Reliving the Crash of '29

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published in Inquiry, November 12, 1979

A half-century
ago, America — and then the world — was rocked by a mighty stock-market
crash that soon turned into the steepest and longest-lasting
depression of all time.

It was
not only the sharpness and depth of the depression that stunned
the world and changed the face of modern history: it was the
length, the chronic economic morass persisting throughout the
1930s, that caused intellectuals and the general public to despair
of the market economy and the capitalist system.

depressions, no matter how sharp, generally lasted no more than
a year or two. But now, for over a decade, poverty, unemployment,
and hopelessness led millions to seek some new economic system
that would cure the depression and avoid a repetition of it.

solutions and panaceas differed. For some it was Marxian socialism
— for others, one or another form of fascism. In the United
States the accepted solution was a Keynesian mixed-economy or
welfare–warfare state. Harvard was the focus of Keynesian economics
in the United States, and Seymour Harris, a prominent Keynesian
teaching there, titled one of his many books Saving
American Capitalism
. That title encapsulated the spirit
of the New Deal reformers of the ’30s and ’40s. By the massive
use of state power and government spending, capitalism was going
to be saved from the challenges of communism and fascism.

One common
guiding assumption characterized the Keynesians, socialists,
and fascists of the 1930s: that laissez-faire, free-market capitalism
had been the touchstone of the US economy during the 1920s,
and that this old-fashioned form of capitalism had manifestly
failed us by generating, or at least allowing, the most catastrophic
depression in history to strike at the United States and the
entire Western world.

Well, weren’t
the 1920s, with their burgeoning optimism, their speculation,
their enshrinement of big business in politics, their Republican
dominance, their individualism, their hedonistic cultural decadence,
weren’t these years indeed the heyday of laissez-faire? Certainly
the decade looked that way to most observers, and hence it was
natural that the free market should take the blame for the consequences
of unbridled capitalism in 1929 and after.

for the course of history, the common interpretation was dead
wrong: there was very little laissez-faire capitalism in the
1920s. Indeed the opposite was true: significant parts of the
economy were infused with proto–New Deal statism, a statism
that plunged us into the Great Depression and prolonged this
miasma for more than a decade.

In the
first place, everyone forgot that the Republicans had never
been the laissez-faire party. On the contrary, it was the Democrats
who had always championed free markets and minimal government,
while the Republicans had crusaded for a protective tariff that
would shield domestic industry from efficient competition, for
huge land grants and other subsidies to railroads, and for inflation
and cheap credit to stimulate purchasing power and apparent

It was
the Republicans who championed paternalistic big government
and the partnership of business and government while the Democrats
sought free trade and free competition, denounced the tariff
as the “mother of trusts,” and argued for the gold standard
and the separation of government and banking as the only way
to guard against inflation and the destruction of people’s savings.
At least that was the policy of the Democrats before Bryan and
Wilson at the start of the 20th century, when the party shifted
to a position not very far from its ancient Republican rivals.

The Republicans
never shifted, and their reign in the 1920s brought the federal
government to its greatest intensity of peacetime spending and
hiked the tariff to new, stratospheric levels. A minority of
old-fashioned “Cleveland” Democrats continued to hammer away
at Republican extravagance and big government during the Coolidge
and Hoover eras. Those included Governor Albert Ritchie of Maryland,
Senator James Reed of Missouri, and former Solicitor General
James M. Beck, who wrote two characteristic books in this era:
Vanishing Rights of the States
and Our
Wonderland of Bureaucracy

But most
important in terms of the depression was the new statism that
the Republicans, following on the Wilson administration, brought
to the vital but arcane field of money and banking. How many
Americans know or care anything about banking? Yet it was in
this neglected but crucial area that the seeds of 1929 were
sown and cultivated by the American government.

