Checks and Balances: Economic protections from another Great Depression
Edina High School
It has generally been the fate of economic theory to run a losing
race against the course of history, and never to have completed the analysis
of one phase of economic development before another takes its place.1
Joan Robinson's words offer insight into major historic economic events.
While the Great Depression will live on in American history, its comprehensive
analysis appears to be far from complete. Bread lines stretching for miles,
families living in cars, school children wearing ragged clothes—these
images need no macro-economic review to be understood; however, the causes
of the Great Depression and whether such destructive economic conditions
could exist again are much more complicated questions. Ultimately, developments
in monetary policy and economic structure, changes in international trade
and globalization, and reform of economic policy and laws will prevent
another Great Depression.
Unlike the Federal Reserve Board of the Depression era that not only
failed to limit the skyrocketing inflation of the Roaring Twenties but
also blundered passively through the rapid deflation of the Great Depression,
today's FRB anticipates changes in price levels and stock market
bubbles. As the 1920s stock market ballooned due to margin purchases,
the FRB should have expected its eventual crash. Its failure to increase
interest rates and halt such "irrational exuberance," along with inflation
of over 60 percent from 1920-1929, allowed unchecked growth that could
not be supported or maintained.2
Moreover, during the Great Depression, savers converted their checkable
deposits to currency during "bank runs," forcing banks to call loans from
customers who had expected large gains in the stock market. However, given
the monetary losses in the desolate market, many of these investors went
bankrupt and were unable to pay: 9,000 banks had no option but to close.
The FRB's failure to decrease interest rates and expand the money supply
discouraged investment and consumer spending, allowing the downward spiral
to go unchecked. Today, however, the FRB uses economic indicators to detect
price level changes and acts against stock market bubbles in advance.
The economic structure today is fundamentally stronger than that of
the '20s and '30s because of its well-organized labor force. A large initial
impact of the Depression was massive layoffs and wage cuts by employers.
However, today's labor unions are a powerful political force that will
not permit labor to be used as a cushion for national disaster as it was
in 1929. This resistance to "wholesale firing of production workers" and
wage cuts that proved to be one of the most significant blows to the 1929
economy will provide a necessary support to the modern economy that simply
did not exist in pre-Depression times.3
Policymakers of the Great Depression also attempted to solve a 25 percent
increase in unemployment,4
six point decline in consumer spending,5
and 30 percent reduction in farm prices6
through protectionist trade policies that magnified economic difficulties—a
situation impossible to replicate today. Although 1,000 economists from
179 different institutions criticized the Smoot-Hawley Act in 1930 as
an economic "injur[y] [to] the vast majority of our citizens," Herbert
Hoover approved this infamous tariff, which increased ad valorem
rates to over 40 percent and imposed a 100 percent tax on imported raw
materials.7 This "last
will and testament of the New Era's every man for himself ethic" deepened
the Depression by shifting the aggregate supply curve to the left,8
and furthered the recessionary gap, unemployment and a decline in real
GDP.9 With passage
of the tariff, the United States entered into a trade war with Canada,
Britain, Switzerland, France, Austria and 20 others.10
The trade war furthered the decline in U.S. exports and hindered growth
in real GDP and aggregate demand, forcing net exports from $1.5 billion
to 1905 levels of $253 million.11
Smoot-Hawley destroyed international trade and prevented the international
economy from helping to solve the Depression. Today, however, similar
protective tariffs [would] never exist. The North American Free Trade
Agreement and the General Agreement on Tariffs and Trade both limit U.S.
international tariffs, while institutions like the World Trade Organization
promote free trade. Because of economic globalization, the disheartening
Depression-era levels of international trade and domestic investment are
unlikely to reappear within the United States.12
Perhaps the most significant outcome of the Great Depression is the
economic legislation that was passed; laws regulating the stock market
and banks, and policies providing economic stimulation have effectively
destroyed chances of another Depression in America. Black Thursday, Oct,
24, 1929, was one of the darkest days of American history. Without regulation,
individuals had invested their life savings in stocks bought on margin
that lost the majority of their value, leaving many bankrupt. However,
the Securities Act of 1933, Securities Exchange Act of 1934 and several
technological improvements should prevent a recurrence. These acts reinvigorated
investor confidence in the market while providing necessary regulation
and oversight by requiring disclosure on new security issues, prohibiting
insider trading and manipulation, and providing FRB authority to fix margin
The Securities and Exchange Commission was established to enforce these
acts along with fairness in investment.14 The SEC has been crucial in deterring corruption and manipulation in the
securities market. Reforms also included the institution of circuit breakers
to suspend trading when declines occurred too rapidly and the implementation
of automatic stabilizers for the stock market. These technological additions
should secure market stability and prevent a stock market crash, thereby
mitigating the chance of another Depression.
