Policy Lessons from the Great Depression

I’ve been reading Amity Shlaes’ wonderful book, The Forgotten Man, A New History of the Great Depression, with an eye out for parallels and lessons for our current crisis. You will find some of those and much, much more.

Amity showed great restraint in writing her book. A scholar with her expertise could have driven the ideological lessons home and saved those of us on a practical mission some time. Instead, she patiently let the characters and the circumstances speak for themselves letting the nuance show through for us to savor.

While I wasn’t totally clueless about the depression, not having lived through it, you see, I must admit that my knowledge of many of the details was limited.

Here’s what I thought I knew going in:

* There was still debate over whether the October 1929 stock market crash caused it, just preceded it, or how big a role it played.

There was general agreement that:

* The Smoot-Hawley tariff was a terrible mistake that made it much worse, and may have made the difference between recession and depression.

* The Fed made it worse by allowing the money supply to shrink.

* Things got better in the mid-thirties, but then worsened again, probably because of policy mistakes.

* Hoover was totally ineffective and did next to nothing to help, while

* Roosevelt was an activist who experimented with cures and generated public hope and was generally successful.

* The depression really didn’t end until WWII.

* The most important change made to prevent future depressions was the FDIC’s deposit insurance.

* The semi-socialist measures of the Roosevelt administration saved capitalism from something far worse.

Here’s what I thought of a couple of things mentioned above:

* I couldn’t really deny the Friedman and Swartz charge that the Fed erred by allowing the money supply to shrink.

* However, I thought insufficient attention had been paid by the economics community to the following factors:

- The shrinkage of the money supply was primarily a by-product of bank failures.

- The world was still on a gold-standard and policymakers were presumably supposed to follow the “rules” of the gold standard game.

- There was no consensus within the economics community on what to do to get out of a depression.

- This consensus would await the publication of Keynes’ General Theory in 1936 and its subsequent popularization and incorporation into economics textbooks.

Here are some of the things I learned by reading the book:

Much of what Roosevelt did on a large scale was begun or done first on a smaller scale by Hoover. Hoover was not sitting on his hands waiting for better times.

Hoover came off better in the book than I expected. Roosevelt came off badly, as expected, based on his economic policies and actions. What I didn’t expect to learn was that Roosevelt was rather petty and vindictive.

The Smoot-Hawley tariff, arguably Hoover’s biggest mistake (expected), came very early (1930) in the first year of his administration without a lot of thought given to it. Protectionism was apparently accepted Republican dogma at the time; so Hoover accepted it almost routinely. (He would try to improve it; not oppose it.)

Hoover’s “economic philosophy” was really an engineer’s view of the world where planning was useful and where problems can be fixed. He was willing to tamper with the machinery up to a point, but he respected the constitution, including the constitution of the gold standard, as limitations on government action.

Roosevelt, on the other hand, had no philosophy to speak of, he cared little about the constitution, and he broke the gold standard with his prolonged devaluation of the dollar. (I had known about the devaluation of the dollar, of course, but I had missed that it wasn’t an immediate thing. Instead, Roosevelt enjoyed setting the price of golf every morning from his bedroom. Different strokes for different folks.)

Roosevelt’s lack of a “North Star” to guide his way made him particularly vulnerable to being pulled in different directions by his staff and “brain trust.” During his administration, policy shifted back and forth between stimulus measures (job creating) and a desire to get back to fiscal rectitude by balancing the budget with large tax increases.

Large and untimely tax increases in the middle of the depression—probably not considered that way then—killed off an incipient recovery.

This should be a huge lesson for us today. Among other potential tax increases implied by various programs under consideration today, we have the pending reversal of the Bush tax-rate cuts looming next year. Could we possibly repeat that mistake?

As for other lessons, for now, I think Chairman Bernanke was very much influenced by this last factor and has resolved to avoid premature “fiscal rectitude.” He considers declaring victory prematurely a bigger danger than waiting too long.

He has already avoided the mistake of allowing the money supply to shrink and have deflation psychology take hold. His critics on that, however, are getting louder and louder, calling for an “end game” sooner rather than later.

One issue involving monetary policy is very much relevant for today: the excess reserves on banks’ (and the Fed’s) balance sheets. As in the 1930s, the banks have more reserves than the law or regulations require them to have—hence the term “excess” reserves. However, also as in the 1930s, banks have good reason to be cautious and remain even more liquid than the law requires. Attempts to “mop up” those excess reserves before they are used in ways that might contribute to inflation could have disastrous results. The fact that banks are holding them voluntarily is proof enough for me that they are “required” reserves in the minds of the bankers and that banks would try to restore them if they were removed by the Fed prematurely.

One final note:  I didn’t realize that our current mob-rule attitude toward successful people that has us cutting executive pay and hauling executives before congressional committees to be humiliated had a counterpart in the 1930s, but, apparently there is nothing new under the sun. Amity has an entire chapter on “Prosecutions” that amounted to political payback. It’s like our leaders are bent on taking the worst lessons from the past.

I had wondered whether Keynes had had much influence on administration policies during the depression since The General Theory came too late. Even though he had earlier influential books, I gather not. My favorite part of Amity’s book was when she describes a meeting that Keynes had with President Roosevelt on May 28, 1934, lasting fifty-eight minutes, about the time of a class-room lecture. Both Keynes and Roosevelt indicated that the meeting did not go well.

