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Why The Great Depression Still Matters So Much Today

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Why worry about an event that occurred almost a century ago? Because history left unexamined is doomed to repeat itself. And sometimes even then, history still repeats itself. “What is past is prologue,” the old saying goes, but it doesn’t have to be that way.

I have previously spent some time taking a closer look at the root causes of the Great Depression, which are widely misunderstood. While mainstream economists will often attribute the crash of 1929 to unbridled capitalism, quite the opposite is true. Government intervention both caused and prolonged the economic crisis, leaving many Americans financially ruined.

But by understanding the root causes of a historical crisis as severe as the Great Depression, we stand a better chance at recognizing the potential for similar events to occur today. And if we know what warning signs to look for, we also stand a better chance at preventing future economic crises from occurring altogether.

In fact, there are two modern examples that perfectly demonstrate the importance of heeding history’s warnings: the housing crisis of 2008 and Trump’s recent trade wars.

The Housing Crisis

The 2008 housing crisis, had many similarities to the Great Depression. But unfortunately, many mainstream economists failed to recognize the warnings signs. Had they been paying closer attention, we may have been able to avoid, or at the very least lessen the impact of, the Great Recession.

Like the Great Depression, the housing crisis has many contributing factors. But both are perfect examples of the Austrian business cycle in action. Just like the Great Depression, prior to 2008, the government had meddled with the monetary supply, artificially lowering interest rates and increasing credit, making it accessible to more people.

This resulted in many people making the decision to purchase a home, and why wouldn’t they? In the short-term, this seemed like a smart idea since interest rates were so low. For a manageable monthly payment, they could own a brand new home, which is more than many thought they would ever be able to afford. But they failed to realize that the low rates were only temporary. Eventually, the regular rates would go back into effect, significantly increasing monthly mortgage payments.

But with each new home loan approved, the housing bubble grew even larger, until eventually, it popped. With new homeowners unable to make their monthly payments, many were left with no option but to foreclose. And with so many people defaulting on their home loans all at once, the bubble burst and the Great Recession was born.

If the elected officials and mainstream economists in 2008 would have paid attention to the Austrian business cycle, they would have recognized what was about to happen. And to be sure, there were many Austrian economists who warned of the coming crash. They were, however, laughed at and dismissed as crazy by the media and other economists.

Tariffs and Trade Wars

Unlike the housing crisis, Trump’s trade wars can still be stopped before they do any further damage, if those in power make the right decisions. Over the last several months, economists from all camps have warned Trump that tariffs on foreign imports would spell disaster for the American economy. The president has been an advocate for protectionist policies, that he believes will boost the American economy by forcing consumers to “buy American,” thus creating more jobs domestically.

But tariffs do not serve to benefit anyone and our economy will most certainly be in extreme trouble if we engage in any actions that bring us closer to a full-blown trade war, as the Great Depression taught us.

In fact, economists have likened the new tariffs to the infamous Smoot-Hawley Tariff, which, as discussed previously, exacerbated the downfall of the economy in the earlier days of the Great Depression by increasing the rates of unemployment. We already know how that story ended, so one can only hope that Trump Administration proceeds with caution lest we end up in a similar position.

The new tariffs, which will focus on Chinese imports, has not gone into effect yet, which means there is still time for President Trump to change his mind. Hopefully, he studies history before engaging in a trade war that could cost many Americans jobs.

Trade Wars Lead to Depressions, Just Look at History

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Tariffs seem to be the topic on everyone’s minds these days, as Trump’s trade war continues. But as we contemplate the consequences that such protectionist policies may have on our modern economy, we would be wise to take a sober look at history. For if we take a closer look at the causes that led to, and prolonged, the Great Depression, we will find that tariffs played a most important and destructive role.

Smoot-Hawley Tariff

Over the last several months, thousands of economists have warned of the negative consequences that inevitably arise from imposing tariffs on foreign countries. Many fear what might happen to the economy if Trump continues his love affair with protectionism. And this fear is not unwarranted or unprecedented.

As mentioned previously, the Austrian business cycle teaches us that economic booms and busts will always occur when the state meddles in the economy. But the situation tends to grow much worse and lasts much longer the more governments intervene and try to correct their mistakes. This is exactly what happened with Smoot-Hawley.

By the time the Smoot-Hawley Tariff Act was passed in 1930, the market had already experienced an economic bust. Economists had warned that instituting new tariffs would result in the economy falling further into a recession. The American Economic Association was so concerned about the impacts that Smoot-Hawley might have, 1,028 of its members even signed and published a statement opposing its passage.  

The statement contained the following concerns:

“We are convinced that increased protective duties would be a mistake. They would operate, in general, to increase the prices which domestic consumers would have to pay. A higher level of protection would raise the cost of living and injure the great majority of our citizens.

Few people could hope to gain from such a change. Construction, transportation and public utility workers, professional people and those employed in banks, hotels, newspaper offices, in the wholesale and retail trades, and scores of other occupations would clearly lose, since they produce no products which could be protected by tariff barriers.

The vast majority of farmers, also, would lose through increased duties, and in a double fashion. First, as consumers they would have to pay still higher prices for the products, made of textiles, chemicals, iron, and steel, which they buy. Second, as producers, their ability to sell their products would be further restricted by barriers placed in the way of foreigners who wished to sell goods to us.

