One perpetual problem in the comments throughout my economic videos is the misunderstanding of the events that led to the Great Depression. Although I’ve already covered much of this, it occurs to me that it would be beneficial to put all of this information into a single video and take you through the history from start to finish– not only showing you the causes of the Great Depression, but how our government seems determined to make the same mistakes all over again. So, some parts of this video will be repeats of information in other videos, but some of it will be new, and it will all be tied together. First, some quick background: In 1907, a banking crisis occurred–the worst one in American history up to that point. The stock market crashed down to half of what it was when it started, and investors rushed to the banks to get out their cash assets. But our banking system had long been set up as fractional reserve thanks to the National Banking Act of 1862. It was banker J.P. Morgan who realized that he could make money by providing liquidity to the system: he used his assets to make low-interest loans to the banks and to the Treasury, knowing that repayment would be secure when the crisis was over. As a result, the entire banking crisis of 1907 lasted less than two months. The economy recovered over the next year. In 1908, Congress passed the Aldrich坊reeland Act and established the National Monetary Commission to propose regulations in the banking industry to prevent such a panic from happening in the future. In 1913, the Federal Reserve Act created the Federal Reserve banking system and the central banking authority was given control over the money supply. In World War I, money was created to fund the war effort, but since the US was only in the war for a little over a year, it wasn’t as bad as it was in England, where high rates of inflation were experienced. Inflation has the effect of sending false signals into the economy, making the value of items appear to be greater than they really are. Once people realize this, the trend becomes to sell off assets– and easily liquidable assets like stocks are often the first and the most sold– and get whatever amount of money they can for them. This happened in 1921, and led to a stock market crash and a recession which, thanks to the Harding administration taking a hands-off approach, recovered in about a year– like the one which preceded it in 1907. Britain had it worse off, and in 1924, the Federal Reserve began to expand credit in the US in order to help the Bank of England recover. The idea was to inflate the dollar and deflate the pound. This initiated an economic boom, spurred further on by another expansion in 1927, and the Roaring ’20s, well, roared. Although no one at the time knew it (except for a few economists such as Ludwig von Mises and F. A. Hayek), this set the stage for another stock market crash. Once again, prices started to soar. It appeared as if everybody were becoming richer, making more money, but this was an illusion caused by inflation. What happens is, business costs rise along with it, and there comes a point where business costs have risen so much that businesses are no longer profitable. This is what triggers the recession. But the Federal Reserve didn’t want that to happen. In 1928, noticing the problem, they tried injecting still more money into the banking system. All this did was prolong the inevitable. Recessions, while undesirable, are necessary in such a case. It’s kind of like when your car breaks down. It may take a few days to repair, during which time you have to walk or take cabs or bum rides off of people. It’s an inconvenience, but it’s necessary in order to fix the car. But if you try a quick-fix, slapping the malfunctioning parts together with bailing wire and duct tape, you’re not only prolonging the inevitable; you’re making the damage much worse, guaranteeing a longer repair time. And so it is with the economy. The Fed’s credit expansions only delayed the coming recession and made it worse than it would have been. In 1929, fearing runaway inflation, the Fed hit the brakes on the money supply, stopping the expansion of credit. By August, it had raised the Discount Rate to 6%, and in response, time-money rates rose to 8% and call rates to 15 and even 20%. The thing is, it takes awhile for market players to realize that this has happened. For another several weeks, people continued to buy in what they considered a bull market. Then, the proverbial feces hit the equally proverbial radial ventilator. On October 24th, finally realizing what was happening, investors rushed like mad to sell their holdings at whatever price they could get for it. The stock market, as was inevitable, crashed. Despite the situation leading up to it, the recession that immediately followed the crash was relatively mild. Unemployment reached 8.7% in 1930. For the sake of comparison, the unemployment rate in the US for May 2009 was 9.1%. Why, then, did we enter the Great Depression? First we must point the finger at President Herbert Hoover. Unlike Harding, Hoover opposed economic readjustment and instituted central government