The Free Market: The Fed’s Scapegoat for the Great Depression


There is a widespread notion that Black Tuesday and the Great Depression were caused by an unfettered free market. This couldn’t be anymore unfounded. This is ignorantly household knowledge, taught in schools, and accepted as a norm when discussing economic matters. Why is it the free market receives the blame, and not the Federal Reserve, whose recent establishment (1913) was intended to prevent these catastrophes? For one, as Milton Friedman claimed, the free market does not have a news press as vocal as the government’s. It is much easier to use a scapegoat for your mistakes when you have a propaganda wing at your expense.

Firstly, let’s establish the US did not have a free market at this time. Government interventions, subsides, income taxes, tariffs and most importantly, the Federal Reserve, were all involved in the economy at this time, specifically during the 1930s. The state of the US economy between 1920-1930 could hardly be deemed a free market.

Let’s start by discussing Black Friday. It is commonly attributed that over-investment and speculation was responsible for this massive crash. Quoting Jim Cox, “The imbalance of income and lack of consumption spending is not only an irrelevancy but also factually incorrect—consumption increased from 73 percent of GNP in 1925 to 75 percent in 1929.” Instead, one particular policy that is not commonly discussed was the Smoot-Hawley Tariff. Although the tariff was not passed until June 1930, its initial announcement negatively affected the stock market. Obviously, speculating on the future value of a stock and determining that a severe tariff would be imposed would dramatically decrease demand. Although cries of protectionist and economic interventionist still call for damaging tariffs in the name of “saving jobs” and “incentivizing domestic spending,” it is common knowledge that tariffs can damage economies.

Although monetarists, such as Milton Friedman, have a different view point on the depression than the Austrians, they nonetheless both claim it was from actions or inaction of the Federal Reserve. Monetarist blame deflation, Austrians point to inflation. According to the Austrians, during the 1920’s the Federal Reserve increased the money supply, which in turn forced low interest rates that incentivized investment in the stock market and real estate. Like many other economic busts, this one occurred after a large boom during the roaring twenties. According to the business cycle theory, mal-investment from artificially low interest rates cause a large increase in capital spending. Soon after this “boom,” consumers then decided to save their money instead of spending which causes a “bust” which essentially is a correction in the market. This is a normal occurrence in an economy that is controlled by a central bank that is coupled with fractional reserve banking. This is shown in the depression from 1921-1922 that was immediately corrected. Friedman, on the other hand, counters it was more of an inaction than an action of the Federal Reserve. He claimed it “was not the inflation in the 1920s, but the 1930s, when the Federal Reserve permitted the ‘Great Contraction’ of the money supply and drove the economy into the worst depression in U.S. history.”

However, President Herbert Hoover attempted to battle this particular bust, and subsequently made it far worse. He gathered major business owners and demanded they keep high wages, enacted the Smoot-Hawley tariff, and raised the income tax to 64 percent. These interventions do not bode well with economic growth, and the depression reflected that. Soon after, FDR was inaugurated and further escalated the government intervention. The federal government confiscated all gold and threatened jail time and established the infamous National Recovery Administration and the Agricultural Adjustment Act (AAA). Instead of fighting cartels, this artificially created them! They instituted price floors and ceilings and high minimum wages while the AAA destroyed crops in order to reduce output and increase prices. Break that down. The government burned and destroyed crops while there was mass starvation as a means of fixing a broken system! The Supreme Court soon found these maneuvers extremely unconstitutional, but it did not stop FDR in his crusade. He imposed new taxes, increased regulations on securities and exchange and enacted the Wagner Act, which maintained unemployment and further crippled already struggling businesses. Between 1937-1938, there was another sharp decline in the economy. This was the first recorded depression within a depression.

This is a very summarized account of the government’s involvement in growing the Great Depression. To blame this unimaginable decade on the free market is a complete disregard of facts, and instead a manipulated decree set forth by the Federal Reserve and the government. What could have been a temporary decline in the national economy was ultimately extended and further expanded due to government intervention.

Next to the evidence, there can be no greater proof than what Ben Bernanke, then Federal Reserve chairman, said during a final statement at Milton Friedman’s 90th birthday. “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

(The information in this article owes a great debt to the writings of Jim Cox and his book, A Concise Guide to Economics.)

* Logan Davies is a contributor and member of Being Libertarian. He graduated with a bachelor’s degree in business from Middle Georgia State University and is pursuing his Master’s in Business Economics. He is a proud father, outdoorsman, and has a keen interest in economic policy.

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Logan Davies

Logan Davies is a Regional Manager in the Banking Services industry, and the director of the non-profit organization, Voluntaryism in Action. He graduated from Middle Georgia State University with a degree in Business Administration. He is the father of a loving son, an avid outdoorsman, firearm enthusiast, and unwavering supporter of liberty.