THE GREAT EXPERIMENT — A THREE-PART HISTORYThe Great Depression: PART I OF III

THE GREAT EXPERIMENT — A THREE-PART HISTORY

PART I OF IIIThe Great Depression: When the Great Experiment Was Put to the Test

How America Entered the Worst Economic Crisis in Its History

There are moments in American history when the country is tested.

Not by an election.

Not by a political argument.

But by reality.

The Great Depression was one of those moments.

Beginning in 1929, the United States entered the deepest and longest economic downturn in its history. The crisis lasted more than a decade, spread across the industrialized world, and transformed American economic and political life.

Businesses failed.

Banks failed.

Factories closed.

Farmers lost farms.

Families lost homes and savings.

Millions of Americans lost their jobs.

By 1933, unemployment had reached roughly 25 percent, while total U.S. economic output had fallen by about 30 percent.

But the Great Depression was more than a collection of terrible economic statistics.

It was a test of American institutions.

It was a test of financial systems.

It was a test of government.

And it was a test of the American people.

To understand what happened, we have to start before the crash.

America Before the Depression

The United States entered the 1920s as an increasingly industrial and modern economy.

The automobile was transforming transportation.

Electricity was spreading.

Factories were becoming more productive.

Consumer goods were becoming more widely available.

American industry was expanding, and the decade became associated with economic growth and rising consumer prosperity.

But economic growth does not mean every part of an economy is healthy.

There were weaknesses beneath the prosperity.

Agriculture was already struggling in important parts of the country.

Farm prices had fallen sharply after World War I.

Many farmers had borrowed during the war-era boom and then found themselves dealing with lower prices and heavy debts.

The financial system also contained vulnerabilities.

The Federal Reserve itself was still relatively young, having been created in 1913.

And policymakers were confronting a problem they had never faced on this scale before:

How do you manage a modern economy that is growing rapidly while financial speculation is increasing?

There was no easy answer.

The Stock Market Boom

During the 1920s, stock ownership expanded and stock prices rose dramatically.

Investors became increasingly optimistic.

Some purchased stocks with borrowed money, a practice known as buying on margin.

That meant an investor could control a larger amount of stock with less money of their own.

When prices rose, the strategy could produce large gains.

But when prices fell, the same leverage could produce devastating losses.

The Federal Reserve became increasingly concerned about speculation in financial markets.

In 1928 and 1929, the Federal Reserve raised interest rates and tightened monetary conditions partly in an effort to restrain speculation. According to the Federal Reserve's historical account, those actions also slowed economic activity.

The economy was already becoming more fragile.

Then the stock market broke.

October 1929

In October 1929, confidence collapsed.

Stock prices fell rapidly.

The famous Wall Street crash unfolded over several days, with particularly severe declines on October 24, October 28, and October 29.

The images became part of American history:

Crowds gathered around ticker machines.

Investors desperately tried to sell.

Newspapers announced enormous losses.

Fortunes disappeared.

Fear spread.

But there is an important historical distinction:

The stock-market crash did not, by itself, cause the entire Great Depression.

The American economy had suffered financial crashes before.

The crash was the beginning of something much larger.

What followed turned a serious downturn into an unprecedented economic catastrophe.

The Economy Starts to Contract

Economic activity in the United States peaked in the summer of 1929.

After that, production began falling.

Businesses reduced investment.

Consumers became more cautious.

Industrial production weakened.

Unemployment began rising.

At first, however, there was reason to believe that the downturn might eventually resemble previous American recessions.

Previous contractions had eventually ended.

The expectation was that this one would too.

And then something happened that changed the course of the crisis.

The banks began to fail.

When the Banks Began to Fall

A bank depends on trust.

People deposit their money because they believe the bank will be there when they need it.

But imagine hearing that your bank might fail.

You don't know whether your neighbor's money is safe.

You don't know whether your paycheck will clear.

You don't know whether your savings will still be there tomorrow.

So you go to the bank.

And you withdraw your money.

Then your neighbor does the same.

And the person across town does the same.

That is a bank run.

If enough people do it at once, even a bank with significant assets can face an immediate liquidity crisis.

And once people see one bank fail, they may begin to fear that another bank will fail.

Fear spreads.

In late 1930, a series of banking crises turned what had appeared to be a serious recession into the beginning of the Great Depression.

This was a critical turning point.

The Banking Panics

The first major wave of banking panics began in late 1930.

Bank failures disrupted credit.

Businesses had greater difficulty borrowing.

Depositors began hoarding cash.

Banks became more cautious about lending.

The amount of money circulating through the economy contracted.

The crisis spread.

Another major banking crisis struck Chicago in 1931.

Then the financial crisis became increasingly national.

In September 1931, Great Britain abandoned the gold standard.

Investors became concerned about the stability of the dollar and began converting dollar assets into gold.

