Diary

Great Depression - why our policies didn't work

This is going to be a light overview of the Great Depression and why we managed that situation poorly.  As a heads up though, nobody else managed it well either (nor could they).

I have lost count of the number of times people have said the world is changing faster today than ever before.  But that really isn’t true.  Let’s take a few examples – if today you want to visit Europe you get on a plane, fly across the Atlantic, spend a week and then fly back.  Fifty years ago you would have done the exact same thing.  Fifty years before that you would have had to take an ocean liner.  If you want to talk to someone in China you pick up a phone and dial (or Skype).  Fifty years ago you did the same thing (except no video component), fifty years before that you wrote a letter.  If you want to visit your grandparents who live out on a farm you get in a car and drive there.  Fifty years ago you did the same thing, fifty years before that you probably had to get on a horse at some point.  Infact, 100 years ago over half our population lived in rural areas.  These are not small towns that we think of as rural now, they are what was considered rural in 1920.  Half the country lived on farms, ranches, or homesteads.  The primary fuel in the United States was coal, the secondary fuel was wood that you chop yourself.

So then – on to the great depression…

In the 1920’s the US turned its wartime industry to domestic use.  The engines that had been designed and built for tanks were re-purposed for tractors.  We built cars, roads, planes, airports, telephones, electric companies, new textile mills, and more.  The economy roared along as we mechanized and electrified everything we could and built products faster, better, and cheaper.  Farmers could now buy tractors that could do the work of 10 men.  The only problem was that these tractors were expensive, but they boosted productivity and brought the price of food down so much that seasonal starvation began to disappear.  In fact, if you wanted to compete in the farming industry the only way you could keep up was to buy one of those tractors.  Before this time farmers would save money from one season to the next so that when they had bust years they could weather through.  However, tractors were too expensive for the farmers savings to cover the cost.  Luckily banks had new abilities to offer you a loan and then sell that loan back to investors in the east.  But then tractors were improved and the only way to keep up was to take out a new loan and upgrade your equipment.

When you have a population that is malnourished (all of the world up until the 1920’s) you can sell the same people more food.  However, once the people are well fed you will only sell more food if there are more people.  By the time the stock market crashed there was already enough food for everyone in the US, and farms were making more than people wanted to eat.  On top of that, since cars were now ubiquitous farms no longer needed to grow feed for horses.  This is where “creative destruction” plays in.  The only way to clear the excess is for some of your farms to go bankrupt.  The reality is that there was a lot of overcapacity, and so a lot of farms had to close.  Honestly I think the standard story of the crash has the causal chain backwards, we typically think that the stock market crashing caused the foreclosure crisis and farms to close.  I think it is more likely that investors realized that their loans could not be paid back with grain prices falling and so companies involved in loans to farms (i.e. banks) had their risks exposed.  Either way, many people had to leave farms.  So where do they go?  Rural life is closed to new applicants, so they make their way to cities.  What are cities building?  Well, they aren’t building stuff to sell to farmers (at least not as much as they used to), so you aren’t going to work building tractors or farm supplies.  The textile mills are already full, and so are the other plants.  So what you do is you bid down the price for labor.  When 30% of your nations jobs disappear due to new equipment you are in a bit of a pickle.  New jobs will come, but nothing you do will bring them around in 1 or 2 years.

As a nation we chose price controls and pretend jobs, that is jobs that created little or no value.  Since we did not allow the new urban workers to bid down the price of labor we effectively shut them out of the labor market and tied them up in government jobs.  Since that time we have seen a trade-off between inflation and employment.  The thing is tractors were not an American problem, the same dynamic played out in Europe as well.  Germany chose to print money and has ever since been afraid of inflation.  Russia chose the worst solution of all – kill the excess farmers.  The thing is, there was no good solution to the problem. If you let the market run its course you cut your living standard dramatically by crushing all the upward pressure there had been on labor costs since Henry Ford started his first assembly line.  If you try to make sure everyone has money to buy food you run into hyperinflation.  If you try to protect income with price floors you get massive overproduction and the government buying the excess.  If you add production limits to the price floors you lock in massive unemployment.  We addressed that unemployment by providing government projects paid for with borrowed money, so we chose some unemployment and a lot of debt.  The thing is, until the number of jobs expands by 30% you will not solve the problem (ignoring of course the Soviet’s solution, France avoided the worst of the Depression largely because they had lost so many in WWI).

Why do I bring all this up?  Today’s tariff discussions largely hinge on our interpretation of Smoot-Hawley in 1930.  The Depression was in full swing, mass migrations were beginning, banks were failing, and demand was collapsing globally.  If you lower tariffs the dislocated farmers in Germany, France, and Britain  will conspire to sell their products for even less.  You can raise tariffs and now your export economy is harmed if your trade partners raise their tariffs (which had already begun before Smoot-Hawley).  Again, there is no good move here, you are not going to fix the problem until the number of non-farm jobs increases by at least 30% (plus population growth over the time to generate the jobs).  Trying to evaluate Smoot-Hawley as a measure of what Tariffs should be expected to accomplish would be a lot like trying to use the Communications Act of 1934 to regulate ISPs today.  There are so many differences that the whole case is irrelevant.