In the 1930s, American capitalism practically stopped working.
For more than a decade, from 1929 to 1940, America's free-market economy failed to operate at a level that allowed most Americans to attain economic success. Those of us lucky enough not to have lived through the ordeal of the Great Depression may have a difficult time imagining the unprecedented depths of economic collapse and social disarray that mired America in the 1930s.
The story of the Great Depression can be told with a litany of bleak statistics:
By 1933, the country's GNP had fallen to barely half its 1929 level12. Industrial production fell by more than half, and construction of new industrial plants fell by more than 90%. Production of automobiles dropped by two-thirds; steel plants operated at 12% of capacity.13
During Herbert Hoover's presidency, more than 13 million Americans lost their jobs. Of those, 62% found themselves out of work for longer than a year; 44% longer than two years; 24% longer than three years; and 11% longer than four years.14Unemployment peaked at a staggering 24.1% in 1933, and never dropped below 14.3% until World War II. (By contrast, the unemployment rate has never surpassed 9.7% since.)15
The financial meltdown initiated by Wall Street's Great Crash of 1929 caused billions of dollars in assets to vanish into thin air. Wealthy Americans—who owned almost all the nation's stocks at the time—were walloped by an 80% decline in the value of the stock market. Even more troubling to the entire population were rampant bank failures—between 1929 and 1933, two out of every five banks in America collapsed, causing more than $7 billion of their customers' hard-earned money to evaporate.16
Ugly as the numbers may be, it's the human stories that truly capture the depths of the crisis:
In 1931, African colonial subjects living in the Cameroons took up a collection to aid the starving people of America, ultimately mailing $3.77 to the mayor of New York City to assist relief efforts there.
Things got so bad, even Calvin Coolidge—whose laissez-faire presidency had fueled the Roaring Twenties' boom and who remains famous for his declaration that "the business of America is business"—lost faith in the free market's ability to fix itself. "In other periods of depression," Coolidge said, "it has always been possible to see some things which were solid and upon which you could base hope, but as I look about, I now see nothing to give ground to hope—nothing of man."17
Perhaps most incredibly, in 1933 more than 100,000 Americans applied to an office in New York City for a chance to emigrate to a foreign country where they believed they could find better economic opportunities. The country? Josef Stalin's Soviet Union.18
What made the miseries of the Great Depression so incomprehensible to those who endured them was the evident fact that the economic collapse had been caused not by want but by material abundance. The problem with American capitalism in the 1930s was that there was too much of everything—too much supply, not enough demand. Too many automobiles, and not enough workers who could afford to buy them. Too much cotton, too much corn, too much pork, too much beef, too much wheat, and not enough buyers able to pay a price that made the crops worth harvesting. Too many workers needing jobs, and not enough employers to hire them. In the memorable words of FDR's first inaugural address, "our distress comes from no failure of substance. We are stricken by no plague of locusts... Nature still offers her bounty and human efforts have multiplied it. Plenty is at our doorstep, but a generous use of it languishes in the very sight of supply."
But why? American capitalism had never endured such a profound or long-lasting market failure before. What caused an ordinary downturn in the business cycle after 1929 to devolve into the Great Depression? Roosevelt's own initial explanation—to blame the entire crisis on the "stubbornness" and "incompetence" of "the rulers of the exchange of mankind's goods... [and] unscrupulous money changers"—was hardly compelling. Scapegoating big businessmen and stock-market speculators may have been politically useful, but the true roots of the Great Depression clearly lay in deeper structural problems in the American economy.
There has never been one consensus explanation for the Great Depression. Since 1929, economists and historians have developed a number of competing theories to explain the American economy's disastrous performance in the 1930s, and their debates over the true causes of the Depression—which have profound public-policy implications even today—have often been quite contentious.
At first, economists schooled in the laissez-faire tradition regarded the Crash of 1929 as an entirely natural—and perhaps even desirable—consequence of Roaring Twenties affluence. Throughout the nineteenth century, every economic boom had been followed by a bust, leading many to view the business cycle as a virtual law of nature—what goes up must come down. In 1930, Herbert Hoover's Treasury Secretary, Andrew Mellon, suggested that the end of the 1920s boom was not only inevitable but beneficial. "It will purge the rottenness out of the system," he said. "High costs of living and high living will come down. People will work harder, live a moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people." Classical economic theory taught that after a brief (if painful) period of liquidation of over-inflated assets, the economy would soon reestablish equilibrium at full employment and growth would resume.