Our export trade, in general, would suffer. Countries cannot permanently buy from us unless they are permitted to sell to us, and the more we restrict the importation of goods from them by means of ever higher tariffs the more we reduce the possibility of our exporting to them. Such action would inevitably provoke other countries to pay us back in kind by levying retaliatory duties against our goods.

Finally, we would urge our Government to consider the bitterness which a policy of higher tariffs would inevitably inject into our international relations. A tariff war does not furnish good soil for the growth of world peace.”

Unfortunately, all these fears came to fruition, which is what inspired modern economists to invoked the 1930 statement in their own recent letter to President Trump. Many hope that if Trump understands how this tariff contributed to the Great Depression, he might be more cautious about repeating history’s mistakes.

Tariffs and The Great Depression

Like Trump’s recent tariffs, Smoot-Hawley was supposed to incentivize consumers to “buy American” by placing high tariffs on foreign goods. And by forcing Americans to buy domestically, the government believed they could solve the unemployment problem. But instead of helping the economy and creating jobs, the tariffs ignited a global trade war. As Lawrence Reed writes:

“They ignored an important principle of international commerce: trade is ultimately a two-way street; if foreigners cannot sell their goods here, then they cannot earn the dollar they need to buy here.”

As America’s new tariffs began reeking havoc on foreign economies, governments overseas began imposing their own tariffs in retaliation. But all this trade war meant that foreign countries were not buying American goods, especially agricultural products. Smoot-Hawley resulted in farmers losing ⅓ of their customers, which signaled the beginning of the decimation of the American agriculture industry.

This, in turn, then led to President Hoover’s plan to save American agriculture through subsidies. Hoover’s administration began allocating millions of dollars to the farmers whose livelihoods he had ruined by signing Smoot-Hawley. These handouts only served to worsen the situation, however, as higher income tax rates were imposed on the American people in order to pay for these subsidies.

And worse still, these subsidies did nothing to help the agriculture industry, which would continue to plummet as the depression continued. In fact, agriculture would continue to play a major role in the depression. Just a few years after Smoot-Hawley, President Roosevelt would propose his own plan to save the agriculture industry as part of his New Deal. Of course, this would also prove to have disastrous consequences, as we will see in the next installment.

The Great Depression and the Austrian Business Cycle

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There is, perhaps, no historical event that is as misunderstood as the Great Depression. As children in school, we were taught that the crash of 1929 was a result of unregulated capitalism. And while this has presented a great opportunity for market critics to throw laissez-faire capitalism under the bus, there is so more to the story than Keynesian economists would have you believe. Luckily, Austrian economists know better.

To fully understand why the Great Depression began, and why it lasted so long, it is important to consider the many different factors that contributed to this economic downturn of historical proportions. In this first part of the series, we will focus on understanding the Austrian business cycle and the role it played in the crash of 1929.

Booms and Busts

The Austrian business cycle asserts that there are “booms” and “busts” that occur in the market. This cycle begins when the government interferes with monetary policy, inflating the money supply and artificially lowering interest rates, thus, making credit more accessible. We saw this happen in 2008 right before the housing market crashed. More people had access to homeownership because the interest rates were artificially lowered, but as we all soon found out, that feeling of prosperity would not last long.

When the state inflates the money and credit supply, lowering interest rates, an artificial period of prosperity ensues. In Murray Rothbard’s book America’s Great Depression, he estimates that between the years of 1921-1929, the Federal Reserve expanded the money supply by 60 percent. It is no wonder this reaped disastrous consequences. “Easy money” caused people to borrow and spend without a care of what would happen when the market corrected itself.

Companies were pleased to have access to seemingly easy money, which they promptly invested in new areas. Individuals borrowed more money at lower rates with ease and then spent this money in the market. When taken for its face value, this inflation seems to benefit all parties involved. But it was all an economic illusion. This period of artificial prosperity is referred to as an economic “boom” in the business cycle.

But booms cannot last forever. As time goes on, the market corrects itself and business costs and interest rates increase once again. This results in a loss of profits. And with interest rates back up, fewer people now have access to credit and those who borrowed at artificially low rates may struggle to pay higher premiums. All this causes people to panic. They stop spending. Governments intervene and once again manipulate the money supply. And the whole economy comes crashing down. This is the economic “bust” of the Austrian business cycle. This is what happened on “Black Tuesday.”

After the “Roaring Twenties” had made easy money the norm, the Federal Reserve rolled back the money supply by a whopping 30 percent and raised interest rates. And this deflation caused the economy to tank.

We saw this type of “bust” occur in the wake of 2008 when people began foreclosing on their homes in droves and prominent banks, once thought of as “too big too fail” closed their doors forever.

Government Intervention Makes Things Worse

But what is particularly fascinating is how long the Great Depression lasted. Prior to 1929, none of America’s economic depressions lasted for more than four years. In fact, the average for American depressions was about two years. But the Great Depression lasted over ten years, which is why it had such disastrous and far-reaching implications.

To think that this manipulation of our money and credit supply was a result of unbridled capitalism is not only false, it completely disregards the role the Austrian business cycle played in both starting and prolonging the Great Depression.

In the next installment of this series, we will further explore how government intervention prolongs depressions and recessions by taking a closer look at FDR’s New Deal.

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