Power of Story: Depressions and Panic

Once upon a time to a fabled piece of real estate came individuals and small clusters of sincere, hard working people. Their intentions were to carve out a place of peaceful and prosperous existence on the prized piece of land that miraculously stretched all the way from the Atlantic Ocean to the Pacific Ocean. They dreamed of their desires and opportunities one day materializing into feelings of security, satisfaction, and happiness. Their economic endeavors eventually found them building thousands of individual businesses and employing tens of thousands of their neighbors as laborers.

Their simple economy included the practice of barter and a currency of metal coins and commodities such as tobacco. By the late 1700s, their economy had begun to mature and even show signs of sophistication. A business observer by the name of J. B. Say wrote that it appeared the very act of producing goods seemed to generate income equal to the value of the goods produced. That idea became known as Say’s Law, where supply creates its own demand. In other words, there will be sufficient spending to purchase all that is produced.

When times were good the business owners would invest in purchasing goods and materials to build their enterprises. They would also buy raw materials in order to produce the items they were going to sell. If they did not have enough money of their own, they would invite investors to share in their business venture. Their hard work and diligence ended up with successful production of goods. Many times their successful endeavors resulted in producing more of the items than the present market could purchase.

Once a businessman’s warehouses were full and he had saturated the marketplace with his goods, he would have to put a bookmark in his production until the customers’ purchases would catch up to his production. He would have to lay off his workers until the demand for his products emptied out his warehouse. That allowed him to start up his business again. The lack of continued investment in production resulted in a temporary recession of business and the occurrence of unemployment. The reoccurring cycle gave the appearance of a boom and bust economic pattern.

Observers, also in the late 1700s, like David Ricardo and John Stuart Mill recognized these bumps in the business experience, along with other interruptions like wars, gold rushes, and droughts, and concluded that over the long haul of time all the bumps would tend to even out, and full employment and production would work out just fine, and that eventually demand must equal supply. There would eventually be sufficient spending to purchase all the supply.

But some of the recessions were worse than others. During the seventy-five years in the U.S. prior to 1929, there had been nineteen business recessions with some gaps that even lasted as long as two years. Then came the Great Depression! TheRoaring 1920s had produced a period of easy money, abuse of credit, speculation in risky ventures, and high expectations driven by greed and lack of discipline.

The 1929 crash of the stock market opened the door to panic, and the people waited in lines at their banks to withdraw their money. But, as we learned earlier, when people deposit their funds in a bank it is unjustifiable to think that everyone can demand their money back all at once. Their money that was deposited was not in the banks at all, but had been loaned out to someone else. The new borrowers were not expected to repay those loans for another ten, perhaps twenty years.

All economic systems depend upon the factors of confidence and convenience. When depositors cannot withdraw the money at will that was deposited, they get quite nervous. When, after standing in lines for a long time, they still cannot withdraw their money, they panic. That panic spreads like a wildfire to all other depositors.

It takes such a tiny pin to prick the balloon of confidence. Early in the Great Depression over one third of all the banks in the U.S. failed and closed their doors. The depositors’ funds evaporated into thin air. The confidence in the system was likewise gone.

More than twelve million people lost their jobs. Production dropped 30% and per capita income shrank 40%. Unemployment jumped to 25%, 85,000 businesses failed, hundreds of thousands of families lost their homes, and over half of home mortgages were in default. The financial constriction did not just solve itself. The Great Depression lasted over ten miserable years with no apparent hope in sight.

The local, county, state, and federal governments likewise panicked. They embarked on harsh plans to quickly increase taxes to cover their losses. But there was no money to pay the taxes. The Federal Reserve Bank failed miserably. It had been empowered to move cash early on to the first banks experiencing runs on their accounts in order to stave off such panics. That probably would have stopped the panic, as the people realized that others were getting their money back. Instead, however, the Fed officials applauded in some cases, saying it was all working to weed out the weak banks and those with bad management practices.

What had gone wrong? Was it possible that Say’s Law was wrong? Why were the safeguards of the Federal Reserve System never implemented? What would pull the economy and the people up and out of the Great Depression?

Next week we will look at Franklin D. Roosevelt and John Maynard Keynes.

(Research ideas from Dr. Jackson's new writing project on Cultural Economics)

© Dr. James W. Jackson  

Permission granted by Winston-Crown Publishing House