Can History Save Us From A Depression?


In the largest sense I don’t think it has very much substance. There’s certainly truth to the idea that most people who are piling into a bull market don’t really know what they’re doing. They’re being pulled in by the vacuum. What’s really happening is an arbitrage between profit opportunities and the availability of capital. And it’s almost a mathematical certainty that if profit opportunities are seen by people, and they are willing to commit enough of their resources, they draw others in.

But what you have with a sharp run-up in the value of shares in the 1920s and 1980s is a reaction to long periods before then of errors in economic policy that drove profit opportunities down to a very low level. And suddenly some smart people came in and changed the structure of government policy. Profit opportunities rose so quickly that markets adjusted rapidly. Then the collapse in prices occurred because a great, almost accidental error was made; in the case of Herbert Hoover it was his signing of protectionist trade legislation.

There’s this idea that much of the run-up occurs because of the greaterfool thesis, that people are buying shares and passing them on, one to the other. But this ignores, especially in the United States, the tremendous hedge markets we have. We’ve got a lot of smart people out there who are selling short, betting the market will fall. And they’re as motivated by greed in their short sales as others who are motivated by greed going long.

I’ve always felt that Galbraith, if he had looked at The New York Times the way I did, might have found the Smoot-Hawley answer. But I think what happened with Galbraith is that he was so far along in his career by the time he had come to write The Great Crash, 1929 , he probably had a research assistant looking at the microfilm who didn’t notice that there was something going on there. So he had to come up with a theory of why the market crashed, and it was a theory that the market crashed because it was too high.

In other words, it’s a nonexplanation. While the forces may be operating—greed is certainly part of life—it doesn’t explain what actually triggered the crash?

Right. The crash of ’29 was triggered by the recognition on the part of the world markets that the United States was more likely at the end of the last week of October 1929 than it was at the beginning of the week to impose protectionist trade barriers on world commerce. And so the Dow-Jones industrial average fell from its peak of 381 around Labor Day of 1929 to a low of 230 in the last week of October. Of course, this was only the first wave. Other countries retaliated against Smoot-Hawley with protectionist tariffs of their own. So you had an imploding of world trade that sent the world reeling backward, giving up perhaps thirty years’ worth of progress. And we had to go through a depression and a world war in order to get to a higher state.

One of the things that’s frightened me throughout the current period is that although supply-siders like me believed they knew what was going on, they were confronting a world of policy makers who didn’t. We believed that unless we could act rapidly enough, we could wind up having the world break down into a global depression that would lead to a nuclear war. The global electorate has to keep its wits about it and move to avoid the same kind of cataclysm we had in the 1930s and 1940s.

A lot of people now are drawing the parallels between ’29 and ’87. We’ve had a boom, and a stock market crash, and now the question on everyone’s mind is, Where do we go from here? Is a recession or even a depression unavoidable?

The adverse effects of the crash of ’29 could have been avoided. The market expectations of October 1929 were that bad things were going to happen in the future. Now if Hoover hadn’t signed the Smoot-Hawley Tariff Act, or if foreign retaliation had not followed and further diminished commerce, something very different might have occurred. And remember, this diminution of commerce brought government revenues down in the United States so much that Hoover said we had to raise taxes to make up for the lost revenues. One error built upon another error until we got to the low point of the Dow Jones Average, 41, that was hit in the summer of 1932. It was within days of Roosevelt’s nomination in Chicago and his acceptance speech with its commitment to free trade.

In the 1930s protectionist tariffs sent the world reeling backward, giving up perhaps thirty years’ worth of economic progress.

Which was a flat repudiation of Hoover and the Republicans as the party of protectionism and isolationism.

Exactly. Our ruling elite didn’t see, in 1929, how important it was that we be international in our approach, how important it was that in being a global leader, we not act as we had in the previous periods of our growing up, as narrow nationalists. In earlier days we could get away with pushing tariffs up and down and had done so. But we were in a far different position by the 1920s.

What had changed?

The United States in the 1920s was already the richest country in the world. We were booming on the supply-side ideas of Andrew Mellon, the Secretary of the Treasury, and Presidents Harding and Coolidge. We were growing at a great pace, and the rest of the world was kind of drawing water and hewing wood in support of our boom. But historically this kind of disequilibrium can’t go on for very long. Either we were going to have to become poorer or they had to become richer.