But as the Depression only worsened through the first years of the 1930s, many began to doubt the classical economists' faith in the market's long-run ability to correct itself. "In the long run we're all dead," protested British economist John Maynard Keynes. "Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again." In his massively influential General Theory of Employment, Interest and Money (1936), Keynes suggested that the Great Depression had been caused by a broad failure of aggregate demand across the economy, which created a new equilibrium at less than full employment—a situation in which Depression conditions might persist indefinitely. In order to increase aggregate demand and get the economy moving again, Keynes argued that the government should massively increase its own spending in times of economic distress, even if it meant running a significant budget deficit. While most of the key players in the Roosevelt administration were initially skeptical of Keynes's theories, the New Deal did end up taking on a broadly Keynesian quality, characterized by major and unprecedented government interventions into the economy. Keynesian ideas went on to dominate academic and government thinking about political economy through the 1960s.
The Keynesian explanation for the Great Depression came under came under heavy fire in 1963, when Milton Friedman and Anna Schwartz published A Monetary History of the United States. Free-market economists philosophically opposed to the heavy government interventionism unleashed by Keynesianism, Friedman and Schwartz made a compelling argument that the Great Depression had been caused less by a failure of aggregate demand than by a sharp constriction in the nation's money supply. Foolish decisions by the Federal Reserve, they argued, combined with hoarding of cash by individuals fearful of bank failures, caused the stock of money circulating in the economy to fall by one-third between 1929 and 1933. This "Great Contraction," as Friedman called it, had a choking effect on employment, incomes, and prices, unnecessarily prolonging the Great Depression by years. The New Deal's Keynesian intrusion into the free market had done little to address the underlying money problem; a savvier monetary policy from the Federal Reserve, Friedman suggested, would have provided better medicine for America's economic sickness during the Great Depression. At first Friedman's monetarist ideas gained little traction in either the academic or political establishment, but since the 1970s the free-market philosophy of Friedmanism has largely displaced Keynesianism to become the dominant economic orthodoxy of our time.
Over the years, historians and economists have explored many variants to the basic Keynesian (aggregate demand) and Friedmanist (monetarism) explanations for the Great Depression. They have blamed the misery of the 1930s on the rigidity of the gold standard, or on the unsustainably unequal distribution of wealth built up through the Roaring Twenties, or on the instability in the American banking system, or on the high tariffs imposed after 1930 that choked off international trade. While each explanation has its supporters and critics, the truth may be that the best explanation for the Great Depression is... all of the above. After 1929, the American economy did suffer a broad collapse in aggregate demand and a sharp constriction in money supply. The effects of the downturn were amplified by the gold standard and maldistribution of wealth and bank failures and protectionism in trade. The search for one true underlying cause for the Great Depression may, in the end, be something of a chicken and egg problem; what is clear is that, by 1932, just about everything in the American economy was broken.
In different ways, both Keynesian and Friedmanist explanations for the Great Depression suggest that American capitalism broke down in the 1930s because of a tragic disconnect between the needs of the economy as a whole and the rational economic actions of the individuals struggling to survive within it.
When one farmer struggling to make his mortgage payment encountered falling prices for wheat, his rational response was to produce more wheat to make up the difference. But when millions of farmers did this, the resulting overproduction flooded the market, driving prices so low that no farmers could sell their crops at a price that justified the harvest.
When one factory owner encountered falling demand for his products, his rational response was to cut production and cut costs by laying off workers. But when thousands of factory owners did this, the resulting mass unemployment and poverty drove demand for all their products even lower.
When one worker encountered the high likelihood of losing his job, his rational response was to hoard his money, saving as much and spending as little as he could. But when millions of workers did this, the resulting lack of spending in the consumer economy destroyed markets for goods and thus caused employers to lay off more workers.
When one depositor learned that his bank might fail, potentially wiping out his savings, his rational response was to withdraw all his cash and put it in a shoebox. But when millions of depositors did this, the resulting runs on banks caused rampant bank failures and the constriction of the national money supply.
Deeply entrenched American ideologies held that individual successes or failures were determined by the hard work, prudence, and industriousness of the individual. During the Great Depression, almost the opposite became true—the hard work, industriousness, and prudence of each individual American tended to make the overall problems of the national economy worse. America's economy during the Great Depression became a seemingly intractable vicious spiral, in which the perfectly rational microeconomic decisions of millions of individuals combined to exacerbate the macroeconomic problems of the system as a whole. And the failure of the system made misery for the individual almost inevitable.