Analysis of The Great Depression, Part 2: Crash of 1929

By 1929, the economy of the United States was heading towards uncharted territory. Despite smaller crashes throughout its history, state intervention had never been seriously considered as a means of dealing with the business cycle. Now, with the recently created Federal Reserve alongside new interventionist theories being promoted by John Maynard Keynes, the role the state would play in planning the economy would grow to heights seldom seen before.

After the elections of 1928, Herbert Hoover was sworn into office, replacing Calvin Coolidge to become the 31st President of the United States on March 4, 1929. Only a few months later, on October 29, 1929, the stock market would experience a major crash, with that day becoming known as Black Tuesday. Unlike his predecessors who managed to generally stay out of interfering with the markets, President Hoover’s stance would be much more involved.

There are a plethora of reasons behind the stock market’s crash in October, but some of the main ones are as follows. For starters, years of easy access to cheap credit stimulated over-leveraged investments on Wall Street. This arrangement works out as long as the over-leveraged investments have positive returns. As soon as the returns start to diminish, or even become slightly negative, a liquidity crisis is born, due to the rush from investors demanding more liquid cash than the economy has in supply in order to de-leverage their investments. Bank runs inevitably ensue, causing more panic across the financial sector.

As a response to this, banks start cracking down on loan payments from borrowers, which leads to defaults by those borrowers who were given access to loans at substandard interest rates and against prudence. At this point, foreclosures and bankruptcies start to appear all across the nation, and the plague of malinvestment finally reveals itself.

This is a broad summary of the economic forces at work in the United States during this crash of 1929. Herbert Hoover, who had previously had experience working as the Commerce Secretary during the depression of 1921, proceeded to institute his favored interventionist policies which focused on the artificial appreciation of wages. Hoover’s logic was based on the stimulation of consumer spending, which he reasoned would require higher wages.

A proper understanding of Say’s Law, however, would reveal the fallacy in this line of thinking. Say’s Law states that it is production, rather than mere spending, that must occur first in order to grow the economy. By artificially stimulating spending without appropriate increases in production, there is only a mere transfer of wealth that occurs, not a creation, due to the broken window fallacy. This fallacy stipulates that spending directed away from savings, investments, or other long-term consumption goals in order to spend in the present leads to a situation of unseen costs, which have to be considered for proper economic analysis.

Because of this, a mere artificial increase in wages by state mandate cannot stimulate the economy, since wealth unduly going towards wages is being diverted from its natural course, which carries with it unseen costs that often, if not always, equal or even outweigh the benefits gained from the new mandated spending. Hoover’s attempts to corral the top industrial magnates of the era into cooperating with his goals for low unemployment and high wages neglected the real market forces that would have worked towards fixing the economy while complicating and prolonging the recovery further.

Aside from these efforts, Hoover’s administration oversaw the creation of various bureaucratic agencies assigned various goals ranging from the expansion of business regulations to the stimulation of labor and employment. The growth of these bureaucracies further exacerbated the process of managing and starting businesses, as well as increasing the costs of acquiring new labor and laying off excess labor. While the intentions of the bureaucracies, as well as the Hoover administration, may have very well been noble, the actual results were the exact opposite.

To add to this seemingly dismal situation, Senator Reed Smoot and Representative Willis Hawley managed to successfully pass through Congress a new series of tariffs, under the pretexts of promoting and protecting US agriculture and industry. This bill saw the dutiable tariff rate rise to 59.1%, being surpassed historically only once in 1830. It is hard to express in words the economic toll this policy had on the United States. American consumers had to divert even more of their spending away from other economic fields towards the now more expensive tariffed goods, effectively decreasing their standard of living. Come election time in 1932, the stage was set for a newcomer to take hold of the Federal government.

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