Six myths about the 1929 crash and the New Deal recovery, tested

Every American schoolchild learns the same bedtime story about the Great Depression. A callous president sat on his hands while the country burned, a charming squire in a wheelchair rode in with a toolbox of alphabet agencies, and the nation was rescued just before the lights went out. It is a wonderful story. It has a villain, a hero and a happy ending. It also has the minor flaw of not matching the ledger.

Let me define the task before I start swinging. A myth, for our purposes, is a claim that is widely repeated, simple to state and contradicted by the documentary record. The record here is not obscure. It lives in statutes, Supreme Court opinions, the Federal Reserve's own balance sheets and the unemployment series the government itself compiled. I will state each of six claims in the form its defenders would accept, test it, and give a verdict. Where the defenders have a point, I will say so, because an argument that cannot admit a fair point is not an argument, it is a pep rally.

One framing note on facts versus values. Whether the New Deal made the Depression shorter or longer is a question of fact, and the evidence is contested enough that honest economists disagree. Whether the federal government should be the nation's employer, price-setter and regulator of last resort is a question of values and of constitutional design, and I will tell you where I stand: it should not. The two questions are related, but they are not the same, and you can reject the standard story without needing to win every empirical point.

Myth one: Hoover was a laissez-faire president who did nothing

The claim. Herbert Hoover believed in leaving the economy alone, trusted the market to cure itself, and the do-nothing policy turned a downturn into a catastrophe.

The strongest version. Hoover did resist direct federal relief to individuals. He worried, with some justice, about a dole that would corrode self-reliance, and he leaned on local charity and state governments for years. If "doing something" means a federal check to the unemployed, he did little of it.

The test. Start with what Hoover actually did. In the weeks after the October 1929 crash he summoned business leaders to the White House and asked them to hold wages and keep investing, an extraordinary use of presidential persuasion to prevent the price of labor from adjusting. He created the Federal Farm Board in 1929 and had it buy up crops to prop prices. In June 1930 he signed the Smoot-Hawley Tariff, which raised duties on thousands of imported goods. In January 1932 he signed the law creating the Reconstruction Finance Corporation, a federal lending agency that put government credit behind banks, railroads and other businesses. He backed a large expansion of federal public works. And in June 1932 he signed the Revenue Act of 1932, which raised the top individual income tax rate from 25 percent to 63 percent, raised the corporate rate, and added excise taxes on items such as gasoline and checks.

Count what that is. A tariff wall, price supports, a federal lender, public works and a sweeping peacetime tax increase. That is not laissez-faire. That is a president who tried nearly everything except getting out of the way.

The best evidence for the point is that Franklin Roosevelt's own campaign thought so, from the other direction. In October 1932 Roosevelt attacked Hoover for reckless federal spending and promised to cut the cost of federal government operations by 25 percent. The man who "did nothing" had already done most of what his successor would do, and had done it on a smaller scale.

Verdict. False. Hoover was an activist, an engineer who believed government could manage the economy. What he lacked was a theory of why his interventions were making things worse.

Myth two: the stock market crash alone caused the Depression

The claim. The Dow fell off a cliff in October 1929, wealth evaporated, spending collapsed, and the Depression followed from the crash.

The strongest version. The crash was no small thing. The Dow peaked in early September 1929 at around 381 and bottomed in July 1932 at around 41, a loss of nearly 90 percent. Black Thursday on October 24 and Black Tuesday on October 29 were genuine panics. Fortunes vanished, and a loss of confidence is a real economic force.

The test. Two problems. First, stock crashes by themselves are survivable. The market also fell sharply in 1987 and 2000, and neither produced a decade of mass unemployment. The question is what turned a financial shock into a collapse of the real economy. Second, the timing is off. Unemployment in 1930 was elevated but not catastrophic, and the economy in the first year after the crash looked like a bad recession, not the abyss. The abyss came later, in 1931 through 1933, and it came through the banks.

Here is the arithmetic that matters. Roughly 9,000 banks failed between 1930 and 1933. Because deposits were not insured, each failure destroyed the savings of depositors and, in the aggregate, pulled money out of circulation. A person whose bank failed did not merely lose a balance; the lending that balance supported also vanished. The crash was a spark. The banking collapse, and what the central bank did about it, was the fire.