The United
States was the last major country to enjoy, or be saddled with,
a central bank. All the major European countries had adopted
central banks during the 18th and 19th centuries, which enabled
governments to control and dominate commercial banks, to bail
out banking firms whenever they got into trouble, and to inflate
money and credit in ways controlled and regulated by the government.
Only the United States, as a result of Democratic agitation
during the Jacksonian era, had had the courage to extend the
doctrine of classical liberalism to the banking system, thereby
separating government from money and banking.

deposed the central bank in the 1830s, the United States enjoyed
a freely competitive banking system — and hence a relatively
“hard” and noninflated money — until the Civil War. During that
catastrophe, the Republicans used their one-party dominance
to push through their interventionist economic program. It included
a protective tariff and land grants to railroads, as well as
inflationary paper money and a “national banking system” that
in effect crippled state-chartered banks and paved the way for
the later central bank.

The United
States adopted its central bank, the Federal Reserve System,
in 1913, backed by a consensus of Democrats and Republicans.
This virtual nationalization of the banking system was unopposed
by the big banks; in fact, Wall Street and the other large banks
had actively sought such a central system for many years. The
result was the cartelization of banking under federal control,
with the government standing ready to bail out banks in trouble,
and also ready to inflate money and credit to whatever extent
the banks felt was necessary.

a functioning Federal Reserve System available to inflate the
money supply, the United States could not have financed its
participation in World War I: that war was fueled by heavy government
deficits and by the creation of new money to pay for swollen
federal expenditures.

One point
is undisputed: the autocratic ruler of the Federal Reserve System,
from its inception in 1914 to his death in 1928, was Benjamin
Strong, a New York banker who had been named governor of the
Federal Reserve Bank of New York. Strong consistently and repeatedly
used his power to force an inflationary increase of money and
bank credit in the American economy, thereby driving prices
higher than they would have been and stimulating disastrous
booms in the stock and real-estate markets. In 1927, Strong
gaily told a French central banker that he was going to give
“a little coup de whiskey to the stock market.” What was the
point? Why did Strong pursue a policy that now can seem only
heedless, dangerous, and recklessly extravagant?

Once the
government has assumed absolute control of the money-creating
machinery in society, it benefits — as would any other group
— by using that power. Anyone would benefit, at least in the
short run, by printing or creating new money for his own use
or for the use of his economic or political allies.

had several motives for supporting an inflationary boom in the
1920s. One was to stimulate foreign loans and foreign exports.
The Republican party was committed to a policy of partnership
of government and industry, and to subsidizing domestic and
export firms. A protective tariff aided inefficient domestic
producers by keeping out foreign competition. But if foreigners
were shut out of our markets, how in the world were they going
to buy our exports? The Republican administration thought it
had solved this dilemma by stimulating American loans to foreigners
so that they could buy our products.

A fine
solution in the short run, but how were these loans to be kept
up, and, more important, how were they to be repaid? The banking
community was also confronted with the curious and ultimately
self-defeating policy of preventing foreigners from selling
us their products, and then lending them the money to keep buying
ours. Benjamin Strong’s inflationary policy meant repeated doses
of cheap credit to stimulate this foreign lending. It should
also be noted that this policy subsidized American investment
banks in making foreign loans.

the exports stimulated by cheap credit and foreign loans were
farm products. American agriculture, overstimulated by the swollen
demands of warring European nations during World War I, was
a chronically sick industry during the 1920s. It had awakened
after the resumption of peace to find that farm prices had fallen
and that European demand was down. Rather than adjusting to
postwar realities, however, American farmers preferred to organize
and agitate to force taxpayers and consumers to keep them in
the style to which they had become accustomed during the palmy
“parity” years of the war. One way for the federal government
to bow to this political pressure was to stimulate foreign loans
and hence to encourage foreign purchases of American farm products.