New Deal remedies also included reform of the banking system to guarantee
a steady supply of money and prevent unforeseen runs on banks. The Emergency
Banking Act established new requirements for banks before lending money,
expanded governmental authority over savings and loans, and provided for
management of failed banks through the Reconstruction Finance Corp. The
Banking Act of 1933 extended this precedent by establishing the Federal
Deposit Insurance Corp. to insure all deposits up to $5,000.15 The Glass-Steagall Act was also passed to separate commercial and investment
banking, thus limiting speculation by banks.16 These acts helped regulate hasty investment, loans and withdrawals while
rejuvenating public confidence in the banking system. Perhaps most significant
of the banking reforms was the abrogation of the gold standard in favor
of a fiat currency.17 This allowed investor confidence to determine the value of the dollar
and provided flexibility in the expansion and contraction of the money
supply. Such freedom in currency is critical to modern economic stability.
Because of the fiscal policies used to stimulate the economy and because
of the adoption of a Keynesian perspective for governmental action during
recessions, another Great Depression is unlikely. During the Depression,
various organizations like the Agricultural Adjustment Agency, Tennessee
Valley Authority and Civilian Conservation Corps helped to stimulate growth.
While some reforms like the AAA focused on containing supply to equalize
quantity demanded and quantity supplied, others focused on increasing
government deficit spending to create demand for goods and services. The
cyclical nature of spending transformed relatively minimal government
stimuli into substantial increases in real GDP, income and growth. Ultimately,
large increases in deficit spending as part of preparation for World War
II brought the country out of Depression. Today, such stimulating policies
exist in many forms—President Bush's tax cut proposal is the most
recent example of how modern economic systems stimulate their economies
before negative growth sets in. Timely policy actions stave off economic
declines and increase consumer spending before problems even arise, nipping
them in the bud.
Despite the Depression's destructive toll on society, the educational
and political benefits from this event are unquantifiable. Any economic
system is susceptible to the macro business cycle; however, knowledgeable
monetary policy, well-managed international trade and prudent economic
reforms can ensure stability. Some financial analysts argue that the "New
Economy"' will inevitably be "infected" with the virus of economic depression;
nevertheless, given current economic policy, the United States appears
to be prepared and vaccinated. The Great Depression is an unforgettable
historical lesson that has shaped our society and its response to financial
problems. As T.S. Eliot once said, "The historical sense involves a perception,
not only of the pastness of the past, but of its presence."18
1. Bernstein, 21
2. Blum, 578
3. Rublowsky, 169
4. McConnell, 167
5. Goldston, 37
6. Goldston, 51
7. McElvaine, 83-84
8. The leftward shift in the
aggregate supply curve was due to the drastic increase in the price of
9. McElvaine, 83-84
10. Warren, 94
11. Warren, 96
12. Friedman, ii-iii, 4-5
13. Galbraith, 171
14. Werstein, 179
15. Boyer, 816
16. Blum, 625
17. Blum, 624
18. Bernstein, 207
Bernstein, Michael A. The Great Depression: Delayed Recovery and
Economic Change in America, 1929-1939.Cambridge: Cambridge University
Blum, John et al. The National Experience: A History of the United
States. San Diego: Harcourt Brace Jovanovich, 1989.
Boyer, Paul S. et al. The Enduring Vision: A History of the American
People. Lexington: D.C. Heath and Company, 1996.
Cole, Harold E. and Lee E. Ohanian. "The Great Depression From a Neoclassical Perspective." Quarterly
Review. Vol.23, No.1. Federal Reserve Bank of Minneapolis, Winter
Fettig, David. "Something Unanticipated Happened: Telling some 'neo' stories about the Great Depressions of the 1930s."The Region. Federal
Reserve Bank of Minneapolis, December 2000.
Friedman, Thomas. The Lexus and the Olive Tree. New York:
Farrar Straus & Giroux, 2000.
Galbraith, John K. The Great Crash. Boston: Houghton Mifflin
Goldston, Robert. The Great Depression. Indianapolis: The
Bobbs-Merrill Co., Inc., 1968.
McConnell, Campbell R. and Stanley L. Brue. Economics: Principles,
Problems, and Policies. New York: McGraw-Hill, Inc., 1996.
McElvaine, Robert S. The Great Depression: America, 1929-1941.
New York: Times Books, 1961.
Prescott, Edward C. "Some Observations on the Great Depression." Quarterly Review. Vol. 23,
No.1. Federal Reserve Bank of Minneapolis, Winter 1999.
Rublowsky, John. After the Crash: America in the Great Depression.
Toronto: Crowell-Collier Press, 1970.
Schwartz, Jordan A. The Interregnum of Despair: Hoover, Congress,
and the Depression. Urbana: University of Illinois Press, 1970.
Warren, Harris G. Herbert Hoover and the Great Depression.
Oxford: Norton Publishing Co., 1976.
Werstein, Irving. A Nation Fights Back: The Depression and its
Aftermath. New York: Julian Messner, 1969.