Can History Save Us From A Depression?

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Jude Wanniski was among the early leaders in the revival of supply-side economic theory. A former associate editor of The Wall Street Journal, he founded and is president of the consulting firm Polyconomics, Inc., which is located in Morristown, New Jersey, and advises leading corporations and institutional investors on economics, politics, and communications. In 1978 Simon & Schuster published his pioneering book on economic theory and history, The Way the World Works. In it he draws heavily on historical precedent to argue that low tax rates are essential not merely to the wealth of a nation but to the welfare of its citizens and the progress of society. His ideas have significantly influenced the Reagan administration. Interestingly, he has no formal training in economics (he holds a B.A. in political science and an M.S. in journalism from UCLA); but the late chairman of the Federal Reserve, Arthur Burns, once observed to him that this was precisely his advantage. In addition to his work as a consultant and economist, Wanniski edits The Media Guide, an annual survey and review of the media that is wide-ranging in its coverage and outspoken in its evaluations.

This conversation took place in Wanniski’s office on Election Day, November 3, 1987.

In your book The Way the World Works, you pin the cause of the crash of October 1929 on the rising protectionist sentiment that ultimately yielded the Smoot-Hawley Tariff Act. That’s not the consensus of economic historians. How did you come to this idea?

Until October 1987, at least, the crash of 1929 was the most cataclysmic economic event of the century. As a result of the crash of ’29, supply-side economic theory, which had been dominant in the Western world for almost two centuries, was forced into retreat. In other words, those economists who built their ideas, their economic models around the assumption that the producer of goods was the dominant actor in the economy couldn’t explain why the market crashed. Consequently, policy makers turned to alternative models. They turned to demand-side economists, the Keynesians and the monetarists, who came up with the idea that the Depression had occurred because of insufficient purchasing power. The masses of people had insufficient purchasing power, insufficient demand power. So the demand-management school of economics took over and bit by bit became dominant throughout Europe and especially in the United States. But by the 1970s the demand-side theories were no longer working. They could not explain the stagflation that began creeping into the system in the late sixties and became a way of life in the 1970s.

This was the state of things that led me to those economists who were reviving classical theory;—supply-side theory—as a way of thinking about the world of the 1970s. But the requirement, I felt, was to find a rationale for the cause of the crash of ’29 that would enable us to rehabilitate the classical model. I knew there had to be some event that caused such a cataclysmic interruption in dealings between producers and traders. And my answer was that it was the Smoot-Hawley Tariff Act of 1930.

How did you make this discovery?

I was at the American Enterprise Institute for Public Policy Research writing my book, and I had promised the publishers that I would explain the crash. But I was already into the fourth chapter, and I was no closer to finding the causes. Then one of the professors at the institute, Dr. Gottfried Haberler, and I had lunch. And I could see that there was nothing I could squeeze out of him that I hadn’t gotten out of the literature. But when I got back to my office, a messenger came from his office with a monograph he had written on the Great Depression. It was only thirty pages long, and, maybe on page 12, Haberler had mentioned something about how the Smoot-Hawley Tariff Act of 1930 had contributed to the Great Depression. When I saw “1930,” I got very excited, because I’d always thought Smoot-Hawley was 1931. But 1930 meant that the Congress that passed Smoot-Hawley was the same one that was sitting in 1929. Well, I couldn’t wait to get into the library to get out The New York Times microfilm and crank it up to the last week in October.

There, at the top of the page, the market was crashing—and on the bottom of the page, the Smoot-Hawley Tariff Act was being debated in the United States Congress. So that was the “Aha!” experience.

In John Kenneth Galbraith’s book The Great Crash, 1929 , he proposes quite a different hypothesis, one that I think appeals to the moralist bent in Americans. He acknowledges that tax rates, monetary policy, and earnings expectations motivate stock prices early in a bull market. But as the prices rise for a period of time, a new element enters. He calls it the “dynamics of speculation”—greed, in short. This dynamic drives the price out of any relation to underlying values. In fact, a crash—the crash of ’29, and I’m sure he’d think much the same about the crash of ’87—is inherent in this very dynamic. It’s inevitable that the bubble is going to burst once this virus has infected the system. How credible an explanation of the rise and fall of bull markets do you believe this is?