The Myth of the New Deal

This is a research paper that I just finished writing for my composition class that I thought was relevant enough to some of today’s political debates for me to post here.  Hopefully, you will find it insightful, though I will warn you that it’s quite a bit longer than anything else I’ve posted before.

Following the economic boom of 1921-1929, the period known as “The Roaring Twenties”, the United States fell into a state of stagnation preceded by a stock market crash in October of 1929 and resulting in an economic collapse that lasted for more than a decade.  The period following this collapse would later be dubbed the Great Depression and be considered the worst economic crisis in the history of the United States.  Decades following the depression; economists, historians, and politicians continue to debate both the underlying causes of the Great Depression and the factors that contributed to the economic recovery of the 1940s that marked that depression’s end.  Although those topics have become less prevalent in most political discussions of the modern day, the implications of these debates remain relevant as they may provide insight into potential solutions to America’s current economic downturn.  As such, this paper will seek to answer the question at the heart of the aforementioned debates: to what extent did government policy cause the Great Depression and lead to the economic recovery of the late 1940s?

This paper will examine the economic policy of “The Roaring Twenties”, any change in policy that may have occurred at the beginning of the Hoover Administration, and the effects of those changes, if any, on the United States economy.  In addition, this paper will examine the economic policies instituted during Franklin Roosevelt’s presidency, often referred to collectively as the New Deal, similarities to or differences with previous economic policy, and their effectiveness in restoring the American economy in the long run.  As a result, this paper intends to show that the federal government directly contributed to the onset of the Great Depression by adopting more burdensome policies for businesses both before and after the market crash in 1929, in contrast with the minimalistic, business-friendly policies of the previous decade.  Furthermore, this paper will show that the New Deal policies of the Roosevelt Administration only served to hinder America’s economic growth and that recovery did not begin until President Roosevelt was forced to unleash American industry shortly before the United States became involved in World War II.

After taking office in 1921, President Harding employed the same pro-business, free market economic policies that had allowed America to prosper in the past.  Harding believed that, with regards to the economy, “We need vastly more freedom than we do regulation” (Murray 171).  Harding also proclaimed in a message to Congress in April of 1920 that, “I have said to the people we meant to have less of Government in business as well as more business in Government” (Murray 172).  This statement would summarize his administration’s entire economic policy.   One of the first actions Harding took as president was to have his Treasury Secretary, Andrew Mellon, conduct a study to examine the effects of increased taxes on tax revenues.  The study indicated that higher taxes “…put a pressure on the tax payer to withdraw his capital from productive business and invest in tax exempt securities…” (Folsom 128).

After the study had concluded, Harding went about lowering the tax rates for all citizens, including the wealthiest Americans.  Harding pushed for an atmosphere of greater cooperation between government and business rather than the adversarial approach that would be taken later that same decade.  As a result of Harding’s economic policies, tax revenues more that doubled, rising from “roughly $300 million to $700 million” (De Rugy para. 5) within the first year of his presidency.  At the same time, Harding’s tax cuts allowed the American economy to grow throughout the 1920s as the nation’s Gross National Product (GNP) grew at a rate of 4.7 percent and unemployment fell from 6.7 to 3.2 percent (De Rugy para. 6).  This was due to the increased incentives to work, save, hire, and invest created as a result of people, both rich and poor, to keep more of their own money to use as they wished due to the tax cuts.

In addition to increasing government revenue through lowered tax rates, Harding managed to limit government spending in order to keep the national debt and deficit under control.  One instance of this sort of fiscal responsibility was when he vetoed a bill that had come to his desk for the purpose of giving more benefits to World War I veterans. In response to the criticism he received, Harding stated that although the country owed its veterans more than it could ever pay, the United States simply could not afford to give more benefits to anyone.  Public opinion was not in Harding’s favor in this matter, however, but his actions only helped in reducing America’s debt and keeping federal spending under control.

When Harding died of a heart attack in 1923, his vice president, Calvin Coolidge succeeded him and continued many of his established policies.  After Coolidge was inaugurated, he quickly became famous for his so-called “active inactivity” on the economy.  “In his Inaugural he asserted that the country had achieved ‘a state of contentment seldom before seen,’ and pledged himself to maintain the status quo” (whitehouse.gov para. 6).  Like his predecessor, Coolidge strongly opposed the federal government interfering in order to keep the economic boom of the 20s in check.  He continued to call for tax cuts and little federal regulation or other means of interference so as not to stunt America’s economic prosperity.  As a result, by 1924, he was hailed as having brought the country into what was called “Coolidge prosperity”.  This prosperity would last until the stock market crashed in 1929, after Coolidge had left office and Herbert Hoover had taken over.  While Hoover has received much of the blame for the onset of the Great Depression, it has been for taking a “minimalistic” approach to government intervention.  However, historical records seem to indicate otherwise.  For the first time in American history, the government stepped in as part of an attempt to solve the country’s economic woes and, as Gene Smiley points out, “What failed in the 1930s were governments, in their eager-ness to direct economic activity to achieve political ends—ends that were often contradictory” (Smiley para. 10).

