conflate the former with the latter. How can we explain this? In some ways, FDR did not so much break from normalcy as return to it. It helps to recall that large-scale systems based on anonymous exchange were a recent phenomenon. The system of orderly, global trade developed in the 19th century under the financial and political leadership of the United Kingdom, and backed by the gold standard, produced growth and prosperity. But it also produced plenty of social disruption and downward as well as upward mobility. It certainly never inspired the kind of devotion that nationalist and communal ideology more readily induce, as suggested by the rise of fascism during the interwar period. The world’s experience with democracy and market capitalism was limited. The more common experience by far consisted of political systems that allowed limited access to property rights and trade, reserving the most exalted benefits for elites who treated control of the political economy as their reward for preserving peace. This older, more organic order, which even today represents the default for most nations, has the advantage of being both stable and intuitively natural. So thoroughly has the West taken for granted the triumph of the more abstract liberal nation-state that its denizens must remind themselves how fragile its origins were and how little emotional loyalty it has commanded. Indeed, the evidence suggests that few people trust large-scale systems of commerce. It is much easier to focus on political economy as a system of extended associations in which successes or failures can be attributed to individuals or groups for whom we feel either loyalty or loathing. Despite the prevalence of market behavior throughout history, it has rarely trumped communal corporate identity, especially in hard or frightening times. Abstractions do not generally prevail over concrete social relations because personal trust is more readily attained and maintained than impersonal trust. Even in America, where visceral support for individualism and self-reliance remains strong, this has always been so. In good times, economic systems are supported by inertia and utilitarian compromise that appeal to the broad center. In hard times abstract convictions tend to melt away. The American preference for the free market is neither as common nor as “American” as many suppose. There are always strong minorities in favor of a more communal, even socialistic approach to the economy, especially among elites, who complement populist pressures in segments of the public at large. It is easy to find those who see markets and the process of commercial integration we now refer to as globalization as fundamentally immoral. And it was easy to find them during and in the immediate wake of the Depression as well. A classic case in point is Karl Polanyi’s famous work, The Great Transformation. Polanyi, a Hungarian-born intellectual who once taught at Columbia University, noted that the “market economy if left to evolve according to its own laws would create great and permanent evils.” Writing in 1944, Polanyi was keen to attack the rise of the modern market economy and to welcome interventions that crippled it. Although economic historians place little stock in his claims that, until just a few centuries ago, markets and market forces played a scant role in most economies, he was correct to observe that states everywhere had tried to control markets, and that the 19th century thus represented a startling shift in the extent to which formal institutions were permitted to abet and encourage market competition. Polanyi has much to teach us. He claimed that reasonably unfettered markets were rare because they were inimical to elites. Their very openness and the instabilities they caused led ruling classes to constrain commerce and markets to ensure order and their own social control. The predictability and stability of slow economic growth more than compensated for the widespread poverty and stagnation it abetted. The 19th century showed that freer markets brought both prosperity and an end to older political systems, but the early 20th demonstrated that the newer system could not guarantee stability despite the confidence governments had in new techniques of administration and organization. Polanyi saw that the inability of government to regulate the market would evoke more calls for regulation and control, and that these new regulations would often be tangential to the specific problems of macroeconomic stability and financial safety. They would be counsels of political fear masquerading as counsels of economic policy. Seen as a reversion to older habits, the odd mix of regulation, make-work, intervention, protectionism, nationalism and (as in Germany and elsewhere) anti-Semitism that characterized the Western policy response to the Depression suddenly seems less like an incoherent flaying in all directions and more like elements of a uniform retrenchment in social relations. What all these habits had in common, in all the countries in which they loomed large, was their role in spurning the system of abstract, anonymous and international exchange for more parochial, inward-looking responses to danger. So afraid of the new were they that some national elites followed this path of retrenchment to the point of utter self-destruction. Indeed, the severity with which people rose to tear up or overturn that still new system, despite the unprecedented prosperity it had wrought, seems indisputable testimony to how paper thin support for liberal trading regimes truly was. The Politics of Trust
