Black Tuesday, October 29, 1929, was “one of those days after which almost everything is different.” That’s how John Kenneth Galbraith described the Great Crash thirty years after the fact – a day of pandemonium on the New York Stock Exchange after a week of declines, the unmistakable end of the great bull market of the 1920s. When share prices finally settled on their lows for the year, in November, they were half of what they had been in September. Frederick Lewis Allen later wrote, “There was hardly a man or woman in the country whose attitude toward life had not been affected by it in some degree and was not now affected by the sudden and brutal shattering of hope.”
About that, at least, there is no controversy. About the causes and cures of the Great Depression that followed, however, economists have been arguing ever since. Unlike the Crash, the Depression didn’t happen all at once. It unfolded gradually, over a decade, a blur of unfortunate policies and events. The spring of 1930 was a time of renewed optimism: share prices regained half of what they had lost, and when a delegation of worried clergymen visited the White House in June, President Herbert Hoover told them, “You have come sixty days too late. The Depression is over.”
By September the stock market was falling again, banks were closing, and the first apple-sellers had made their appearance on Wall Street. In the countryside, farm income fell from $6 billion in 1929 to $2 billion in 1932; coal prices from $4 a ton in the ’20s to $1.41 in 1932. By the winter of 1932-33, 13 million people, a quarter of those looking for work in the US, were unemployed. This was much worse than the familiar “business cycle” – the regular periods of long booms and short busts, each with its own surprises, stretching as far back as anyone could remember.
Always capitalism had snapped back before. Now the fear of losing things, permanently — a job, a life’s savings, a business, a piece of property — became part of the fabric of everyday life. Was this the final collapse of the capitalist system which Marx had predicted 75 years before? A reporter asked Keynes, if anything like it had happened before. Yes, he replied, “It was called the Dark Ages, and it lasted four hundred years.”
All the more alarming were the reports that in the communist Soviet Union, where the economy was extensively controlled by government, things apparently moved briskly ahead. Italy already had a fascist government. In January 1933, Adolph Hitler became chancellor in Germany and the Nazis came to power, promising national economic planning derived from the successes of the German economy during World War I. In the United States, Franklin Delano Roosevelt defeated Herbert Hoover, in November 1932. His inauguration wouldn’t occur until the following March.(A Constitutional; amendment subsequently changed the date to January.) Something like the fate of civilizations seemed to hang in the balance.
The financiers, bankers and industrialists who had presided over the boisterous Twenties now seemed to have little to offer. Instead, four economists spoke out about the circumstances with sufficient clarity that we remember them in the present day. For decades, John Maynard Keynes dominated interpretations of the Great Depression. In the 1970s, the name of Friedrich von Hayek was heard more frequently, especially in British discussions of the event; he himself had been rejuvenated by the Nobel Prize he shared, with Sweden’s Gunnar Myrdal, in 1974. In the early 1980s, the memory of Joseph Schumpeter was dusted off, after Silicon Valley began to make its disruptive presence known. Only after 2011, when Grand Pursuit: The Story of Economic Genius, by economics journalist Sylvia Nasar appeared, was the figure of Irving Fisher restored to a central place in the debate; economists had revived his “debt-deflation” theory of the Great Depression after the 2008 crisis. Each of the four had a distinctive way of framing the problem. Each is remembered by different constituencies for different reasons. Part of the charm of remembering is that all four lived such colorful lives.
It was, however, a Practical to whom we owe the single greatest debt for reforms that rendered a second Great Depression much less likely. Marriner Eccles, a banker who became Roosevelt’s chairman of the Federal Reserve Board, lived a long and interesting life. It was he, with the assistance of economist Lauchlin Currie, who took the steps in 1935 that enabled authorities seventy-five years later to deal more decisively with the crisis of .
. Getting Stuck?
If you had met John Maynard Keynes in the 1920s, you would have known him as an influential financial journalist and a speculator. As an undergraduate at Kings College, Cambridge, where his economist father, John Neville Keyes, was a close associate of Alfred Marshall, he was said to be fond, above all else, of “being in the swim.” And while he had clearly been born to succeed, it wasn’t necessarily as an academic. After disappointing exams, Keynes joined the India Office of the Civil Service in London in 1906. Two years later, he resigned in favor of a lectureship in economics at Cambridge.