I will also give the crash its due on another count. An earlier credit boom and the later collapse of lending and asset prices left households and firms with debts that were fixed in dollars while prices and incomes fell. That debt deflation is a serious mechanism, and the stock market was part of the story. It is a part, not the whole.

Verdict. Misleading. The crash was a trigger and a symptom. The Depression, in its depth, was made by the contraction that followed.

Myth three: the Federal Reserve did all it could

The claim. The Fed, newly created in 1913, was a young and untested institution. It faced a tidal wave and acted reasonably given the tools and understanding of the day.

The strongest version. The Fed was operating under a gold standard that constrained it, and the economics profession had little framework for what to do in a banking panic. Some of its governors did try to ease policy at points, and the institution was fragmented among twelve regional banks that did not always agree.

The test. This is the one place where a Nobel-winning conservative economist won the argument so thoroughly that the Fed's own later chairman conceded it. In their 1963 book A Monetary History of the United States, 1867-1960, Milton Friedman and Anna Schwartz documented that the stock of money in the United States fell by roughly a third between 1929 and 1933 (the Federal Reserve's own history puts the fall at nearly 30 percent from the fall of 1930 to the winter of 1933). Close to a third. The central bank, whose entire job is to prevent that, let it happen. It did not supply cash to banks facing runs. When Britain left the gold standard in September 1931, the Fed responded by raising its discount rate sharply in October, in the middle of a deepening crisis, to defend the dollar's gold value. A central bank facing a panic tightened credit.

Ben Bernanke, who later chaired the Fed and who is an economic historian of the Depression, said at a 2002 event honoring Friedman that the Fed had been responsible and was sorry, and that it would not make the same mistake again. That is paraphrase, not a quotation, and I give it to you to check rather than to rest on. The point is that the "Fed did all it could" defense has been abandoned by the Fed.

Why does this belong in an argument against big government rather than for it? Because the lesson cuts both ways, and I would rather you hear that from me. The Depression's worst policy error was a failure of a government-created institution to do its single job. Conservatives who want rules for monetary policy, an anchor, a clear mandate, can take that as a lesson about why discretion without discipline is dangerous. For more on how the Fed's mandate was shaped, see The Fed's dual mandate and the 1977 law that gave it two masters and the comparison at Gold standard, Friedman's rule or today's Fed, three answers compared.

Verdict. False. The money supply collapse of 1929 to 1933 is the central fact of the downturn, and it was a policy failure.

Myth four: Smoot-Hawley had nothing to do with it

The claim. The tariff is a footnote. Trade was a small share of the economy, and economists who blame the 1930 tariff are grinding a free-trade axe.

The strongest version. This is the myth where the skeptics have the better of the numbers, and I will not pretend otherwise. Imports and exports were a modest fraction of American output in 1930, so even a large fall in trade could not by itself account for a fall in output of a quarter. Many economists today treat the tariff as an aggravating factor and not the main cause.

The test. The tariff did not cause the Depression, and I do not claim it did. The claim I make is narrower and, I think, unanswerable: it made things worse and it was avoidable. President Hoover signed the act on June 17, 1930, over the public objection of more than a thousand economists who had signed a petition urging a veto. Other countries retaliated with duties of their own. World trade shrank sharply in the following years. The act raised duties on a wide range of goods at a time when American farmers and manufacturers needed foreign customers more than ever.

The mechanism is not mysterious. A tariff is a tax on the American consumer and on the American firm that buys imported inputs, and it invites retaliation against the American exporter. Each of those effects moves in the wrong direction when demand is already falling. The tariff also fed the international scramble to protect gold reserves that tightened credit everywhere.

I will add a Founding-era note, since this is where the American tradition on tariffs is more complicated than either side admits. Alexander Hamilton argued for protective duties on infant industries, and the early republic raised most of its federal revenue from tariffs. Conservatives are not of one mind on the subject, and you can see the argument in Hamilton's Report on Manufactures and the conservative case for tariffs and the story of an earlier bruising fight in The Tariff of 1828 Was So Hated Its Enemies Called It the Tariff of Abominations. My claim here is about 1930, a tariff passed in the teeth of a collapsing economy, and not a general theory of trade.

