A Historian on the Lessons of the Depression

Are we witnessing the birth pangs of another Great Depression? Karl Marx once observed that history repeats itself, “first as tragedy, second as farce.” But the record of the past emphatically suggests that we are not suffering through a play-by-play recapitulation of the catastrophe of the 1930s. To be sure, we may be brewing our very own 21st century economic calamity. But if so, it will be altogether different in its sources, scale, severity and duration from the last century’s ghastly, decade-long, globe-girdling ordeal. It is only the consequences that may be similar.

Several chronic infirmities afflicted the international economic order in the 1920s: the massive destruction World War I inflicted on key economies like those of Britain, France and Germany, and the lingering distortions in trade, capital flows and exchange rates occasioned by the punitive Treaty of Versailles. Memories of the war’s bitter fighting and vengeful conclusion had rendered the international atmosphere toxic, making a mockery out of the one transnational institution to have emerged from the conflict, the League of Nations. Adding to those abundant ills was the near religious faith in the sacred orthodoxies of laissez-faire and the gold standard–the economic equivalents of the Nicene Creed.

The U.S. was not immune to those ailments as the decade of the ’20s reached its operatic climax, and it suffered from some others that were peculiarly its own. A stubborn agricultural depression had blighted the American countryside since the conclusion of World War I, crimping the incomes of the 20% of the workforce who were farm laborers and significantly limiting domestic purchasing power. Meanwhile, a notoriously ramshackle, poorly regulated banking system had managed to wobble its dysfunctional way into the modern era. Some 25,000 banks–most of them highly fragile “unitary” institutions with tiny service areas, little or no diversification of clients or assets, and microscopic capitalization–composed the astonishingly vulnerable foundation of the national credit.

Government spending at all levels, though fairly stable even as the Depression set in, constituted only about 15% of GDP in the 1920s. Less than one-fifth of that was federal expenditures. “If the Federal Government should go out of existence, the common run of people would not detect the difference in the affairs of their daily life for a considerable length of time,” said famously taciturn President Calvin Coolidge in one of his more long-winded (and accurate) assessments of the national scene. The Federal Government, in other words, was a kind of 90-lb. weakling in the fight against the Depression monster.

There are no equivalents to those circumstances today. The “real” economies of most major nations remain robust. No major war has disrupted international trade in more than a half-century. On the contrary, the explosion of global commerce in the past several decades has underwritten prosperity not only for developed countries but for many other nations as well–notably China, India and Brazil–lending today’s world economy degrees of diversity, dynamism and resilience that simply did not exist eight decades ago. The abandonment of the gold standard has opened space for countries to adjust their monetary and fiscal regimes without fear of deflation or devaluation. And a landscape populated by an array of multilateral institutions like the IMF, the World Bank and the WTO has nurtured habits of international economic cooperation in times of crisis, as witnessed by the recent round of consultation among the G-7 countries and the coordinated efforts of finance ministries and central banks around the world to restore confidence and liquidity in the credit markets.

At home, agricultural employment today, at less than 2% of the labor force, is markedly smaller than what it was, and though sectors like the car and financial-services industries have been hit hard by the current downturn, none is nearly as sick as agriculture was throughout the 1920s. And for all the current ills of megabanks like Washington Mutual and Wachovia, the national banking system still enjoys a measure of stability far greater than in the 1930s–or even the ’20s. The kinds of “runs” on savings institutions that we watch Jimmy Stewart battle every Christmas season are all but unimaginable, thanks in large measure to the psychological reassurance provided by a landmark New Deal innovation, the Federal Deposit Insurance Corporation (FDIC), whose authority to guarantee bank deposits has recently been expanded. And today’s federal outlays make up nearly 20% of GDP, with state- and local-government spending adding another 10%–weighty ballast in the face of economic bad weather.

The Great Depression may have been triggered by a financial crisis, but its lasting story is written in the miseries of massive unemployment. Some 25% of the labor force stood idle in 1933–a rate that never went below 14% for the remainder of the decade. No unemployment insurance backstopped laid-off workers or kept communities going when paychecks disappeared. Given the demography of a workforce in which scarcely any married women toiled for wages, a 25% unemployment rate effectively meant that nearly 1 in 4 households had no income in 1933.

A similar unemployment rate today, when a majority of women, both married and single, are in the workforce, is fearful to contemplate. But it would be unlikely to translate into equivalent hardship for individual families. And thanks to Social Security, a solid floor of support exists for elderly Americans–which guarantees a minimum level of consuming power for the economy as a whole.

These material and structural differences between the Depression era and the crisis we face today are significant. But the most important and consequential differences lie in the realms of ideas and attitudes, especially regarding the role of government. Consider what might be called “the tale of two Secretaries.” Treasury Secretary Hank Paulson (along with Federal Reserve Chairman Ben Bernanke, who presides over an immeasurably more potent Federal Reserve system than existed in 1929) has acted with vigor to bring the full powers of the Federal Government to bear in the current crisis. In dramatic contrast, when Herbert Hoover asked his Secretary of the Treasury, Andrew Mellon, for advice on how to cope with the financial implosion of 1929, Mellon replied, “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system.” Echoes of that old-time sentiment can still be heard today, but they are mere vestiges of the stifling tyranny of laissez-faire thinking that paralyzed so many governments in an earlier era.

Franklin Roosevelt wondered frequently during the 1932 electoral campaign at what he saw as the surprising docility of the American people in the face of the Depression. “Repeatedly he spoke of this,” his aide Rexford Tugwell recalled, “saying that it was enormously puzzling to him that the ordeal of the past three years had been endured so peaceably.” That odd passivity has intrigued historians, who have noted that it forced Roosevelt to simultaneously invent the tools to combat the Depression and establish their very legitimacy in the eyes of the people.

Today the debate about the legitimacy of government’s role is largely ended. What argument remains focuses on the efficacy and fairness of various policy choices, not on the idea of intervention itself. Public opinion is far from unanimous about what should be done, but it is virtually unanimous that something must be done. That represents a seismic shift in popular attitudes.

It is now inarguably clear that what we know as the New Deal was important not for ending the Depression–it didn’t–but for putting in place a host of creations like the FDIC, Social Security, unemployment insurance, the Securities and Exchange Commission and a vastly strengthened Federal Reserve system. Complemented by the multilateral bodies that were spawned at the end of World War II, these institutions formed a latticework of stability and security on which the nation’s and the world’s economies grew so robustly that a new word, globalization, was coined to describe the results.

Recent events have demonstrated, though, that rampant globalization has outpaced intellectual and political innovation. Exotic investment instruments like credit-default swaps and collateralized debt obligations have eluded meaningful monitoring, baffled regulators and investors alike and raised hob with markets worldwide. What is now manifestly needed is a round of creative institutional invention like what the New Deal gave us. Then history will have repeated itself neither as tragedy nor as farce but as common sense and consequential reform.

Kennedy is a professor of history at Stanford University and author of the Pulitzer Prize-winning Freedom from Fear: The American People in Depression and War, 1929-1945