Editor’s Note: The "V&V Q&A" is an e-publication from The Center for Vision & Values at Grove City College. Each issue will present an interview with an intriguing thinker or opinion-maker that we hope will prove illuminating to readers everywhere. In this latest edition, Dr. Paul Kengor, the executive director of The Center, interviews Dr. Jeffrey M. Herbener, the chair of the department of economics at Grove City College and fellow for economic theory & policy with The Center, on the topic of economic booms and busts. This is one of an ongoing series of interviews on the current economic crisis with Jeff Herbener.
Dr. Paul Kengor: Dr. Herbener, tell us, in short, the difference between how the U.S. government dealt with major economic downturns, including market crashes, in 1920-21 and the 1990s, compared to how it reacted during the 1930s Great Depression and how it is reacting today.
Dr. Jeffrey M. Herbener: There was a 50-percent inflation of the money stock during the First World War. In the resulting boom, the stock market rose 140 percent in the five years from mid-1914 to its peak in mid-1919. Two years later it reached bottom, having fallen 50 percent from its peak level. The federal government did very little to interfere with the liquidation and reallocation process. What followed was a sharp financial downturn and short recession. Prices fell 35 percent in less than a year, unemployment rose, briefly, to 12 percent, but real GNP fell only 2 percent. By 1923, real GNP had reached an all-time high and unemployment stood at 3 percent.
The boom leading up to the Great Depression was bigger. In the five years from October 1924 to its peak in October 1929, the stock market rose 260 percent. Three years later it bottomed out, having fallen nearly 90 percent. Although less vigorously than FDR, Herbert Hoover intervened in the economy in ways not seen since the First World War. One of his favorite policies was to attempt to prop up prices and wages. As a result, the 35-percent decline of prices that took less than a year in 1920, stretched out for three years. By blocking the efficient adjustment process, the Hoover administration’s policies resulted in 25 percent unemployment and a 30 percent reduction of real GNP by 1933.
Kengor: One of the enduring myths is that Herbert Hoover was somehow laissez faire. Is it true that the crashed economy of the initial Great Depression (1929-33), had largely recovered prior to FDR's New Deal? Arguably, it was the intervention of the New Deal that caused the sharp downturn in 1937, which ultimately worsened and prolonged the Great Depression?
Herbener: After 1933, the economy began to recover. From its low point in mid-1932, the stock market rose 373 percent by early 1937. While still nearly 50 percent below its pre-crash high in October 1929, the stock market gains between 1932 and 1937 reflected a significant recovery. By 1937, real GNP had regained nearly all that it had lost from 1929 to 1933 and the unemployment rate had fallen to 14 percent. Unfortunately, Roosevelt’s New Deal policies hindered the recovery. Price controls and crop destruction in agriculture, cartelization of businesses, fiat paper money, bailouts, labor-union privileges, make-work projects, and so on, prevented a complete recovery as had occurred after the bust of the early 1920s. As the Supreme Court struck down early New Deal legislation, including the National Industrial Recovery Act, in July 1935, and the Agricultural Adjustment Act, in January 1936, a more robust recovery appeared possible. Roosevelt’s court-packing scheme in 1936 and later appointments to the court, however, led to a reversal and the court’s seal of approval to the New Deal. The economy sagged under the anticipation of greater government burdens. From early 1937 to early 1938, the stock market fell 50 percent, real GNP declined 4 percent, and unemployment rose to 19 percent.
Kengor: You say that it isn't a mystery how World War II solved the unemployment problem during the Great Depression. Solve that mystery for us here.
Herbener: During the Second World War, the federal government distorted the capital structure and resource uses even further from normalcy. The government took over production facilities, built new factories, borrowed enormous sums of money, inflated the money stock tremendously, and spent massive amounts of money on war production. Government officials controlled wages and prices in the economy leading to shortages and further distortions of production. Far from leading to economic recovery, practices such as government spending, borrowing, inflating, and controlling prices and production, left the capital structure of the economy more distorted relative to consumer demands than it was in the Great Depression. The transition to a war economy pushed the stock market down 38 percent from the spring of 1940 to spring of 1942.
The unemployment problem was not solved by these policies either. Despite the burdens of New Deal policies, entrepreneurs had managed to adjust production significantly before American entry into the war. The unemployment rate, which stood at 19 percent in 1938, had been cut almost in half to 10 percent by 1941. This left nearly seven million persons unemployed in 1941. The government “solved” the residual unemployment problem by conscripting 10 million men into the armed forces. By extracting such large numbers, conscription squeezed the unemployment rate to the artificially low figure of 1.2 percent in 1944 and impaired labor efficiency in the economy.
Kengor: You say the more interesting mystery is how those 10 million men got jobs when the war was over. How did that happen? Did the government find work for them?
Herbener: Government and academic economists, who had adopted the mistaken view that the massive federal-government expenditure for the war had pulled the economy out of the Great Depression, feared a return to depression after the war when the government slashed its spending and released its conscripts back into civilian life. Instead, the lifting of the burden of government price and production controls, the return of capital capacity to entrepreneurs, the shrinking of the government’s spending, taxing, borrowing, and monetary inflation, paved the way for a smooth transition to normalcy. Free from these burdens, entrepreneurs liquidated and reallocated capital, built new production facilities, started new businesses, and employed more workers. Instead of returning to depression levels after the war, the unemployment rate stood at 3.9 percent in 1946 and 1947 and 3.8 percent in 1949. In 1929, at the height of the boom, the unemployment rate was 3.2 percent.
Kengor: So, what about today? Some are claiming we are headed for an economic disaster akin to the 1930s. Could we be headed for a crash similar to the Great Depression?
Herbener: It depends entirely on government policy. The massive monetary inflation and credit expansion of the past several years engineered by the Fed has led to the financial panic. This reckless policy has opened the door to several highly undesirable outcomes, including a depression, a “lost decade” like the Japanese in the 1990s, a stagflation like the United States in the 1970s, and even a hyperinflation. But whether or not the liquidation and reallocation of the capital structure to restore normalcy occurs quickly and efficiently depends on the extent of government interference with the process. If the government were to slash its spending and taxing, cease its monetary inflation, reduce the burden of its regulations, and leave entrepreneurs free to adjust production, then we could see a rapid and efficient transition, like the early 1920s or after the Second World War. If the government continues on its current course of bailouts, re-inflation, a 21st century New Deal, enhanced regulation, and so on, then difficulties lie ahead. Stay tuned.
Kengor: We certainly will. And we look forward to additional insights from you, Dr. Herbener. Thanks for your time.
Dr. Jeffrey M. Herbener is chair of the department of economics at Grove City College and fellow for economic theory & policy with The Center for Vision & Values. Dr. Paul Kengor is professor of political science at Grove City College and executive director of the Center for Vision & Values.