Verdict. Mostly false. It was not the cause, but it was a self-inflicted wound that deepened the injury.

Myth five: New Deal programs restored employment

The claim. Roosevelt took office in March 1933 with unemployment at about a quarter of the workforce. By the end of the decade the government's alphabet agencies had put America back to work.

The strongest version. Something did turn around in 1933. Output grew strongly from the bottom for several years. The banking holiday and later deposit insurance stopped the panics. Work relief gave millions of men a paycheck and left behind roads, bridges and public buildings that are still in use. Those are real accomplishments, and the human relief mattered.

The test. Look at the unemployment series for the whole decade rather than the first recovery years. Unemployment peaked around 25 percent in 1933, fell during the middle 1930s, and then in 1937 and 1938 rose again in a second downturn, back to close to 19 percent by the standard measure. Six years after Roosevelt took office, after the largest peacetime expansion of the federal government in American history, nearly one worker in five was out of work. Count the work-relief jobs as employed and the number comes down, but it is still not a picture of a restored economy. Unemployment did not return to its pre-1929 level until the 1940s.

Now consider the design of the main programs. The National Industrial Recovery Act of June 1933 created codes under which industries, under federal supervision, set prices, wages and output. That is a plan to raise prices in the middle of a deflation and to cartelize each industry, and it kept wages above what employers would pay for the workers available. The Supreme Court struck the act down unanimously in Schechter Poultry Corp. v. United States, decided May 27, 1935. The Court held that Congress had delegated lawmaking power to the executive without adequate standards and had reached local commerce beyond its constitutional power over interstate commerce. When Justice Brandeis, no friend of big business, voted with the unanimous Court, the administration lost the keystone of its first recovery plan. The following year the Court struck down the Agricultural Adjustment Act's processing tax in United States v. Butler, which taxed food processors to pay farmers who cut their planted acreage, a scheme the Court said reached into matters reserved to the states.

Then came the policy changes of 1936 and 1937, which turned a recovery into a recession. Payroll taxes for Social Security began to be collected in January 1937, pulling money from workers' paychecks. The Federal Reserve doubled reserve requirements on banks in 1936 and 1937, draining credit. The federal budget moved toward balance. Union organizing under the Wagner Act of 1935 was accompanied by labor conflict and wage pressure. Whatever mix you choose to blame, the second downturn happened on the New Deal's watch and in the face of its policies.

What is the fairest accounting? The monetary side of the New Deal, ending the gold standard's hold in 1933, devaluing the dollar and the gold inflows that followed, did expand the money supply and helped the recovery. The banking reforms ended the runs. Those pieces worked. The pieces that raised the cost of hiring and tried to manage prices and output did not, and the evidence that they delayed a fuller recovery is substantial. The strongest scholarly case that they delayed it is old enough and well known enough to be checked rather than taken from me; ask any good economic historian for the literature on the NIRA and the length of the recovery.

Verdict. Mostly false. The recovery from 1933 was real but incomplete, and the worst of the New Deal's own programs were struck down or fed a second downturn.

Myth six: World War II spending proved Keynes right

The claim. Only when the government finally spent enough, and the war supplied the occasion, did the Depression end. Massive deficit spending cured unemployment, which proves the stimulus was too small, not wrong.

The strongest version. Federal spending did rise enormously during the war, and unemployment fell to about 1 percent. Output boomed. If you believe government demand creates jobs, the war is the largest natural experiment in the history of the theory, and it appears to confirm it.

The test. Four problems, which I will number.

