One of the great myths about the great depression is that it was a failure of capitalism. Much as today, in 2011, the myth is rapidly spreading that our "Great Recession" is too, showing that somehow, it is a failure once again of capitalism.

To blame the great depression or even the problems of our own time on capitalism, simply ignores the truth of history.

Somebody once said, A Myth is like an Air Mattress. It is nice and comfortable but when you pull the plug out, you see that it is full of hot air.

With that in mind, I would like to give you the History of the Great Depression and show that it was not a failure of Capitalism but rather a failure of government. I can even specifically tell you, through the facts of History, exactly who was to blame. It just so happens they are also at fault today.

If you have only studied the Great depression in Elementary School, or you were taught economics in the USA in the last 70 or so years, this will be a fascinating read for you.

There is no way to give you detail and briefness, though, this is my attempt at doing both. If you have read Nobel Prize winning and Doctor of Economics, Milton Friedman, there will not be much new below for you.

It begins as most know, on a street in New York City...

Wall street, most of us know what happened there in 1929....

On Oct 29th, 1929 the market collapsed. It came to be known as Black Tuesday.

The wall street crash was followed by the worst (until maybe now) depression in United States History.

That depression has been blamed on the failure of capitalism. It was no such thing but the myth lives on. What really happened was very different.

Although prior to the collapse, things looked healthy on the surface, business had begun to turn down in mid- 1929. The following crash intensified the
recession.

So did continual bank failures in the south and mid-west but the recession only became a crisis when these failures were spread to New York.

And in particular, when it spread to the Bank of United States. The failure of this bank had far reaching effects and it need never of happened.

It was somewhat of an historical accident that this bank played the role that it did.

Why did it fail? It was a perfectly good bank. Many banks were in far worse financial shape, had come into difficulties before it did and had, through the cooperation of other banks, been saved.

The reason why the Bank of Untied States was not saved had to do with its very special character.

First it's name. Bank of Untied States. A name that made immigrants believe it was an official government bank, although in fact it was just an ordinary
commercial bank.

Second, the religion of the ownership was Jewish, both its name and the religion of its ownership which had so much to do with attracting depositors also, very unfortunately had the effect of alienating other bankers who did not like the special advantage of the name and did not like the Jewish ownership.

As a result, other banks were all too ready to spread rumors to help promote an atmosphere in which runs got started on the bank in which it came into great difficulty

These other banks, obviously, were less than willing to cooperate in the efforts that may have helped to save it.

Only a few blocks away was the federal reserve Bank of New York, it was here that the bank of United states could have been saved. Indeed, the Federal Reserve system had been setup, 17 years earlier precisely to prevent to worst consequences of bank failures.

The federal reserve bank of new york, devised a plan in cooperation with the super-attendant of banking for the State of New York to save the Bank of United States.

Their plan called for merging the Bank of United States with several other banks and also providing a guarantee fund to assure the depositors that the assets of the Bank of United Stated was safe and sound.

The reserve bank called meeting after meeting to try to put the plan into effect. It was on again off again for some time but finally, after an all night meeting on December 10th, 1930, The other bankers, including notably J.P. Morgan (the person) refused to subscribe to the guarantee fund and the plan was off.

The next morning, The Bank of United States closed its doors, never again to open for business.

For those depositors, who saw their savings tied up and their businesses destroyed the closing was tragic. Yet when the bank was finally liquidated, in the worst years of the depression, it paid back .92 cents on the dollar.

Had the other banks cooperated to save it, nobody would have lost a penny.

For the other New York banks, they thought the closing of the Bank of United States would have purely local effects. They were wrong.

Partly because it had so many depositors, partly because so many of the depositors were small business men, partly because it was the biggest bank that had ever been permitted to fail in the United States up to this time, the effects were far reaching.

Depositors all over the country were frightened about the safety of their funds and rushed to withdraw them. There were bank runs and failures of banks in droves.

