ET COGNOSCETIS VERITATEM ET VERITAS LIBERABIT VOS
SLUH REVIEW Vol. 1 Issue 8
A journal of Faith, thought, and civics
Great Myths of the Great Depression By Luke Chellis, Senior Editor
March 4, 2010
the early twenties or in previous decades. In fact, in the fall of 1928 margin requirements began to rise, and borrowers were required to pay a larger share of the purchase price of the stocks.”
Most students have a skewed impression of this nation’s greatest economic calamity, believing that the Great Depression was caused by free-market Capitalism and only finally righted by government intervention. This belief is potentially the greatest myth of the 20th century, with the most catastrophic of consequences. Though modern myth claims that the free market “self-destructed” in 1929, government policy was the debacle’s principal culprit. Active government policy, both monetary and fiscal, played the central role in causing and prolonging the destruction of the Great Depression.
But what did cause the burst bubble of malinvestment, that calamity that began in 1929 and lasted at least three times longer than any of the country’s previous depressions? People who argue that the free-market economy collapsed of its own weight in the 1930s seem utterly unaware of the critical role played by the Federal Reserve System’s gross mismanagement of money and credit. Using a broad measure that includes currency, demand and time deposits, and other ingredients, economist Murray Rothbard estimated that the Fed bloated the money supply by more than 60 percent from mid1921 to mid-1929. When government inflates the money and credit supply, interest rates at first fall. Businesses invest the government’s “easy money” in new production projects and a boom takes place in capital goods. As the boom matures, business costs and prices rise, interest rates readjust upward, and profits are squeezed. Because money was so cheap, investors pushed the stock market to dizzying heights. The money created out of thin air diverts real wealth, or real, saved, final goods, towards the holders of new money. As a result, less real savings become available to fund wealthgenerating activities. This in turn leads to a weakening in economic growth, creating a bubble of consumption of wealth. What’s the rationale for inflationary policy? The most influential man of this line of thinking, British economist John Maynard Keynes, said, “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”
Most history texts state that the Depression was caused by over-speculation and excessive investing with borrowed money, or marginal lending. At their peak, stocks in the Dow Jones Industrial Average were selling for 19 times earnings—somewhat high, but hardly what stock market analysts regard as a sign of inordinate speculation. Also, notes Marquette University economist Gene Smiley, “There was already a long history of margin lending on stock exchanges, and margin requirements—the share of the purchase price paid in cash—were no lower in the late twenties than in
The market needed to contract away from these non-productive activities; however, severe market intervention by Presidents Herbert Hoover and Franklin Roosevelt only exacerbated the necessary -1-