Is it still paper thin? It seems odd that humans in their day-to-day interactions think of buying or selling as the most natural of activities, recreating markets unprompted in the most dismal of circumstances. Yet there is something about the ideology of a market system, or of any generally decentralized order, that seems inconceivable to most people. Support for any existing abstract economic order seems predicated on generally favorable circumstances, and even in good times markets find themselves subjected to acute scrutiny for the disorder and creative destruction they invariably unleash. In bad times, support for the system shifts into a rush to assign blame and to personalize or politicize failure.In a sense, Western markets are like Western medicine: Just as an outbreak of incurable plague would lead to both a renewed search for sound cures and an atavistic appeal to folk remedies, so the Depression stimulated both productive thinking about the sources of business instability as well as destructive appeals to extreme nationalism, protectionism and military aggression. Economists have a hard time dealing with nationalism. The essence of Adam Smith’s insight is that voluntary trade is mutually beneficial; hence specialization leads to to riches. Indeed, the Ricardean corollary of comparative advantage is that trade between people or nations with different preferences and capacities is especially beneficial. In difference is wealth. But difference evokes a rejoinder from Smith’s historical predecessor and intellectual counterpoint, Thomas Hobbes. For Hobbes, the problem of political economy is the maintenance of public order, which in his view is essentially an uphill battle against the human tendency to engage in conflict. Hence, to the extent people prefer those who are most like them, usually meaning those of similar ethnicity, religion, culture or nationality, then difference can undermine order as easily as it can promote prosperity. The contradiction between the economically integrative and the politically divisive dimensions of difference is activated in a crisis. In a crisis, people want action, and they tend to ignore boundaries between economic policy and politics more broadly construed. A severe economic crisis implicates the entire system of political economy, regardless of how narrow the source of that crisis may be. Thus those with long-simmering fears and resentments—as well as those with more venal or ideological motives—see crisis as an opportunity to strike out at the system. The Depression empowered both the venal and the ideological, but especially the latter. The managerial interventions of the Roosevelt era, and the even more dramatic centralization of the economy in Germany and other parts of Europe, were different in degree but not in kind from earlier interventions in the late 19th century. There had already been attempts to re-impose protectionism and reassert national control in Europe, and to extend the regulatory powers of the Federal government in the United States. Anti-market movements, whether pushed by Populists or Progressives in the United States or the various forms of socialism in Europe, took for granted that vigorous political action was the only way to impose order and bring social harmony to an unfettered market economy. But the specific remedies and the zeal with which reformers sought to repudiate the past belie ideological origins more than technocratic ones. Indeed, although Hoover’s fumbling mix of interventionist and managerial solutions was in many ways similar to Roosevelt’s, FDR’s fumbles were greeted both during and after the Depression with greater forbearance largely because he seemed to have a coherent social vision that rejected the past and sought a new system. He had mastered the politics of trust. Roosevelt was careful, therefore, to avoid any suggestion that he wanted to overturn the entire American economic structure. Nor did he or his advisers think they were promoting anything as radical as socialism or fascism. Nonetheless, members of FDR’s famed Brain Trust were associated with a rejection of market competition and went out of their way to signal that the interventions were part of a new paradigm. The most prominent of these “critics” was Professor Rexford Tugwell of Columbia, whose writings stressed the failure of laissez faire and market competition, which he saw as outmoded (rather than as too novel, as did Polanyi). Tugwell argued for increased concentration and regulation of business. He especially favored the expansion of business size, arguing that in expansion lay both greater efficiencies and a greater ease of government regulation. Tugwell backed Roosevelt’s desire to