Friends called him to the Treasury in August 1914, where he became immersed in the global banking panic that accompanied the outbreak of World War I. (He may or may not have tumbled on to Britain’s secret plan to bring Germany to its knees through a lightning economic blockade, described nearly a hundred years later by historian Nicholas Lambert in Planning Armageddon:British Economic Warfare and the First World War (Harvard, 2012); in any event, he starterd a book on the crisis, then put it aside.) Thereafter Keynes rose rapidly and, when the war ended, represented the Treasury at the 1919 Paris Peace Conference. The Economic Consequences of the Peace, his brilliant criticism of punitive reparations imposed on Germany, appeared soon afterwards and made him famous.
His reputation as an economist rests on three books. A Tract on Monetary Reform, in 1923, codified much of what had become known about the ability of central banking to control inflation and deflation, which he bruited as “one of the biggest jumps ever achieved in economic science.” Many years later, through the reasoning of his acolytes, Keynes had become identified with the proposition that money does not matter. Allan Meltzer, of Carnegie Mellon University, remarked the irony: “Throughout his life, Keynes gave first importance to monetary arrangements and the monetary system.”
He craved scholarly recognition, and, just a year after the Wall Street crash, published a two- volume Treatise on Money, seeking to explain the experience the instability of prices over the previous fifty years, no longer in terms of money, credit and banking but instead of the fluctuations of investments and savings. His biographer Robert Skidelsky later wrote that much of the confusion that ensued might have been avoided “had he allowed the following shaft of sunlight to play on his argument earlier than page 458”:
Thus thrift may be the handmaid and nurse of enterprise. But equally she may not. And perhaps, even usually she is not. For enterprise is connected with thrift not directly; but at one remove; and the link which should join them is frequently missing. For the engine which drives enterprise is not thrift but profit.
The continuing slump gave Keynes an opportunity to rewrite, and so he did, producing The General Theory of Employment, Interest and Money amid great excitement in 1936. This time he argued that fluctuations of output and employment were the deeper problem. Unemployment might turn out to be chronic, requiring constant management by government – much like inflation.
More has been written about The General Theory than any other work in twentieth-century economics, as David Laidler has observed. Just last month Robert Dimand told the History of Economics Society, meeting in East Lansing, Michigan, about a series of letters Keynes had written for the Dutch electronics firm N.V. Philips, more or less narrating the Depression at intervals between October 1929 and November 1934. The trove had lain undiscovered in the microfilm version of Keynes’s paper until Dimand and Bradley Bateman, of Randolph College, had independently rooted them out. The find is certain to enhance our understanding of the development of Keynes’ views.
But this much is clear from any angle. What had begun as an enthusiastic embrace of monetary policy had by the mid-’30s become Keynes’ strong advocacy of fiscal policy as well – of compensatory government spending, especially in the midst of the Great Depression. The economy would require some degree of management. It could no longer be expected to function entirely on its own.
In contrast, if you had met Hayek in New York in 1923, it might have been sitting at a library table, with barely two dimes to rub together, wearing two pairs of socks to hide the holes.—a strange turn for a son of privilege. He had come to economics by stages, serving in the Austrian army in World War I until malaria took him down, recuperation in Zurich, a return to his studies in Vienna, passing through stages of Marxism and psychoanalysis, ostensibly studying law, until, when the Weimar inflation ended, in the summer of 1922, his curiosity took him to New York. There, where Hayek enrolled at New York University and discovered how badly he had been fooled by the wartime propaganda of the Austro-Hungarian Empire. He resolved not to be fooled again, and returned to Vienna in 1924. He was 25.
The next year a pair of Americans, William Foster and Waddill Catchings, published “The Dilemma of Thrift, an article in The Atlantic Monthly in which they argued that oversaving and, therefore, underconsumption was the principal cause of business cycles, including the dramatic crash of 1920-21. Foster and Catchings offered a $5,000 prize for the most trenchant criticism of their thesis. Hayek didn’t take them up – 435 others did, including many professors of economics, in 40 countries around the world – but he did begin work on a rebuttal of his own, emphasizing traditional Austrian mistrust of credit and concern for understanding the passage of time in economic processes. “The ‘Paradox’ of Saving”: appeared in a German economics journal in 1929. “The slump was nature’s cure,” Hayek wrote, “a purgative which eliminated those investments which were not financed by real savings.”