At the same time, American depositors were withdrawing money from banks.

These pressures reduced the supply of money and deepened deflation.

The economic crisis was becoming a financial-system crisis.

And that distinction matters.

The Problem of Deflation

Today, people generally think about inflation.

Prices go up.

The dollar buys less.

During the Great Depression, America experienced the opposite problem on an enormous scale.

Deflation.

Prices fell sharply.

At first, falling prices might sound like good news.

Cheaper goods should help consumers, right?

Not necessarily.

Imagine owing $10,000.

Then imagine your wages fall.

Your business revenue falls.

The prices you receive for your products fall.

But your debt does not automatically fall with them.

The real burden of that debt becomes greater.

That is what happened throughout the Depression.

According to Federal Reserve historical research, the U.S. money supply fell by nearly 30 percent between the fall of 1930 and the winter of 1933. The resulting deflation increased debt burdens, reduced consumption, increased unemployment, and pushed banks, businesses, and individuals toward bankruptcy.

The downward cycle became increasingly difficult to stop.

A Vicious Cycle

Consider what happens when a business loses customers.

It sells less.

So it produces less.

It needs fewer workers.

Workers lose income.

Those workers spend less.

Other businesses lose customers.

Those businesses cut production.

More workers lose jobs.

Banks become nervous about lending.

Businesses have less access to credit.

Investment falls.

The economy contracts further.

Now add failing banks.

Then add deflation.

Then add falling agricultural prices.

Then add international financial instability.

Each problem can make the others worse.

This is how a recession can become a depression.

The economy can enter a downward spiral.

What Happened to American Farmers?

The Depression did not begin farmers' problems.

Many American farmers were already struggling during the 1920s.

During World War I, demand for American agricultural products had increased.

Farmers expanded production.

Many borrowed money to purchase land and equipment.

After the war, European agricultural production recovered.

Demand for American farm exports weakened.

Prices fell.

Farmers who had borrowed during the boom could find themselves owing more than their farms were worth.

Then the Depression made the situation worse.

Agricultural prices collapsed.

Farm income fell.

Foreclosures increased.

For many rural Americans, the economic crisis was not something that arrived in 1929.

It had already begun.

The Depression simply made it much worse.

The Gold Standard

Another piece of the story was the international monetary system.

At the time, the United States was operating under the gold standard.

The dollar's value was tied to gold.

This system placed constraints on monetary policy because maintaining confidence in the dollar and protecting gold reserves were major considerations.

When Britain abandoned the gold standard in 1931, pressure increased on the United States and other countries.

Gold flowed out of the United States.

The Federal Reserve responded by raising interest rates in an effort to protect the country's gold position.

But higher interest rates also placed additional pressure on an already struggling economy.

The gold standard helped transmit financial stress from one country to another.

The Depression was no longer simply an American problem.

It had become an international crisis.

The Federal Reserve's Difficult Position

This is one of the most important and complicated parts of the story.

The Federal Reserve was created in 1913 partly to provide stability to the banking system.

But during the early Depression, Federal Reserve leaders disagreed about what should be done.

Some favored providing liquidity to banks facing runs.

Others believed monetary expansion during a contraction could create additional problems.

The institution also faced the constraints of the gold standard.

The Federal Reserve did take actions to expand the monetary base at various points.

But historians and economists have concluded that those actions were insufficient to offset the collapse of the banking system and money supply.

The result was devastating.

The Federal Reserve's own historical account states that its failures contributed substantially to the severity of the Depression.

That does not mean the Federal Reserve single-handedly caused the Depression.

History is more complicated than that.

It means that monetary policy and institutional decisions mattered enormously.

And they can make a crisis better—or worse.

The Hoover Administration

Herbert Hoover was president when the stock market crashed.

He entered office in 1929 believing strongly in economic growth, voluntary cooperation, and limited reliance on direct federal relief.

But as the crisis deepened, the federal government did not simply sit still.

The Hoover administration supported measures intended to stabilize the economy and financial system.

Congress created the Reconstruction Finance Corporation in 1932.

The RFC provided loans to banks, railroads, and other financial institutions in an effort to stabilize the financial system.

The Banking Act of 1932 also expanded the Federal Reserve's ability to provide credit during economic downturns.

These actions are important because they complicate the common historical picture.

It is inaccurate to describe Hoover's response as simply:

“He did nothing.”

The federal government did take action.

The historical debate is over what those actions accomplished, what they failed to accomplish, and whether different policies might have produced a better result.

But the Crisis Kept Getting Worse

Despite the government's actions, the Depression deepened.

Unemployment climbed.

Bank failures continued.

Businesses closed.

Farm foreclosures continued.

Families struggled to survive.

By 1932, Americans were looking for answers.