The “farm
bloc,” it should be noted, included not only farmers; more indirect
and considerably less rustic interests were also busily at work.
The postwar farm bloc gained strong support from George N. Peek
and General Hugh S. Johnson; both, later prominent in the New
Deal, were heads of the Moline Plow Company, a major manufacturer
of farm machinery that stood to benefit handsomely from government
subsidies to farmers. When Herbert Hoover, in one of his first
acts as president — considerably before the crash — established
the Federal Farm Board to raise farm prices, he installed as
head of the FFB Alexander Legge, chairman of International Harvester,
the nation’s leading producer of farm machinery. Such was the
Republican devotion to “laissez faire.”

But a more
indirect and ultimately more important motivation for Benjamin
Strong’s inflationary credit policies in the 1920s was his view
that it was vitally important to “help England,” even at American
expense. Thus, in the spring of 1928, his assistant noted Strong’s
displeasure at the American public’s outcry against the “speculative
excesses” of the stock market.

The public
didn’t realize, Strong thought, that “we were now paying the
penalty for the decision which was reached early in 1924 to
help the rest of the world back to a sound financial and monetary
basis.” An unexceptionable statement, provided that we clear
up some euphemisms. For the “decision” was taken by Strong in
camera, without the knowledge or participation of the American
people; the decision was to inflate money and credit, and it
was done not to help the “rest of the world” but to help sustain
Britain’s unsound and inflationary policies.

the World War, all the major nations were on the gold standard,
which meant that the various currencies — the dollar, pound,
mark, franc, etc. — were redeemable in fixed weights of gold.
This gold requirement ensured that governments were strictly
limited in the amount of scrip they could print and pour into
circulation, whether by spending to finance government deficits
or by lending to favored economic or political groups. Consequently,
inflation had been kept in check throughout the 19th century
when this system was in force.

But world
war ruptured all that, just as it destroyed so many other aspects
of the classical-liberal polity. The major warring powers spent
heavily on the war effort, creating new money in bushel baskets
to pay the expense. Inflation was consequently rampant during
and after World War I and, since there were far more pounds,
marks, and francs in circulation than could possibly be redeemed
in gold, the warring countries were forced to go off the gold
standard and to fall back on paper currencies — all, that is,
except for the United States, which was embroiled in the war
for a relatively short time and could therefore afford to remain
on the gold standard.

After the
war, the nations faced a world currency breakdown with rampant
inflation and chaotically falling exchange rates. What was to
be done? There was a general consensus on the need to go back
to gold, and thereby to eliminate inflation and frantically
fluctuating exchange rates. But how to go back? That is, what
should be the relations between gold and the various currencies?

Britain had been the world’s financial center for a century
before the war, and the British pound and the dollar had been
fixed all that time in terms of gold so that the pound would
always be worth $4.86. But during and after the war the pound
had been inflated relatively far more than the dollar, and thus
had fallen to about $3.50 on the foreign-exchange market. But
Britain was adamant about returning the pound, not to the realistic
level of $3.50, but rather to the old prewar par of $4.86.

Why the
stubborn insistence on going back to gold at the obsolete prewar
par? Part of the reason was a stubborn and mindless concentration
on saving face and British honor, on showing that the old lion
was just as strong and tough as before the war. Partly, it was
a shrewd realization by British bankers that if the pound were
devalued from prewar levels England would lose its financial
preeminence, perhaps to the United States, which had been able
to retain its gold status.

So, under
the spell of its bankers, England made the fateful decision
to go back to gold at $4.86. But this meant that Britain’s exports
were now made artificially expensive and its imports cheaper,
and since England lived by selling coal, textiles, and other
products, while importing food, the resulting chronic depression
in its export industries had serious consequences for the British
economy. Unemployment remained high in Britain, especially in
its export industries, throughout the boom of the 1920s.

To make
this leap backward to $4.86 viable, Britain would have had to
deflate its economy so as to bring about lower prices and wages
and make its exports once again inexpensive abroad. But it wasn’t
willing to deflate since that would have meant a bitter confrontation
with Britain’s now-powerful unions. Ever since the imposition
of an extensive unemployment-insurance system, wages in Britain
were no longer flexible downward as they had been before the
war. In fact, rather than deflate, the British government wanted
the freedom to keep inflating, in order to raise prices, do
an end run around union wage rates, and ensure cheap credit
for business.