planning. He urged businesses not to cut prices and wages, but to increase spending. Sound familiar? Then, President Hoobama–I mean, Hoover–embarked in deficit spending and increased funding for public works. President Bushama even–sorry, President Hoover even attempted price supports on wheat, cotton, and other crops. Then came the Smoot-HawleyTariff Act of 1930. This act raised tariffs to unprecedented high levels. This stifled foreign trade and according to most economists was the genuine start of the Great Depression. Other countries raised their tariffs and other trade barriers in response. Unemployment grew all over the world. The passage of the act even prompted another stock market crash. Restriction of imports had the effect–as they always do–of hampering exports as well. The agricultural industry collapsed, taking rural banks with them. The panic spread to banks that remained open. European countries froze the credit of the US and Britain. This led to a collapse of bond credits, and with it the destruction of the investment portfolios of banks in both countries. As if they hadn’t already done enough damage, the Federal government passed the Federal Revenue Act of 1932, which doubled the Income Tax, lowered exemptions, and eliminated the Earned Income Credit. The states followed suit, and the already crippled economy was brought to its knees. The American people voted Hoover out and FDR in. It hardly made a difference. FDR exacerbated the problems created by Hoover, erecting new barriers, seizing private gold holdings, and devaluing the dollar another 40%. He instituted a Minimum Wage, a 35-hour work week, and a ban on teenage labor, but of course all that does is destroy even more jobs and annihilate smaller businesses who just can’t afford all of that extra expense. Unemployment shot up to almost 25%. The South was hit especially hard, blacks and other minorities the hardest. At the same time, banks continued to fail. The Federal Reserve was created just for this purpose: to step in as Lender of Last Resort, creating money to supply liquidity to the banks, preventing more closures. The Fed refused to do this. In 1933 came the worst banking crisis in the history of the United States– the very thing the Fed was created to prevent. The thing about the free market is, it’s both powerful and resilient. Even being stifled as much as it was, it still had one more tool in its arsenal, one that would have solved the whole problem: the Gold Standard. In cases where the dollar is tight, people–and especially foreign banks–will turn in gold in exchange for dollars. Tons of gold came in from overseas, especially Britain. Under the rules of the Gold Standard, the Fed was supposed to use this gold as the basis for the creation of new money. But it didn’t. They just locked the gold away in a vault, and it was as if it didn’t even exist– even worse, since much of the money went to foreign banks in exchange for the gold, the US experienced Capital Flight. The Free Market was cut off at the knees. Contrary to popular belief, the New Deal was of no help at all. People not too well versed in economics, or who are deliberately spinning to support their political policies point to what they call enormous growth in the form of increasing GNP. Indeed, GNP did begin increasing in 1934, by 7.7%, up to 14.1% in 1936, but there are two things that this argument ignores. First, it’s much easier to achieve high growth rates when you’re at rock bottom. If all the money you have is a penny, and you find another penny on the ground, congratulations–you’ve just doubled your money! But how much better off are you, really? The second thing they ignore is, it didn’t last once the New Deal took effect. The biggest rise followed the Supreme Court overturning the National Recovery Administration in 1935 and the Agricultural Adjustment Act in 1936. This was the time of the biggest rise. Then, in May of 1937, GDP started dropping again. This was the year the Wagner Act, passed in 1935 in response to the Supreme Cort overturning the NRA, had its full effect on the economy. Unemployment rose yet again. Then from August 1937 to March 1938, the stock market fell by 50%. Finally, during World War II, the Fed released its stranglehold on the money supply when the government needed to fund the war effort. Of course, most of the money created went straight into the war, but after the war was over, the new money finally got us out of the Great Depression. There’s no reason why that couldn’t have happened immediately and prevented ALL of this. It is plain to see from this that the culprits responsible for the Great Depression are not the free market and the gold standard, but the Federal government and the Federal Reserve Bank. And extremely well-established economic principles predict that the same thing will happen again, if the same course of action is taken. And with President Obama reiterating the myths about the Great Depression, and relying on Works programs and other New Deal-style “solutions,” it seems that our government is entirely determined to repeat the mistakes of the past. George Santayana must be spinning in his grave.