Business & Society
March 30, 2009
Lessons from the Great Depression
The Great Crash of October 1929 was precipitated by a speculative fever in the stock
market. The crash in the stock market, however, does not fully explain why the U.S.
economy fell into the great depression of the decade of the 1930s. In his best seller entitled
The Great Crash, the late John Galbraith explained the major causes of the Great Depression
which left 25 percent of the American labor force unemployed.
The main point Galbraith raises is that the U.S. economy was fundamentally unsound
in 1929. According to him, five weaknesses seem to have had an especially intimate bearing
on the ensuing disaster. They were:
1) The bad distribution of income. In 1929, the rich were astoundingly rich. It was
estimated that the 5 per cent of the population with the highest incomes in that year received
approximately one third of all personal income. In 1929, therefore, the U.S. had much of the
characteristics of a Third World country today. The highly unequal income distribution
meant that the economy was overly dependent on a high level of investment or a high level of
luxury consumer spending or both. This high-bracket spending and investment were
especially susceptible to the crushing news from the stock market in October of 1929.
2) The bad corporate structure. American enterprise in the 1920s had opened its
hospitable arms to an exceptional number of promoters, grafters, swindlers, impostors, and
frauds. There was a veritable flood tide of corporate larceny. The most important corporate
weakness was inherent in the vast new structure of holding companies and investment trusts.
The holding companies controlled large segments of the utility, railroad, and entertainment
business. Here, as with the investment trusts, was the constant danger of devastation by
reverse leverage. The corporate system was very susceptible to continue and accentuate a
3. The bad banking structure. There were too many independent small banks. When
one bank failed, the assets of others were frozen while depositors elsewhere had a pregnant
warning to go and ask for their money. Thus one failure led to other failures, and these
spread with a domino effect. When income, employment and values fell as the result of a
depression, bank failures quickly became epidemic. This happened after 1929. The weak
destroyed not only the other weak, but weakened the strong.
4. The dubious state of the foreign balance. The favorable balance of trade prevailing
in the 1920s was artificial. When the crash came in 1929, countries could not cover their
adverse trade balance with the United Sates with increased payments of gold, at least not for
long. This meant that they had either to increase their exports to the U.S. or reduce their
imports or default on their past loans. President Hoover and Congress moved promptly to
eliminate the first possibility--that the accounts would be balanced by larger imports--by
sharply increasing the tariff. Accordingly, debts, including war debts, went into default and
there was a precipitate fall in American exports.
5. The poor state of economic intelligence. Instead of going into pump priming, the
Hoover Administration committed itself to a balanced budget. It then meant there could be
no increase in government outlays to expand purchasing power and relieve distress. It meant
that there could be no further tax reduction. There was also a great fear of inflation. This
fear reinforced the demand for a balanced budget. The rejection of both fiscal (tax and
expenditure) and monetary policy amounted precisely to a rejection of all affirmative
government economic policy. The economic advisers of the day had both the unanimity and
the authority to force the leaders of both parties to disavow all the available steps to check
deflation and depression.
From the above, I conclude that another Great Depression is highly improbable today
because the conditions in 2008--the year when the ongoing recession started--were quite
different from those described above by Mr. Galbraith. First of all, it was not a speculative
fever in the stock market that caused the crash. It was the subprime crisis, which is
equivalent to a speculative fever in real estate fueled by easy credit. Because income in the
U.S. is now more evenly distributed among the population, the massive pump priming that is
planned by Obama Administration has a high probability of leading to a quicker recovery in
the real estate market. This is especially true because a significant amount of the pump
priming is going to be targeted towards low-income and middle-income homebuyers.
Although the present version of capitalism in the United States has had its own version
of swindlers, impostors and frauds, these wrongdoers are the exception rather than the rule.
Also, thanks to the quick action of the Bush Administration, there has been no danger of the
collapse of the banking system. With the timely infusion of capital into the large banks, there
has been no panic of depositors which characterized the 1929 Crash. The U.S. economy has
been incurring huge trade deficits for some time now and there is no danger of a precipitate
fall of American exports. It is even possible that as the U.S. dollar depreciates for the rest of
2009, there may be a recovery in the U.S. balance of trade. Finally, it is quite clear that the
Obama Administration will do everything possible to check deflation and depression.
Although U.S. economist Paul Krugman opines that President Obama may not be doing
enough and should spend more than $ 1 trillion to pump prime the U.S. economy, I think
Krugman is giving short shrift to the very dynamic entrepreneurial population and the
demographic dividend that the U.S. is still enjoying. There is also the possibility that
President Obama will up the ante by spending more in the pump priming exercise.
Furthermore, I expect the multiplier effects of even the limited amount currently programmed
by the Obama Administration to be great enough to help the economy to recover by 2010.
It is important that countries like the Philippines do not dwell on the worst-case
scenario of another Great Depression happening. The ongoing global recession is bad
enough to keep us on our toes in looking for all the opportunities that still exist in both our
domestic market and in the world markets. Worrying unnecessarily about the prospects of a
Great Depression may just distract us from all the positive measures that we should
implement to get our economy growing again at 6 to 7 percent by 2010. For comments, my
email address is firstname.lastname@example.org.