The British
authorities had boxed themselves in: They insisted on several
axioms. One was to go back to gold at the old prewar par of
$4.86. This would have made deflation necessary, except that
a second axiom was that the British continue to pursue a cheap
credit, inflationary policy rather than deflation. How to square
the circle? What the British tried was political pressure and
arm-twisting on other countries, to try to induce or force them
to inflate too. If other countries would also inflate, the pound
would remain stable in relation to other currencies; Britain
would not keep losing gold to other nations, which endangered
its own jerry-built monetary structure.

On the
defeated and small new countries of Europe, Britain’s pressure
was notably successful. Using their dominance in the League
of Nations and especially in its Financial Committee, the British
forced country after country not only to return to gold, but
to do so at overvalued rates, thereby endangering those nations’
exports and stimulating imports from Britain. And the British
also flummoxed these countries into adopting a new form of gold
“exchange” standard, in which they kept their reserves not in
gold, as before, but in sterling balances in London.


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In this
way, the British could continue to inflate; and pounds, instead
of being redeemed in gold, were used by other countries as reserves
on which to pyramid their own paper inflation. The only stubborn
resistance to the new order came from France, which had a hard-money
policy into the late 1920s. It was French resistance to the
new British monetary order that was ultimately fatal to the
house of cards the British attempted to construct in the 1920s.

The United
States was a different situation altogether. Britain could not
coerce the United States into inflating in order to save the
misbegotten pound, but it could cajole and persuade. In particular,
it had a staunch ally in Benjamin Strong, who could always be
relied on to be a willing servitor of British interests. By
repeatedly agreeing to inflate the dollar at British urging,
Benjamin Strong won the plaudits of the British financial press
as the best friend of Great Britain since Ambassador Walter
Hines Page, who had played a key role in inducing the United
States to enter the war on the British side.

Why did
Strong do it? We know that he formed a close friendship with
British financial autocrat Montagu Norman, longtime head of
the Bank of England. Norman would make secret visits to the
United States, checking in at a Saratoga Springs resort under
an assumed name, and Strong would join him there for the weekend,
also incognito, there to agree on yet another inflationary coup
de whiskey to the market.

this Strong–Norman tie was crucial, but what was its basic nature?
Some writers have improbably speculated on a homosexual liaison
to explain the otherwise mysterious subservience of Strong to
Norman’s wishes. But there was another, and more concrete and
provable, tie that bound these two financial autocrats together.

That tie
involved the Morgan banking interests. Benjamin Strong had lived
his life in the Morgan ambit. Before being named head of the
Federal Reserve, Strong had risen to head of the Bankers Trust
Company, a creature of the Morgan bank. When asked to be head
of the Fed, he was persuaded to take the job by two of his best
friends, Henry P. Davison and Dwight Morrow, both partners of
J.P. Morgan & Co.

The Federal
Reserve System arrived at a good time for the Morgans. It was
needed to finance America’s participation in World War I, a
participation strongly supported by the Morgans, who played
a major role in bringing the Wilson administration into the
war. The Morgans, heavily invested in rail securities, had been
caught short by the boom in industrial stocks that emerged at
the turn of the century. Consequently, much of their position
in investment-banking was being eroded by Kuhn, Loeb & Co.,
which had been faster off the mark on investment in industrial

World War
I meant economic boom or collapse for the Morgans. The House
of Morgan was the fiscal agent for the Bank of England: it had
the underwriting concession for all sales of British and French
bonds in the United States during the war, and it helped finance
US arms and munitions sales to Britain and France. The House
of Morgan had a very heavy investment in an Anglo-French victory
and a German-Austrian defeat. Kuhn, Loeb, on the other hand,
was pro-German, and therefore was tied more to the fate of the
Central Powers.