Early in the year 1929, many European countries had stopped paying off their loans to the United States, leaving America with a large debt left to repay despite what Presidents Harding and Coolidge had done to reduce it.  Compounding this damage was the passage of the Smoot-Hawley Tariff Act, which placed tariffs on thousands of imported goods and increased tariffs on hundreds more.  President Hoover received numerous letters imploring him to veto the legislation, but he signed it into law regardless, resulting foreign countries placing higher tariffs on American goods being exported to those countries. In addition, Hoover attempted to avert economic crisis by instituting policies contrary to the ideas employed by his predecessors.  He raised taxes and urged companies to keep wages artificially high, although he did not pass any law establishing a minimum wage.  Instead, Hoover induced higher prices to make firms more willing to produce.  While Hoover intended to maintain spending across the consumer spectrum, most were still feeling the effects of the stock market crash and were unwilling or unable to pay inflated prices for goods.  As a result, foreign trade in the US stagnated, as did American industry.  To complement the president’s mistakes, the Federal Reserve responded to the market crash by “…cutting the money supply by nearly a third, thus choking off hopes of a recovery. Consequently, many banks suffering liquidity problems simply went under…” (Investopedia para. 4) resulting in the rampant bank closures in the early years of the depression.

Herbert Hoover’s presidency marked a change in economic policy from the business-friendly policies of the Harding and Coolidge Administrations to a more interventionist approach, especially following the stock market crash in 1929.  This change in policy would continue through the duration of Hoover’s presidency and, ultimately, do little to alleviate the economic downturn America was experiencing.  In the presidential election of 1932, Franklin Delano Roosevelt promised to restore America’s former prosperity and to put an end to the period of unchecked private sector growth that he blamed for the depression.  He claimed that the depression was brought about “primarily…because rulers of the exchange of mankind’s goods have failed through their own stubbornness and their own incompetence” and that by “…direct recruiting by the Government itself…” and “…engaging on a national scale in a redistribution…” (Roosevelt para. 4 and 9) America’s economy could be restored.

However, despite Roosevelt’s claims that his philosophy on the role of government in the economy was immensely similar to that of Herbert Hoover.  As such, President Roosevelt began a series of government programs, later called the New Deal, modeled after the economic philosophy of John Maynard Keynes, an economist who believed that it was necessary for the government to take an active role in reversing economic downturns, and designed to reduce unemployment, initiate several public works projects, and reign in the private sector, particularly the banking industry, so as to avoid another stock market crash as well as ensure that the big capitalists did not take advantage of the consumer or their workers.  One of the first measures taken by Roosevelt was the “bank holiday” in which every bank in the nation was closed down for one week so they could be “screened” by the federal government.

At the end of the one-week period, only the banks that the government had determined were stable enough to continue functioning would be allowed to reopen.  The purpose of the holiday was to ensure that the people’s money would be left in the most stable banks.  However, the bank holiday only hurt the industry as a whole.  “Banks needed permission from the secretary of the Treasury to do anything.  Businesses were undoubtedly reluctant to accept checks because banks couldn’t clear checks” (Powell 54).  In contrast, during the Panic of 1907, industrialist J P Morgan took control of the bank rescue and allowed them to continue to clear checks despite their being closed resulting in much more rapid, efficient recovery.  As Murray Newton Rothbard asserts, “The laissez-faire method would have permitted the banks to close…” and “…be transferred to the ownership of their depositors.  There would have been a vast, but rapid, deflation, with the money supply falling to virtually 100 percent of the nation’s gold stock” (Rothbard 329).

Another measure taken by Roosevelt during the Great Depression was to increase the amount of revenue available to the government for public works projects through increased taxes.  Roosevelt chose to keep the excise taxes established under Hoover, introduce new taxes such as the social security tax, and raise taxes on the wealthiest Americans in an attempt to “…equalize wealth, which Roosevelt thought was especially important during such a time of economic hardship” (Folsom 131).  Unfortunately, these additional taxes did little to help improve the economy.  In fact, they had the opposite effect, putting a greater burden on lower earners as well as corporations and reducing the amount of revenue that the government took in.

The burden of the social security tax–a small tax on income meant to fund the Social Security System and provide a safety net for those unable or too old to work–fell hardest on low-income families since only the first $3,000 of income was subject to social security taxes.  Tax rates on the rich were increased as well, with the highest marginal tax rate raised “…to 79 percent, the highest in US history” (Folsom 128).  The increased tax rate added to the financial burden carried by the top earners in America, and, just as Andrew Mellon predicted in his aforementioned study, more capital was driven out of the economy and thus brought in little revenue for the federal government.  Ultimately, Roosevelt’s tax policy did little to balance the budget and instead brought about growing government expenditures, mostly on public works projects meant to provide relief for those left unemployed by the onset of The Great Depression.