The presidential election that year became a referendum, in part, on how the country was responding to the economic crisis.

Franklin D. Roosevelt defeated Hoover and was elected president.

But Roosevelt would not take office until March 1933.

That waiting period would become one of the most dangerous periods of the entire Depression.

The Winter of 1932–1933

By early 1933, the American banking system was approaching collapse.

Bank runs spread.

States began declaring banking holidays to temporarily stop withdrawals.

Michigan declared a banking holiday in February.

Other states followed.

The pressure on the nation's gold reserves intensified.

Even the Federal Reserve system itself was under extraordinary strain.

By March 1933, the banking crisis had become national.

America was approaching a breaking point.

March 1933

Franklin Roosevelt took office on March 4, 1933.

The banking system was in crisis.

The following day, Roosevelt issued a proclamation closing the nation's banks.

A nationwide bank holiday began March 6.

The goal was to stop the panic and give the government time to determine which banks were financially sound enough to reopen.

Congress then passed the Emergency Banking Act.

The legislation had actually been prepared in large part by Treasury officials during the Hoover administration, an important reminder that major historical events rarely fit neatly into presidential boundaries.

The banking system was about to enter a new era.

And so was the federal government.

The Turning Point

By March 1933, the United States had traveled a remarkable distance in only a few years.

In 1929, America had been experiencing economic expansion.

Then came the crash.

Then recession.

Then banking failures.

Then deflation.

Then mass unemployment.

Then a nationwide financial crisis.

The country had reached the point where the old assumptions about government, banking, finance, and economic policy were being challenged.

The question was no longer simply:

How did this happen?

The next question was much bigger:

What should the government do now?

A New Chapter

The Great Depression had not yet ended.

Far from it.

The unemployment crisis remained.

The economy remained deeply damaged.

Millions of Americans were still struggling.

But something had changed.

The American people had elected a new president.

Congress was preparing to enact sweeping legislation.

The federal government was about to assume new responsibilities.

New agencies would be created.

New financial rules would be established.

New programs would reach into the lives of ordinary Americans.

And the relationship between the American people and the federal government would never be quite the same.

That is where Part II begins.

What Can We Learn From Part I?

Before we move into the New Deal, there are already lessons worth remembering.

Economic crises rarely have one cause.

The Great Depression was not simply a stock-market crash.

It involved banking failures, monetary contraction, deflation, international financial pressures, the gold standard, agricultural problems, and other economic weaknesses. Historians and economists continue to debate the relative importance of different factors.

Institutions matter.

The decisions made by the Federal Reserve, Congress, the administration, banks, businesses, and other institutions affected the course of the crisis.

Financial stability matters.

When banks fail, ordinary people can lose access to savings and credit.

The consequences can spread far beyond Wall Street.

Government decisions have consequences.

Policies are not abstract.

They affect workers, businesses, families, savers, borrowers, farmers, and communities.

Good intentions do not guarantee good outcomes.

Many policymakers believed they were acting in the public interest.

Some actions helped.

Some actions failed.

Some had unintended consequences.

That is an important lesson for every generation.

And history is rarely as simple as the political slogans that come afterward.

The Great Depression was not simply:

“The market failed.”

It was not simply:

“Government failed.”

It was not simply:

“One president caused it.”

And it was not simply:

“One president fixed it.”

The truth is more complicated.

And because it is complicated, it is worth learning.

The Great Experiment

The Great Depression tested the United States in ways the Founders could never have imagined.

They had created a constitutional system designed to govern a growing nation.

They could not have known about modern stock markets.

They could not have known about a nationwide Federal Reserve System.

They could not have known about modern banking.

They could not have known about global financial markets.

But they left behind something that remained just as important:

A system in which citizens ultimately hold the power to choose their representatives and hold their government accountable.

The Depression would change what Americans expected from that government.

But before we decide whether those changes were good, bad, necessary, excessive, successful, or unsuccessful, we have to understand what actually happened.

That is what history is for.

Not to give us slogans.

Not to give us heroes and villains.

But to give us enough knowledge to ask better questions.

Part II: The New Deal

The crisis had brought America to a crossroads.

The banking system was collapsing.

Unemployment remained enormous.

Millions of Americans needed help.

And a new administration was taking office.

Franklin Roosevelt and Congress were about to embark on one of the largest expansions of federal economic activity in American history.

New agencies would appear.

New regulations would be written.

New programs would be created.

The federal government's relationship with the American people would change.

Some of those changes would become temporary.

Others would become permanent.

And some would remain subjects of debate for generations.

What happened next?

What did the New Deal actually do?

Which programs succeeded?

Which failed?

What did it cost?

And how did it permanently change the role of the federal government?

Those are the questions we will examine in:

THE GREAT EXPERIMENT — PART II

The New Deal: A New Role for Government

The People. The Voice. The Future.