The cement
binding Strong and Norman was the Morgan connection. Not only
was the House of Morgan intimately wrapped up in British finance,
but Norman himself — as well as his grandfather — in earlier
days had worked in New York for the powerful investment-banking
firm of Brown Brothers, and hence had developed close personal
ties with the New York banking community. For Benjamin Strong,
helping Britain meant helping the House of Morgan to shore up
the internally contradictory monetary structure it had constructed
for the postwar world.

The result
was inflationary credit, a speculative boom that could not last,
and the Great Crash whose 50th anniversary we observe this year.
After Strong’s death in late 1928, the new Federal Reserve authorities,
while confused on many issues, were no longer consistent servitors
of Britain and the Morgans. The deliberate and consistent policy
of inflation came to an end, and a corrective depression soon

There are
two mysteries about the Great Depression, mysteries having two
separate and distinct solutions. One is, why the crash? Why
the sudden crash and depression in the midst of boom and seemingly
permanent prosperity? We have seen the answer: inflationary
credit expansion propelled by the Federal Reserve System in
the service of various motives, including helping Britain and
the House of Morgan.

But there
is another vital and very different problem. Given the crash,
why did the recovery take so long? Usually, when a crash or
financial panic strikes, the economic and financial depression,
be it slight or severe, is over in a few months or a year or
two at the most. After that, economic recovery will have arrived.
The crucial difference between earlier depressions and that
of 1929 was that the 1929 crash became chronic and seemed permanent.

What is
seldom realized is that depressions, despite their evident hardship
on so many, perform an important corrective function. They serve
to eliminate the distortions introduced into the economy by
an inflationary boom. When the boom is over, the many distortions
that have entered the system become clear: prices and wage rates
have been driven too high, and much unsound investment has taken
place, particularly in capital-goods industries.

The recession
or depression serves to lower the swollen prices and to liquidate
the unsound and uneconomic investments; it directs resources
into those areas and industries that will most-effectively serve
consumer demands — and were not allowed to do so during the
artificial boom. Workers previously misdirected into uneconomic
production, unstable at best, will, as the economy corrects
itself, end up in more secure and productive employment.

The recession
must be allowed to perform its work of liquidation and restoration
as quickly as possible, so that the economy can be allowed to
recover from boom and depression and get back to a healthy footing.
Before 1929, this hands-off policy was precisely what all US
governments had followed, and hence depressions, however sharp,
would disappear after a year or so.

But when
the Great Crash hit, America had recently elected a new kind
of president. Until the past decade, historians have regarded
Herbert Clark Hoover as the last of the laissez-faire presidents.
Instead, he was the first New Dealer.

had his bipartisan aura, and was devoted to corporatist cartelization
under the aegis of big government; indeed, he originated the
New Deal farm-price-support program. His New Deal specifically
centered on his program for fighting depressions. Before he
assumed office, Hoover determined that should a depression strike
during his term of office, he would use the massive powers of
the federal government to combat it. No more would the government,
as in the past, pursue a hands-off policy.

As Hoover
himself recalled the crash and its aftermath,

primary question at once arose as to whether the President
and the federal government should undertake to investigate
and remedy the evils…. No President before had ever believed
that there was a governmental responsibility in such cases….
Presidents steadfastly had maintained that the federal government
was apart from such eruptions … therefore, we had to pioneer
a new field.

In his
acceptance speech for the presidential renomination in 1932,
Herbert Hoover summed it up:

might have done nothing…. Instead, we met the situation
with proposals to private business and to Congress of the
most gigantic program of economic defense and counterattack
ever evolved in the history of the Republic. We put it into
action…. No government in Washington has hitherto considered
that it held so broad a responsibility for leadership in
such times.

The massive
Hoover program was, indeed, a characteristically New Deal one:
vigorous action to keep up wage rates and prices, to expand
public works and government deficits, to lend money to failing
businesses to try to keep them afloat, and to inflate the supply
of money and credit to try to stimulate purchasing power and
recovery. Herbert Hoover during the 1920s had pioneered the
proto-Keynesian idea that high wages are necessary to assure
sufficient purchasing power and a healthy economy. The notion
led him to artificially raising wages — and consequently to
aggravating the unemployment problem — during the depression.