Lionel Robbins invited Hayek to lecture at the London School of Economics, which had emerged as the free-market pole of the British debate. Hayek was just the voice needed to oppose to Keynes – “a stopped clock, right twice a day,” Robbins complained. Hayek arrived in January 1931, with the first half of his acerbic review of Keynes’ Treatise on Money already in print. Keynes wrote in the margins of his copy, “He evidently has a passion which leads him to pick on me, but I am left wondering what this passion is.” The series of four lectures Hayek gave, describing the Depression as the equivalent of a “cold douche,” would appear later as Prices and Production. There was nothing to be done, Hayek wrote, but to let the Depression run its course.
Even before it appeared, Keynes attacked Hayek’s book as “one of the most frightful muddles I have ever read… an extraordinary example of how, starting with a mistake, a remorseless logician can end up in Bedlam.” Since then, their argument has been reprised many times, including a book by Nicholas Wapshott, Keynes Hayek: The Clash that Defined Modern Economics, and a memorable “rap anthem” written by Russ Roberts of the Liberty Fund.
By March 1933, the debate was over. With the Depression at its nadir, the young Austrian had been completely defeated. Even Robbins had switched sides. Hayek retreated. He declined to review the General Theory when it appeared in 1936. He wrote a book, The Pure Theory of Capital, which was judged an embarrassment. And, in 1944, he published a jeremiad against war-time planning, The Road to Serfdom, that made him a star in conservative political circles but which put him all but out of court in technical economics for thirty years. He moved to the United States, divorced his wife, and married a long-lost first love from Vienna.
Before he left London, though, Hayek began a transformation that would occupy the second half of his career. He started to examine issues of knowledge and decentralization. He pursued his interest in the history of money and banking. And he prepared a new edition of Paper Credit, Henry Thornton’s little-remembered dissent from Adam Smith about the necessity of central banking, and wrote a bracing introduction.
. Forging Ahead?
Also hoping for a call in the spring of 1931 – not to London but to the University of Berlin – was Joseph Schumpeter. He was Keynes’ exact contemporary, born in 1883, trained in Vienna, and he had been much faster out of the blocks. His Nature and Essence of Theoretical Economics, in 1908, spelled out for a skeptical German-speaking audience much of what had happened elsewhere in the last hundred years, mainly the marginal revolution, the restatement of economics in terms of the differential calculus as a series of problems of optimization. The Theory of Economic Development, in 1911, with its emphasis on new goods, new sources of raw materials, and new means of production, and the importance played by entrepreneurs and financers, made him famous as an alternative to Marx. He was invited to teach at Columbia University.
The outbreak of World War I dimmed his star in the English-speaking lands.
He returned to Germany and entered politics. After the war he served as Austria’s finance minister for a time, tried banking, went broke, accepted a job at the University of Bonn, failed to get another book of economics off the ground, spent a year teaching at Harvard, and hoped for that chair at Berlin. In the early 1930s, he was taken aback at the attention paid to Keynes. When the call to Berlin didn’t come, he moved to Harvard in 1932 and threw himself into a two-volume study of business cycles. The first volume didn’t appear until 1939. And it was only in a wartime volume of essays, Capitalism, Socialism and Democracy (1942), that Schumpeter coined the phrase for which he is best remembered: the “creative destruction” with which capitalism proceeds.
Experts still debate Schumpeter’s views on the complicated mechanics of boom and bust. The economic historian J. Bradford DeLong, of the University of California at Berkeley, reading Schumpeter’s 1927 prolegomena to his two-volume study, remarked recently how strange it was to find Schumpeter laying out his “ depressions-cause-structural-change-and-growth” at the same time he propounded his “entrepreneurs-disrupt-the-circular-flow-and-cause-structural-change-and-growth-theory of enterprise.” The former is wrong, says DeLong, a noted Keynesian: “Growth comes from entrepreneurs pulling resources into the sectors, enterprises, products, and production methods of the future. It does not come from depressions pushing resources into unemployment.”
