Prolong the Depression it did — but it never replaced the Federal Reserve and its monetary policy as the main culprit.
Seventy-six years ago in the depths of the Great Depression, FDR launched its intended solution, the New Deal. If, as it now seems, the current financial crisis’s closest counterpart is the Great Depression, it is paramount we understand both it and its intended solution. In contrast to conventional wisdom, the Depression’s cause — not its cure — came from the government and the New Deal did less than both its supporters and critics claim.
The stock market’s crash on October 29, 1929, did not immediately trigger its larger economic effects. However, within a year they were well underway and produced huge Republican losses in Congress — compounded again in 1932 with the loss of the presidency. Franklin Roosevelt’s response to the Depression was the New Deal, an unprecedented peacetime governmental response to the spiraling economy.
Popularly remembered as massive government intervention, government spending did not surge as many believe. Certainly federal spending increased — 40% from 1932 to 1934 — but it had already surged 49% from 1929 to 1932, prior to FDR even taking office. From 1934 to 1940, it increased another 44%, hardly dramatic given previous increases. The larger and overlooked surge in government spending actually occurred around World War I: from 1916-1928, government spending increased four-fold; from 1929-1940, it tripled.
On the receipt side, revenues fell, as is standard during economic downturns. However, by 1933, revenues had begun to grow again. By 1936, federal revenues exceeded their 1929 level — fully four years before the economy did likewise.
For these reasons, the federal deficit did not exhibit an inexorable growth. It was actually rather stable. The budget swung into deficit in 1931 by $462 million. By 1932, it was $2.7 billion in the red, but again this was before FDR even took office. By 1940, after eight years of Roosevelt, the deficit was $2.9 billion.
The New Deal’s economic results are far more contrarian than its fiscal impact. America began 1929 with a GDP of $103.6 billion. Yet for all the New Deal hoopla, when 1940 began — the final year of FDR’s second term — GDP stood at just $101.4 billion — still below its level of eleven years earlier.
Why is the breakpoint of 1940 chosen for all these comparisons? Not because it was the year in which FDR would seek an unprecedented third term. It was the year prior to what really ended the Great Depression: WWII’s massive military build-up.
Beginning with 1941’s Lend-Lease program to arm the Allies, American military spending exploded. From 1940 to 1941, U.S. military spending grew from $2.2 billion to $6.4 billion. With America’s direct involvement in 1942, it rose to $25.7 billion — roughly double the previous year’s entire federal budget ($13.7 billion). By 1945, federal spending was $92.7 billion — higher than GDP ($92.2 billion) when 1939 began!
As the economy grew — and even more importantly, enlistments — unemployment fell dramatically. In 1940, America had 533,000 military personnel. That grew to an annual average of 1.6 million in 1941, 4 million in 1942, 8.9 million in 1943, 11.4 million in 1944, and 11.6 million in 1945 (11% of the US population). Unemployment fell apace: 4.7% in 1942, 1.9% in 1943, and 1.2% in 1944.
While it was war, not government, that solved the Depression, it was government — in the form of the Federal Reserve and its mishandling of the money supply — that caused it. We have known this, though many still refuse to accept it, since Nobel laureate economist Milton Friedman wrote A Monetary History of the United States, 1867-1960 in 1963. Friedman dispatched the prevailing Keynesian mindset and showed monetary policy, not fiscal policy, was the dominant economic determinant.
As biographer Lanny Ebenstein writes, Friedman showed the Federal Reserve decreased America’s money supply during the post-Crash years. These “unprecedented annual consecutive declines…constituted the Great Contraction and were the primary source…” of the Great Depression.
What do the numbers add up to? First, they give us better perspective on the two financial crises. The current financial crisis is not the Great Depression. Even with unemployment now 8.5%, it is still just over half the lowest point attained for any year during FDR’s pre-WWII administration. The current economy has experienced just three consecutive quarters of negative GDP growth; from January 1, 1929 to January 1, 1933, it shrunk for four consecutive years and did not regain its 1929 level for eleven years.
Second, it shows that the New Deal of rhetoric was not the New Deal of reality. The New Deal’s real contribution was as a precedent for government involvement in a peacetime economy. While it did not end the Depression it laid the foundation for the massive federal entitlement edifice now threatening the federal budget and, ironically, the economy the New Deal is popularly claimed to save.
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H/T to National Review Online