As soon
as the stock market crashed, Hoover called in all the leading
industrialists in the country for a series of White House conferences
in which he successfully bludgeoned the industrialists, under
the threat of coercive government action, into propping up wage
rates — and hence causing massive unemployment — while prices
were falling sharply. After Hoover’s term, Franklin D. Roosevelt
simply continued and expanded Hoover’s policies across the board,
adding considerably more coercion along the way. Between them,
the two New Deal presidents managed the unprecedented feat of
making the depression last a decade, until we were lifted out
of it by our entry into World War II.

If Benjamin
Strong got us into a depression and Herbert Hoover and Franklin
D. Roosevelt kept us in it, what was the role in all this of
the nation’s economists, watchdogs of our economic health? Unsurprisingly,
most economists, during the depression and ever since, have
been much more part of the problem than of the solution. During
the 1920s, establishment economists, led by Professor Irving
Fisher of Yale, hailed the 20s as the start of a “New Era,”
one in which the new Federal Reserve System would ensure permanently
stable prices, avoiding either booms or busts.

the Fisherites, in their quest for stability, failed to realize
that the trend of the free and unhampered market is always toward
lower prices as productivity rises and mass markets develop
for particular products. Keeping the price level stable in an
era of rising productivity, as in the 1920s, requires a massive
artificial expansion of money and credit. Focusing only on wholesale
prices, Strong and the economists of the 1920s were willing
to engender artificial booms in real estate and stocks, as well
as malinvestments in capital goods, so long as the wholesale
price level remained constant.

As a result,
Irving Fisher and the leading economists of the 1920s failed
to recognize that a dangerous inflationary boom was taking place.
When the crash came, Fisher and his disciples of the Chicago
School again pinned the blame on the wrong culprit. Instead
of realizing that the depression process should be left alone
to work itself out as rapidly as possible, Fisher and his colleagues
laid the blame on the deflation after the crash and demanded
a reinflation (or “reflation”) back to 1929 levels.

In this
way, even before Keynes, the leading economists of the day managed
to miss the problem of inflation and cheap credit and to demand
policies that only prolonged the depression and made it worse.
After all, Keynesianism did not spring forth full-blown with
the publication of Keynes’s General
in 1936.

We are
still pursuing the policies of the 1920s that led to eventual
disaster. The Federal Reserve is still inflating the money supply
and inflates it even further with the merest hint that a recession
is in the offing. The Fed is still trying to fuel a perpetual
boom while avoiding a correction on the one hand or a great
deal of inflation on the other.

In a sense,
things have gotten worse. For while the hard-money economists
of the 1920s and 1930s wished to retain and tighten up the gold
standard, the “hard-money” monetarists of today scorn gold,
are happy to rely on paper currency, and feel that they are
boldly courageous for proposing not to stop the inflation of
money altogether, but to limit the expansion to a supposedly
fixed amount.

Those who
ignore the lessons of history are doomed to repeat it — except
that now, with gold abandoned and each nation able to print
currency ad lib, we are likely to wind up, not with a repeat
of 1929, but with something far worse: the holocaust of runaway
inflation that ravaged Germany in 1923 and many other countries
during World War II. To avoid such a catastrophe we must have
the resolve and the will to cease the inflationary expansion
of credit, and to force the Federal Reserve System to stop purchasing
assets, and thereby to stop its continued generation of chronic,
accelerating inflation.

This appeared

N. Rothbard
(1926–1995) dean of the Austrian School
and the founder of modern libertarianism – was the
author of Man,
Economy, and State
, Conceived
in Liberty
, What
Has Government Done to Our Money
, For
a New Liberty
, and many other books and articles.
He was editor — with Lew Rockwell — of The
Rothbard-Rockwell Report
, and appointed Lew his literary

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