Perhaps the most notable programs enacted under he New Deal were the previously mentioned public works projects and government agencies set up to rebuild the economy.  One of these agencies was the Agricultural Adjustment Administration (AAA), which was established in order to ensure that the farming industry remained solvent throughout the depression.  To do so, the AAA offered subsidies to farmers who were willing to destroy a percentage of their product and, in some cases, not grow their crops in the first place.  This procedure was meant to keep the price of crops high in order to keep those farmers in business as well as maintain high wages.  In practice, however, these high prices that were put in place strained an America that desperately needed inexpensive food.  As such, most middle class citizens could not afford these higher prices, and food shortages continued into the late 1930s.  These high wages also “…led to further job loss, particularly in manufacturing” (Cole para. 9).  Thus, government action to artificially induce higher prices and wages only served to add to unemployment “…because companies couldn’t afford to keep large payrolls at the rates set by the government” (Investopedia para. 10).

Public works projects proved to be failures as well; while many succeeded in creating jobs, the vast majority of these were temporary positions in construction projects, which would end within a few years.  Many public works projects also failed to increase production of valuable goods as most of the projects focused on rebuilding America’s infrastructure and creating jobs regardless of where those jobs were actually needed.  As a result, much of the additional work force was put into areas that did not greatly contribute to economic growth.  As Professor Joab Corey of Florida State University’s Department of Economics states, “If you pay half the unemployed people to dig holes and the other half to fill them up, everybody’s going to be employed, but nothing is going to be produced.”  President Roosevelt’s efforts to rebuild America’s economy through government intervention proved unsuccessful and in some cases counterproductive.

It was only when it became necessary to increase America’s defense due to the threat posed by Germany, its allies in Europe, and Japan that Roosevelt “…wanted lots of things made inexpensively, and pushed wages and prices below market levels” (Investopedia para. 11) so as to get businesses to produce goods to be used in war.  As a result, businesses had more capital to put toward production and, thus, fuel the economy.  With this increase in production, and the federal government purchasing more and more war goods, businesses were able to hire more workers and increase wages naturally as the market began to improve and unemployment dropped.  Later “when the war finished, the trade routes remained open and the post-war era went from recovery to a bull run in a few short years” (Investopedia para. 11) resulting in the economic prosperity America experienced in the late 1940s and continuing through the 1950s.

Ultimately, there was no failure of private business or free enterprise that created the Great Depression; the market simply went through the natural process of boom and bust inherent in any free economy.  It was government intervention meant to resolve the initial stock market crash in 1929 that actually produced the depression.  In spite of this reality, though, Franklin Roosevelt blamed his predecessor not for the actions Hoover took while in office, but rather for remaining inactive, which ran counter to the truth. By blaming Hoover’s policies, Roosevelt justified his initiation of a Keynesian economic recovery.  However, the policies enacted under Roosevelt’s New Deal were largely unsuccessful and often contributed to the prolonging of the depression.  Higher taxes and wages put a greater burden on business and led to high unemployment throughout the 1930s.

Although Roosevelt was able to bring unemployment down slightly with public works projects focused on infrastructure, the jobs created were temporary and did not increase production of valuable goods.  Only during World War II, when Roosevelt reversed several of the anti-business policies of the New Deal did the economy began to recover due to the surge in production caused by the increase in the amount of capital that businesses were allowed to keep and spend on additional product.  After the war, this change in policy remained, allowing international trade to flourish once again. In short, it was the government’s policy of intervening in the private sector rather than allowing the economy to right itself through natural market forces that was directly responsible for the onset of the Great Depression; the subsequent New Deal programs that perpetuated the decline brought on by the depression.

Works Cited

1. Cole, Harold L., and Lee E. Ohanian. “How Government Prolonged The Depression.” The Wall Street Journal 2 Feb. 2009: n. pag. Print.

2. Corey, Joab. Personal Interview. 6 November, 2013

3. De Rugy, Veronique. “1920s Income Tax Cuts Sparked Economic Growth and Raised     Federal Revenues.” Cato Institute. N.p., 4 Mar. 2003. Web. 16 Nov. 2013.

4. Folsom, Burton W., Jr. New Deal or Raw Deal? New York: Threshold Editions, 2008. Print.

5. Murray, Robert K. The Harding Era. University of Minnesota, 1969. Print.

6. Powell, Jim. FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression. New York: Crown Forum, 2003. Print.

7. Roosevelt, Franklin. “First Inaugural Address.” Washington DC. 4 March, 1933

8. Rothbard, Murray Newton. America’s Great Depression. Princeton, NJ: Van Nostrand, 1963. Print.

9. Smiley, Gene. Rethinking the Great Depression. Chicago: I.R. Dee, 2002. Print.

10. “Warren G. Harding.” The White House. Web. 26 Apr. 2012. <http://www.whitehouse.gov/about/presidents/warrenharding&gt;.

11. “What Caused The Great Depression?” Investopedia. N.p., 26 Feb. 2009. Web. 31 Oct. 2013.

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2 Responses to The Myth of the New Deal

  1. Navy1630 says:

    This is a great essay. I’ve looked thru some of your sources and they paint a different picture of the Great Depression than I learned in my history class. For 150 years, when the US economy was left alone, it recovered on its own. For over a decade, the government’s fixes only made the situation worse. I noticed you are a college student. You should take this essay and turn it into a more detailed research paper with layers of information about various programs.

    Anyway, nice job, Jake.

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