Yet in A Great Leap Forward: 1930s Depression and US Economic Growth (Yale 2011), economic historian Alexander Field, of Santa Clara University, found that despite the double-digit unemployment of the 1930s, the decade experienced very high rates of technological innovation, thanks to projects in the works of the research and development system, and to public spending on roads and bridges. “Schumpeter developed his homage to the power of creative destruction against the backdrop of what turned out to be the most technologically dynamic epoch of the twentieth century,” Field wrote.
By the time the US entered World War II, the FBI viewed Schumpeter as an enemy sympathizer; and his wife, Elizabeth Boody Schumpeter, an expert on Japan, as possibly even worse. He helped his friend Arthur Cole found the Center for Research in Entrepreneurial History at the Harvard Business School after the war, from which many notable careers were launched, including those of Alfred Chandler and F.M Scherer; served a term as president of the American Economic Association, in 1947, and died in 1950. Until he was rediscovered in the 1980s, Schumpeter was remembered mainly for his magisterial History of Economic Analysis, published posthumously in 1953.
. A Leverage Trap?
Of the four economists, Irving Fisher of Yale University was the one closest to power at the time. A celebrated public intellectual, he wrote a widely-syndicated newspaper column and had supported President Hoover in the 1928 election campaign. But Fisher had a problem, and in 1930, it was getting worse.
As an unusually talented undergraduate at Yale, he was expected to pursue a PhD in mathematics, but a summer encounter with an essay in the new marginalism by Rudolf Auspitz and Richard Lieben turned him into a student of economics. His dissertation, Mathematical Investigations of the Theory of Value and Price, was supervised by J. Willard Gibbs (1839-1903), the inventor of statistical mechanics and the greatest American scientist of his day. It catapulted Fisher into the front ranks of leadership in general equilibrium analysis, in a league with Walras and Francis Ysidro Edgeworth To illustrate its principles, Fisher built an elaborate hydraulic model replete with pulleys and pans, which was accidentally destroyed on its way to be exhibited at the Columbian Exposition in Chicago in 1893.
The bimetallic controversies of the 1890s led Fisher to the quantity theory of money, relatively neglected since the time of Adam Smith. By the time he published The Role of Interest, in 1907, he had laid the foundation for modern monetary economics and become the first great American economist.
Fisher survived a bout of tuberculosis and became a reformer: prohibition, eugenics, diet fads, ozone machines. His 1911 book. The Purchasing Power of Money, made him a public figure as well as president of the Stable Money League. By 1917, he was president of the American Economic Association. He sold a company he had founded to make a Rolodex-like card-filing system to a precursor of Remington Rand in 1925.He bought stocks with the proceeds, borrowed money and bought more. By 1929 he was worth $10 million.
Fisher had become the leading spokesman for what was said to be a New Era of stock market valuations. When Roger Babson in September 1929 told the annual National Business Conference that a crash was coming, Fisher called The New York Times and arranged for an interview in which he assured readers that stocks had reached “a permanently high plateau.” Already the margin calls had begun. Facing financial disaster, Fisher borrowed money from his wife’s wealthy sister in the expectation that things would turn up. They didn’t.
He continued to give advice to Congress and Hoover throughout, visiting the White House in the summer of 1931. He urged the Federal Reserve Board to expand the money supply instead of permitting it to contract. The following year he published Booms and Depressions, a little book spelling out for the first time a “debt-deflation” theory of the depression that today seems strangely modern. After a period of excessive borrowing, debts had become out of proportion to all else. Distress selling had initiated a downward spiral; bank money and credit had shrunk apace. Only the central bank could halt the process, much as Henry Thornton had argued 120 years before.
The main contribution of this book is that depressions are, for the most part, preventable and that their prevention requires a definite policy in which the Federal Reserve System must play an important part.