1. The unemployment rate was manufactured by the draft. At the war's peak roughly twelve million Americans were in uniform. People in the armed forces are not counted as unemployed. Take millions of workers out of the labor market and unemployment falls. That is accounting, not recovery.
2. Civilians did not enjoy a boom. Consumer goods were rationed. Automobile production for civilians stopped. Price and wage controls suppressed the visible price level. A population working long hours with little to buy and rationing books in the kitchen drawer is not what a prosperous economy looks like, even if the output statistics were high. Measure prosperity by what families can buy and do with their lives, and the war years do not pass.
3. The theory predicted a postwar disaster, and it did not come. Many economists in the Keynesian tradition feared that when the government stopped spending the Depression would return. The opposite happened. Federal outlays fell from about $93 billion in 1945 to about $30 billion in 1948, a drop of roughly two-thirds, and the economy adjusted and grew. Private demand came back when the controls were lifted and the taxes did not rise to replace the cuts. If government spending is what sustains employment, a two-thirds cut should have been a catastrophe.
4. The comparison to 1920 is instructive. In the depression of 1920 and 1921 unemployment spiked and prices fell sharply. Federal spending was cut sharply, and the economy recovered within about a year and a half (the National Bureau of Economic Research dates the downturn from January 1920 to July 1921) without a stimulus program. That is one data point, and I will not oversell it, because the 1920 downturn did not involve a banking collapse and a one-third fall in the money supply. But it shows that a deep contraction does not require years of federal rescue.

Here is the fair concession. Spending on the war did get resources, plant and workers into use, and the productive capacity built during the war served the later boom. But a war is a command economy by necessity, built to produce tanks, not a model for peacetime prosperity.

Verdict. False. The war does not prove what the theory's defenders say it proves.

What a constitutionalist takes from the Depression

Set the economics aside for a moment and look at the structure of the thing. The first New Deal was thrown out by a unanimous Supreme Court in 1935 because it was not law in any recognizable constitutional sense. Congress had handed the President the power to approve industry codes that carried the force of law and the threat of penalties. The Court said what Madison would have said: the legislative power belongs to the legislature. The question under the commerce clause was equally basic. If a poultry slaughterhouse in Brooklyn was within the federal commerce power, what was outside it?

The administration answered that question the following year, when Roosevelt, angry at the Court, proposed in February 1937 to add up to six new justices. The proposal failed in the Senate, but the Court's later decisions broadened what Congress could do under the commerce clause, and the era of the limited, enumerated federal government gave way to the era in which nearly any activity could be reached. You can read the original text at the Constitution page, and I recommend you do, because the distance between the document and the reach of the modern state is the point.

The Founders' alternative was not indifference to suffering. It was the idea that a free, self-governing people, working through families, churches, local governments and markets, creates more prosperity and more relief than a central planner can. The Depression tested that idea under the harshest conditions in American history and the central story is that the government-created monetary contraction, the tariff wall and the tax increases did the damage, while the system's own recuperative power did the rebuilding wherever it was allowed to. For the larger argument about schools of economic thought, see Austrian, Chicago and Keynesian economics compared on one table. For the tax history that frames Hoover's 1932 act, see a century of top income tax rates, from 7 percent in 1913 to the 2018 law. And if you want to see how the debt looks today, the national debt clock has the number.

The strongest objection, answered

The best objection to everything above is this: you are judging the New Deal against an imaginary world in which nothing went wrong, and no one can know what the Depression would have looked like under different policies. That is true, and it is the reason I have confined my claims to what the record shows. I have not claimed the economy would have healed painlessly. I have claimed that specific policies, the tax increase, the tariff, the monetary contraction and the price-fixing codes, did harm, and that the record contains no evidence that the Depression needed the New Deal's central planning to end.

The second objection is that the human suffering was so great that doing something, anything, was a moral duty. I agree that doing something is a duty. Doing the right thing is a different duty. A doctor who prescribes bloodletting is doing something. The measure of a policy is whether it works, and the first obligation of the person in charge is to stop making the patient worse.

The case in brief

1. Hoover was an interventionist who raised tariffs and taxes and expanded federal lending, so "he did nothing" is false.
2. The 1929 crash was a trigger, but the money supply fell by roughly 30 percent or more between 1929 and 1933 and thousands of banks failed, and those were policy failures.
3. Smoot-Hawley did not cause the Depression, but it deepened it and invited retaliation.
4. The New Deal's price-fixing and cartel codes were struck down in 1935, and unemployment was still close to 19 percent in 1938.
5. World War II ended unemployment by drafting millions, and the postwar spending cut, followed by growth, undercuts the claim that deficits are what pull an economy out.

What you can do: read the Commerce Clause and the first sentence of Article I at the Constitution page, then ask your representative's office which clause authorizes the next large program they vote for.