exploit public regulation and control as a check on monopoly, but he also saw regulation as a superior alternative to private enterprise. However different the National Industrial Recovery Act (NIRA) or the Agricultural Adjustment Act (AAA) were from the more radical state expansions throughout Europe, the new thinkers on both sides of the Atlantic shared the view that planning was inevitable, modern and good. Roosevelt deserves credit for largely resisting these ideological enthusiasms. On balance, he dealt with the crisis pragmatically and forthrightly. He realized that everyday citizens and experts alike understood only poorly what was happening in the world, that reliable data was hard to find, and that no one could really know how new measures, beyond the experience of the economics profession and the government, would work out. But his pragmatism was tied to a rhetorical spin, concocted by the President himself, that rendered his policies more odious to some and more praiseworthy to others than the policies themselves deserved. This raises an interesting question: If FDR had left out the high-flying rhetoric and only pursued an attenuated New Deal—namely the financial policies that economists now agree truly helped us out of the Depression—would he be as celebrated a figure as he is today? Not likely. He might have had even more, and more venomous, critics then and today. But we can’t know for sure, of course, because Roosevelt’s place in the pantheon of American leaders cannot be separated from the fact that he was a successful wartime President; he has not been judged by posterity on the years 1933–39 alone. The end of World War II furnishes still more evidence that political images leave a wider trace in historical memory than actual policies. Harry Truman left office in 1953 a very unpopular man. Almost no one at the time gave him credit for overseeing a period of rapid recovery that was much broader and more impressive than anything that happened under Roosevelt’s tenure—and this at a time when most economists predicted a deep postwar recession. He did this while shrinking the government and dismantling wartime regulations at a rate Ronald Reagan could only have dreamed of. He smoothly pulled us back from a regime of wage and price controls that could have easily been allowed to linger (indeed, it would have if those sharing Rexford Tugwell’s views had gotten their way). Thanks to Truman we were once again moving in the direction of a competitive, open-access market economy. Had there been a lingering recession and a continuation of older, harmful regulations into the 1946–48 period, Truman, not his predecessor, would have been blamed. Yet Truman’s stellar reputation today owes nothing to his economic achievements, which most of those who today praise his foreign policy acumen know nothing about. The main lesson that comes out of all this for us is that we should be focused on whatever it is that restores impersonal trust. But of what does it consist? How much of it is skillful leadership? How important was it that, mixed policy success aside, Roosevelt could inspire confidence while Hoover could not? Or that Roosevelt could speak as though he had a master plan while acting all the while as a pragmatist, often against the advice of his own advisers? (President Obama, take note). How much of it has to do with substantive rules and regulations that prevent good times from suddenly lunging into bad ones? After all, as the heterodox economist Hyman Minsky argued long ago, capitalist financial systems are prone to booms and busts, so that regulation to tame the casino-like tendencies of financial markets has to be different from, and stronger than, that pertaining to other market sectors.1 Still, it is no easy matter for regulators to know what will work in different circumstances. The Federal Reserve of 1929, given the constraints of the gold standard, may have known what to do but been unable to do it. On the other hand, Roosevelt’s fortuitous decision to abandon the gold standard might have been an arbitrary judgment made largely for the wrong reasons. The right solution at any one time can morph into a new problem in due course. Perhaps the strong role assigned to the postwar Federal Reserve to assume the dual task of stabilizing price levels and keeping watch on output and employment contributed to the present crises. In any event, we would do well to bear in mind how important, yet also how unnatural, the modern system of impersonal finance and trade really is. If we would preserve that system as a basis for our prosperity, we must recognize that many of the regulatory solutions we apply to our current crisis may themselves induce responses that can generate new crises. History suggests, too, that fears of the market and the political pressures it generates will wax and wane as crises deepen or ease. Patience and prudence are, therefore, the best watchwords for government amid the many trials and errors we will surely endure in the months, and perhaps years, ahead.
1Hyman Minsky, “The Financial Instability Hypothesis”, Jerome Levy Economics Institute Working Paper no. 72 (May 1992).