It was too late. By 1932, Fisher had lost almost everything. He considered running for the Senate from Connecticut and decided against it. He continued to give Congressional testimony. He wrote 100 letters to Franklin D. Roosevelt over the next ten years and received 25 in return. In the eyes of the public, he had become a joke. By 1938 he had lost much of his sister-in-law’s fortune. The university bought his house in 1940
Fisher did have one important success in those years. As early as 1912, when he had difficulty publishing a paper that combined a high level of statistical analysis with mathematics and theory, he had envisaged the need for an interdisciplinary effort to pioneer a new quantitative economics. When a well-to-do Yale alumnus named Alfred Cowles visited him in 1930 to inquire what might be done to prevent a future depression, Fisher persuaded him to bankroll the creation of an elite corps of economists to pursue and combine the latest methods. He enlisted Keynes, Schumpeter, and several members of a younger generation that included the Norwegian Ragnar Frisch. Together they founded the Econometric Society, in 1932. The Society played only a small part in what happened next in economics, in the years after World War II. Since the 1960s, however, it has played a growing role.
. Institutional Design?
Looking back, the ideas of economists seem more powerful than they ever were at the time. The responsibility for dealing with the Great Depression as it ground on fell to practical men and women at every level – above all, to elected officials and the public servants whom they appointed. Three of these in particular stand out.
The first was, of course, the newly elected president. Roosevelt had campaigned on a promise to balance the budget, but when he took over on Saturday, March 4, 1933, nation was flat on its back. Banks in various regions of the country had been in trouble since the beginning. But since a highly visible meeting designed to reassure the public after the 1929 crash, the New York banks had remained open. The threat of a run on them had reignited in January 1933 in the interregnum between the election and the inauguration Roosevelt’s advisers urged him to wait, hoping that the mere act of taking office would restore confidence. Instead Roosevelt declared a bank holiday, closing all banks for eight days, and at the same time declared the nation would no longer redeem notes for gold. The New York Stock Exchange closed up 15 percent the next day. The following Sunday, March 12, in “The Banking Crisis,” the first of what came to be known as his “fireside chats,” Roosevelt explained what he had done.
First of all, let me state the simple fact that when you deposit money in a bank, the bank does not put the money into a safe deposit vault. It invests your money in many different forms of credit — in bonds, in commercial paper, in mortgages and in many other kinds of loans. In other words, the bank puts your money to work to keep the wheels of industry and of agriculture turning around. A comparatively small part of the money that you put into the bank is kept in currency — an amount which in normal times is wholly sufficient to cover the cash needs of the average citizen. In other words, the total amount of all the currency in the country is only a comparatively small proportion of the total deposits in all the banks of the country.
What, then, happened during the last few days of February and the first few days of March? Because of undermined confidence on the part of the public, there was a general rush by a large portion of our population to turn bank deposits into currency or gold — a rush so great that the soundest banks couldn’t get enough currency to meet the demand. The reason for this was that on the spur of the moment it was, of course, impossible to sell perfectly sound assets of a bank and convert them into cash, except at panic prices far below their real value. By the afternoon of March third, a week ago last Friday, scarcely a bank in the country was open to do business.
Roosevelt had closed the banks to stop the run. Congress had authorized a new currency, no longer backed by promises of gold. The Bureau of Engraving was already shipping notes to the twelve regional Federal Reserve Banks. They would begin supplying cash to local banks the next day. When the biggest banks began opening for business on Tuesday, Roosevelt said, “No sound bank [will be] a dollar worse off than it was when it closed its doors last week.” The New Deal began with an authoritative end to a nationwide banking panic.
The second Practical of great influence was Carter Glass, Senator from Virginia, one of the authors of the 1913 measure that created the Federal Reserve Board. He was instrumental in the passage, in May, of the Banking Act of 1933, which contained two major provisions which further calmed the situation. It created the Federal Deposit Insurance Corporation, which guaranteed the safety of deposit accounts in member banks; and it separated the activities of commercial banks involved in managing low-risk consumer debt from risk-taking securities firms. The latter portion of the law quickly became known as the Glass-Steagall Act, after its sponsors, Glass and Congressman Henry B. Steagall of Alabama, both legislators of long experience.
Roosevelt and the heavily-Democratic Congress that had been elected in 1932 passed so much legislation that it is hard to know what really mattered. Some clearly failed — the National Industrial Recovery Act in particular. Some had mixed results: the Agricultural Adjustment Act stabilized food production, but heavily favored big farmers over small ones. Others measures succeeded — the Securities and Exchange Commission, the Civilian Conservation Corps, the Tennessee Valley Authority.
