Solving depression
There is no greater obstacle to formulating sound public policies than a mistaken understanding of history. Unfortunately, popular culture is full of historical ignorance about the economy. Perhaps the most devastating historical myth in America involves the Great Depression.
That economic collapse was not caused by laissez-faire capitalism. Instead – as argued by the late Nobel Prize-winning economist Milton Friedman and co-author Anna Schwartz – the Depression was caused by the Federal Reserve’s insufficient flow of money into the banking system. From August 1929 to March 1933, the Fed allowed the dollar supply to decline by more than one-third. It was unexcused deflation that turned this mild and short-lived recession into the Great Depression.
The unprecedented interventionist policies of Presidents Herbert Hoover and Franklin Roosevelt made matters worse. The Fed’s New Deal interventions and anti-capitalist rhetoric were particularly damaging. These interventions and the Fed’s anti-market stance in Washington created what economic historian Robert Higgs called “regime uncertainty.”Investors feared what the government might do to their property: tax it excessively, control it until most of the value was squeezed out of it, or confiscate it.
In such an economic environment, investment dries up – and with it, job creation. Therefore, the depression was not prolonged due to lack of funds. Instead, spending deficit government policies are hostile to business and entrepreneurial activities.
Contrary to myth, New Deal policies prolonged and deepened the Great Depression. They did not interrupt him.
A related legendary depression was finally saved by America’s involvement in World War II. While unemployment fell and industrial output rose during World War II, neither of these events can be read as signs of economic recovery. That massive military mobilization forced millions of young men into the armed services and employed millions more in factories ordered to produce weapons and ammunition.
Not just the US, but for most of the 1940s it was a command economy where people, even if they were employed, could use relatively little. It is unlikely that America’s involvement in World War II brought about the kind of recovery that people imagine when they think that the market economy will recover its ability to create widespread prosperity and economic opportunity.
Persuasive evidence supported by Higgs shows that the real economic recovery in the US came after FDR succeeded the less ideological Harry Truman in the White House and market-friendly Republicans took control of both houses of Congress in 1946.
Higgs makes sense given the regime’s instability and America’s recovery from the Great Depression. If wartime spending had been enough to cure depression, war zones in the world today would be among the most economical places on earth. Egypt and Syria are each experiencing remarkable economic growth. Of course, the people of these countries are very poor and seem destined to remain poor for the foreseeable future. The reason is that economic prosperity grows not only from spending, but rather from secure property rights and entrepreneurship.
