The Great Depression: contrary to conventional wisdom, the historical record shows that interventionist policies during the Hoover and FDR administrations caused and prolonged the Great Depression

New American, The, June 23, 2008 by Charles Scaliger

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On October 29, 1929, the world turned upside down. For more than a month, stock prices, which had risen to giddy new levels throughout the decade now known as "the Roaring Twenties," had been faltering. Since early September, when stock prices peaked, the market had lost about 17 percent of its value, and the previous Thursday, October 24, the decline turned into a free fall, prompting leading U.S. financiers like Thomas Lamont to place bids substantially higher than market prices on large blocks of blue-chip stocks in a last-ditch effort to restore confidence and stave off a market meltdown.

But it was to no avail. On Monday, the market continued its sell-off, falling 13 percent further. On Tuesday, October 29, the damage continued. When the closing gavel finally fell just before eight in the evening of that calamitous day, stocks had lost an additional 12 percent. Stunned crowds of investors filled the streets outside the New York Stock Exchange on Wall Street. The Great Depression, the greatest economic and financial crisis in American history, was underway.

The "Black Tuesday" stock market crash has attained iconic status in American lore. But contrary to present-day misconception, the crash neither initiated nor was chiefly responsible for the depression that followed.

Americans were no strangers to economic downturns stretching all the way back to the Panic of 1819. Most such episodes, including the then-recent Panic of 1907, when the stock market fell almost 50 percent from its 1906 high, and the post-war recession of 1918-1921, in which the American economy shrank by a greater degree than it did during the Great Depression, tended to be severe but brief interruptions in otherwise robust economic growth. In late October 1929, there was little reason to believe that the latest market calamity would be otherwise.

But this time, things would turn out very differently. For although this economic downturn, like all other downswings in the business cycle, had been brought about by unwarranted credit expansion on the part of the banking system, spearheaded in this instance by the brand-new Federal Reserve, the actions of bankers and politicians before and after the stock market crash turned a much-needed market correction into an economic apocalypse.

Inflationary Roots

The roots of the Great Depression extended back as far as the Panic of 1907. That panic, primarily a bankers' affair that resulted in runs on numerous banks and trusts, especially in New York City, was over in a few weeks with minimal impact on the public at large. J.P. Morgan organized bankers and financiers to arrange new lines of credit amongst themselves and buy up stocks of otherwise healthy corporations. The panic was thus solved expeditiously by market forces and affected parties like Morgan acting in their own self-interest. Yet it persuaded many on Wall Street that the time had arrived for America to have a central bank, as England and most of the wealthy nations of Europe had had for many years. Bankers, like Jacob Schiff of the investment firm Kuhn, Loeb, and Co., were vociferous in demanding a central banking authority to stabilize the allegedly chaotic banking system.

Six years later, in 1913, they got their wish when the Federal Reserve Act, which created the Federal Reserve, was passed. The act was shepherded through Congress by Senator Nelson Aldrich, with the secret support of many of America's--and the world's--wealthiest men, like international banker Paul Warburg and the aforementioned Schiff.

The most powerful man at the new Federal Reserve was Benjamin Strong, the strong-willed and secretive head of the Federal Reserve Bank of New York from 1914 until his death in 1928. It was Strong, far more than the several chairmen of the Fed who came and went during his tenure, who was most influential in shaping U.S. monetary policy during the 1920s. Strong had been present at a secret meeting on Jekyll Island, Georgia, in 1910, where what became the Federal Reserve System was planned. Strong was also well connected in international banking circles, especially with Montagu Norman, governor of the Bank of England. It was Strong's relationship with Norman, probably more than any other factor, that led to the Fed's inflationary (monetary expansion) policies of the 1920s and set the stage for the 1929 bust.

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Montagu Norman, whom economist Murray Rothbard aptly termed "the Mephistopheles of the inflation of the 1920s," had great difficulty propping up Britain's postwar finances. Under pressure to restore British currency to the prewar gold standard--which would have required credit contraction to offset the effects of wartime inflation--Norman chose instead to open the money spigots wider. As a consequence, the British pound continued to lose value and, more alarmingly for British bankers, British gold migrated across the Atlantic to the United States, where it found more stable valuation in the U.S. dollar. As long as the disparity between American and British monetary policy continued, so would the flight of gold from a weaker to a stronger currency. From Norman's viewpoint, something had to be done.