A Random Walk Through The Rubble

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How much did we lose?” my wife asked me on the day the stock market sank like a stone last October. I did some quick arithmetic and answered, with remarkably good cheer under the circumstances, that we had lost only a little more than two times our annual income.

To cushion the blow, I quoted Mark Twain. “October,” he wrote in Pudd’nhead Wilson . “This is one of the peculiarly dangerous months to speculate in stocks. … The others are July, January, September, April, November, May, March, June, December, August and February.”

My wife was not amused. “Will we have a depression?” she asked. We had intended to go out for dinner, but even a modest meal at the Chinese restaurant across the street suddenly seemed extravagant. That decision, multiplied ten billion times, was what the experts were talking about on television, using phrases like “the effect on consumer spending.”

Will we have a depression? was the question Jim Lehrer asked the Nobel Prize-winning economist from MIT. He used more elegant language, but I sensed that the Nobel Prize-winning economist wanted to say exactly what I had said when my wife asked the same question: “How the hell am I supposed to know?”

Later that night I sat down to see what I, an intelligent layman, could learn about stock market crashes and depressions from people who had really studied them.

For the general reader, John Kenneth Galbraith’s The Great Crash , 1929, originally published in 1955, remains the most readable—if not the final—account of the market collapse that ushered in the Great Depression. Galbraith’s gift for tart commentary makes him an ideal guide to a period in which, as he says, “great drama” was joined with “a luminous insanity.”

Galbraith takes special satisfaction in the discomfiture of the “official optimists” whose pronouncements fueled the bull market. Comments by Bernard Baruch (“the economic condition of the world seems on the verge of a great forward movement”) and Professor Irving Fisher of Yale (“stock prices have reached what looks like a permanently high plateau”) prepare us for the response of Herbert Hoover after the market plunged: “The fundamental business of the country … is on a sound and prosperous basis.”

In general, Galbraith comments, “the greater the earlier reputation for omniscience, the more serene the previous idiocy, the greater the foolishness now exposed.” But his book is not merely a study of foolishness in high places. It is a study of universal foolishness. “No one was responsible for the great Wall Street crash,” he concludes. “No one engineered the speculation that preceded it.” That speculation was entered into freely and even joyfully by hundreds of thousands of individuals who “were not led to the slaughter” but “were impelled to it by the seminal lunacy” that convinces people that they are destined “to become rich without work.”

When he considers whether the crash caused the Depression, Galbraith grows cautious. The economy, he notes, had begun to weaken well before the dive. The distinguishing feature of the crash of ’29 was that “the recession continued and continued and got violently worse.”

To a large extent, Galbraith finds, things got worse because in the years after the crash, “the burden of reputable economic advice was invariably on the side of measures that would make things worse.” Galbraith notes in particular the unwillingness of government officials to pump money into the economy even though “the country was experiencing the most violent deflation in the nation’s history,” and he notes the commitment of both political parties to a balanced budget (which ruled out deficit spending by the government to reinvigorate the economy). The rejection of both monetary and fiscal measures “amounted precisely to a rejection of all affirmative government economic policy,” to “a triumph of dogma over thought” that converted the crash into a catastrophe.

Having examined the views of a celebrated Keynesian, I turned to celebrated monetarists. In Free to Choose , Milton and Rose Friedman have a chapter on the crash that is addressed to the general reader. Their conclusion? “The depression was not produced by a failure of private enterprise, but rather by a failure of government.”

The Friedmans emphasize the role of the Federal Reserve System, which regulates the supply of money. After the crash, they argue, the Fed should have expanded the money supply to counter the contraction. Instead, it “allowed the quantity of money to decline slowly throughout 1930.”

The Fed also failed in its response to the series of bank failures that began in 1930. It should have purchased government bonds on the open market to provide banks with the cash to meet the demands of their depositors. Instead, the Fed “stood idly by and let the crisis take its course,” with the result that ten thousand banks closed and the nation experienced “a monetary collapse without precedent.”

The Friedmans and Galbraith agree that the crash of ’29 did not precipitate the Depression. But they differ sharply in the lessons they draw from the crisis. Galbraith favors the kind of economic initiatives we associate with the New Deal. The Friedmans lament the “rapid growth of government” that began with the Roosevelt administration and suggest that the shift of opinion in favor of government intervention in the economy “resulted from a misunderstanding of what had actually happened.”