The President indicated that “Keynes had left him, disappointingly, with a ‘rigmarole of figures.’ He must be a mathematician rather than a political economist.”

Don’t you just love “rigmarole of figures?”

P.S. I worry that I have done Amity Shlaes, The Forgotten Man, a disservice by my inadequacy in describing it. Even if I haven’t conveyed its merits sufficiently, trust me, it’s great, and well worth your time.

Comments (9)

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  1. John Booke says:

    The price of “Golf?” Anyway I just finished Liaquat Ahamed’s book, “Lords of Finance.” He tries to place alot of blame for the Great Depression on inept central bankers. But my take-away was the real blame goes to beligerant, war crazy Germans. Can we blame our problems today on our war in the Middle East or should we stick with plain old fraud?

  2. Brian W. says:

    Great book review. You won’t see something like this in the New York Times Sunday Book Review.

    Chiseled in stone at the entrance of the National Archives in Washington is this statement: “What is Past is Prologue.” Let’s hope we can learn from the past so we don’t repeat the same mistakes.

  3. Pedro Albuquerque says:

    FDR was indeed a “rather petty and vindictive” politician, the product of a period that shouldn’t ever make humanity proud of itself. Watch the excellent PBS/BBC documentary “WWII Behind Closed Doors” (http://www.pbs.org/behindcloseddoors/) for some interesting and dark examples, including the now well researched fact that he would have allowed Western Europe to fall to Stalin. Fortunately for the world, Truman changed FDR’s ill-conceived foreign policies in time to avoid further disaster.

  4. I learned a lot for Amity Shlaes excellent telling of the Great Depression. Bob, I respect how you admitted to not knowing everything there is to no about that calamity. A lot of people in the business media should follow suit. Personally, I didn’t know nearly enough about that time in history before reading The Forgotten Man.

    Another aspect which struck me was that many of FDR’s advisers had an a affection for central planning and what they saw as a successful model in Russia. In the end, this group of people did much to steer Roosevelt’s policies. Everyone is free to decide for themselves if there are any parallels between that presidency and the current administration. In my view, there are some red flags.

  5. JustOne says:

    Interesting review of an interesting book. I spent most of the day listening again to an old documentary on Google videos. It is titled “The Money Masters (http://video.google.com/videoplay?docid=-515319560256183936#).

    I am not much of a historian and have very limited knowledge of banking. However, I thought some of the comments and findings about the depression and what caused it were quite interesting (but perhaps too paranoid?). The authors seem to be suggesting that a monetary approach like the one used by Lincoln (“green backs”) should be revisited. It’s amazing how much I don’t know about these things (and I am likely more informed than most of our Senators and Representatives).

    Since you have a much broader perspective, I’d be interested in your comments about “The Money Masters” video if you care to do so.

    It seems to me that our leaders need to make a thorough review of the alternatives and implement a monetary system and policies that are focused on the maximizing the resulting benefits to our country … not Wall Street. I’m not sure that is the focus of the powers that be. Money is power … power corrupts.

    Enjoy IT … Whatever IT is.

  6. kharris says:

    I am disappointed to see no recognition whatsoever of the many criticisms leveled against Shlaes scholarship and method of argumentation as represented in “The Forgotten Man.” These criticisms are widely known by now, so it is hard to believe our host is unaware of them.

    I won’t bother linking to objections raised by Krugman, who despite his Nobel is somehow not deemed worthy of honest consideration. Let’s have a look at what self-described libertarian and frequent friend of conservative causes Megan McArdle has to say:

    “The problem is that Shlaes way, way, way overstates her case. There is an academic argument that the National Recovery Administration prolonged the Great Depression; I’m on the run right now, but will find the link later. But the Great Depression is complicated, and it’s hard to make the case that government intervention was the main problem with the economy. As economic history, the book is interesting if one sided. But as an argument, it leaves a lot to be desired.”

    Here is a simple rule of thumb that I find useful. If you know the typical perspective of an author, try to predict before reading what argument the author will make. If you can, for the most part, predict what the author has written, then you have strong reason to believe the author began from the conclusion, and wrote to justify it. If the author surprises you, then very likely either you don’t know the author’s views well enough to make accurate predictions, or the author is actually allowing herself to be led by the facts, rather than turning the facts to her purposes.

    I was able to predict where Shlaes would end up. McArdle can tell you why:

    “The thesis of the book, for those who don’t know it, is that government intervention made the Depression worse by heightening uncertainty. Obviously, this is an explanation much in vogue with conservatives.”

    This is anything but a “great book”.

  7. Bob McTeer says:


    Thanks for your comment. Actually, I thought I had tried your rule of thumb and that Amity had passed it. From interviews I’d seen her do before I read the book, I knew her general conclusions. Also, just knowing her economic philosophy, I could anticipate many of her conclusions. However, I was impressed with the degree to which she let the facts and the characters speak for themselves. I actually thought she understated the conclusions I expected.

    I guess that’s what makes horse races. Again, thanks for your comments.


  8. Mark says:

    Great review… This was on my reading list, so thank you.

  9. Bob McTeer says:

    To John Brook:

    “The price of golf” should have been “the price of gold.”