All but unnoticed was the appointment, in 1934, of Marriner Eccles as chairman of the Federal Reserve Board. Eccles was a successful banker in Utah, who, in the 1920s, had invented the bank holding company. He had tumbled on to the underconsumptionist literature of Foster and Catchings and become A passionate advocate of compensatory government spending. The University of Chicago economist (and later senator) Paul Douglas discovered him in Utah, Rexford Tugwell, one of Roosevelt’s economic advisers, brought Eccles to Washington. Treasury Secretary Henry Morgenthau put him to work. Roosevelt liked him and nominated him to head the Fed.
Eccles was the third Practical of great importance. He agreed to take the job on the condition that he be allowed to restructure the Fed. The Fed was a new organization, he explained, still learning about its powers and limitations, and its conduct through the Depression had been deeply unsatisfactory. The Board itself appointed chairmen in each of the twelve banks, but real power was vested in the chief executives of the banks, designated “governors,” and chosen by the local banking community.
Things had gone along pretty well as long as Ben Strong was governor of the powerful New York bank, Eccles told Roosevelt. (This from the indispensable account of Eccles’ career in The Vital Few: The Entrepreneur and American Economic Progress, by economic historian Jonathan Hughes.) Strong was highly experienced; he regarded the twelve reserve banks as eleven too many; he had the ear of the Treasury and the President when he needed it. But Strong had died in 1928. He was replaced by George Harrison, a far more timid banker who enjoyed the protection of none other than Carter Glass. Governors of other regional banks were free to do as they pleased, including withholding funds from the Federal Open Market Committee when it sought to expand bank credit. As Eccles wrote,
A more effective way of diffusing responsibility and encouraging inertia and indecision could not very well have been devised.
Roosevelt liked his audacity. Eccles didn’t write a book about the Great Depression; he wrote a statute (with the help of the young Harvard economist Currie, whom he drafted from the Treasury Department). The Banking Act of 1935 reorganized the governance of the Fed completely and moved its control to Washington from New York. It eliminated the chairmen of the regional banks and demoted their “governors” to presidents, their appointments subject to approval of the the renamed Federal Reserve’s Board of Governors. It gave the Board responsibility for the conduct of monetary policy, raising and lowering interest rates by buying or selling government securities in the bond market, and authorized to the central bank to lend against any worthy asset in an emergency. Senator Glass fought hard against the measure. From Harvard, Schumpeter joined others who wrote to say that the passage of such a measure would court disaster by inviting reckless lending on the part of banks (the same argument that Thomas Hankey had made to Walter Bagehot about emergency lending by the Bank of England sixty years before). But the Banking Act of 1935 passed into law and lay mostly unremarked for 65 years. In 1982, the Fed, under Paul Volcker, renamed its headquarters building for Eccles.
. Economists between Two Worlds
There are few greater pleasures for a financial journalist than wallowing in the history of the Great Depression. The outlines are clear; the details are known: there are excellent biographies of all the major players. From a distance of eighty years, what is striking how old-timey they were. Keynes, Hayek, Schumpeter and Fisher were all born in the nineteenth century. They listened to Caruso recordings and wore high-button shoes. Keynes and Schumpeter were nearing their fifties when the crisis started; Fisher was sixty-two. None but Hayek lived to see the postwar boom that became the dominant fact of the lives of the next several generations. Keynes died in 1946, Fisher in 1947, Schumpeter in 1950.
All four of had some piece of the truth. Three of them carried forward the banners of Adam Smith’s original three prongs of investigation: Hayek, of general equilibrium; Schumpeter, of growth; Fisher, of money. And if Keynes invented something new, macroeconomics, meaning the study of the behavior of the economy as a whole, in the hope of diminishing its perturbations, it looked suspiciously like something old — the fuzzier, somewhat organic vision of the economy that Smith had supplanted with his Wealth of Nations, the system of the inveterate reformer Sir James Steuart, who thought the appointment of “statesman” to oversee the banking system of a nation was a place to start.