And all the time, the federal reserve system stood idly by when it had the power and the duty and the responsibility to provide the cash that would of enabled the banks to meet the demand of their depositors without closing their doors

The way runs on banks can spread and can be stopped is a consequence of the "why" our banking system works.

You may think, that when you take some cash to a bank and deposit it the bank takes that money and sticks it in a vault some where.

To wait until you need it again to turn back over to you.

The bank does no such thing. It immediately takes a large part of what you put in and lends it out to somebody else. How else would you suppose it earns interest to pay its expenses or to pay you something for the use of your money?

The result is, that if all depositors at all the banks tried at once to withdrawal there wouldn't be anywhere close to enough cash in all the banks of the country to meet the demand. In order to prevent such an outcome, in order to cut short a run

There has to be a way to prevent people from asking for it or some additional source through which cash can be obtained.

This was to be the intended purpose of the Federal Reserve System.

It was to provide the additional cash to meet the demands of depositors when a run on banks arose.

The system was used successfully with other banks, such as the two in Salt lake city at the time. The banks used a system of psychology to end the bank run in two days.

The first day they offered money as slowly as possible while awaiting the arrival of reserve funds, by the second day with the funds arrived, they processed customers as quickly as possible so that a line could not form. By noon on the second day, people in the community understood that there money was available and left it in the bank.

One of the salt Lake banks even made a temporary loan to the competing bank when they ran out of funds so that word would not spread that a bank could not meet demand, thus ensuring that both banks could keep doors open. This option completely halted all bank runs in thecity. (testimony of George S, Eccles; Chairman, First Security Corporation)

It was all just a matter of reassuring the public that they could in fact get their money. The federal reserve system was their to ensure this happened by supplying cash to the banks.

So why didn't the system prevent the great depression after 1929? They knew what to do and did the opposite.

From 1929 to 1930 after the stock market crash the federal reserve system allowed the quantity of money to decline slowly, thereby throttling the monetary structure.

By December, 1930, the quantity of money had fallen 3%. This may not seem like much but a "growing" economy needs additional money in order to prevent deflation and the problems it brings.

Given this throttling of the monetary system, what happened after that was more or less inevitable. If it was not the Bank of the United States that had failed it would have been another bank failing that would have set off the runs.

Once the runs started, the federal reserve could of prevented them from having the disastrous consequences that they did by stepping in and providing the banking system in general with the cash they needed to meet the demands of depositors

After all, once depositors start trying to take their money out of the banks there is a strong tendency for the quantity of money to fall, each dollar of cash that is withdrawn from a bank had been backing several dollars of deposits.

If the federal reserve had stepped in. bought government securities on a large scale and provided the cash the depositors would have found that they could get their money and would of stopped asking for it.

Ironically, the people at the New York reserve bank, knew this was the right policy. No one had advocated it more forcefully than Benjamin Strong, The first head of the bank. Tragically for America, he died two years before the real crisis occurred.

With the death of Benjamin Strong, a struggle for power took place between The New York Reserve bank, the other reserve banks and the board in D.C.

The New York Reserve bank lost and the other banks and to a greater extent, the board in D.C. won.

This was a little noticed event but it was the first step, in the massive move of power to Washington, D.C. that has dominated our lives ever sense.

So what happened from this? Well the federal reserve system refused to buy government bonds, despite the plea from the New York Reserve bank.

The buying of government bonds would have supplied cash to the commercial banks so that they could have more easily meet the demands of the depositors.

Instead, what the Reserve system did was stand idly by while banks crashed around them on all sides.

As bank after bank closed, a chain reaction was in process, destroying money as it went.

Its a process, that even today, few bankers understand.

This is because the process does not take place within the bank, but rather through bank to bank transactions. You would have to talk to a bank accountant to get the real story which goes a little something like this:

As the people who ran the federal reserve knew very well, money is created by banks when money is loaned by one bank is deposited in another bank to be loaned out yet again.

During the depression, this worked in reverse. Banks were destroying money.

None the less, the federal reserve let it happen.

The end result was that by the time the whole, sorry episode was over, by 1933, the quantity of money in the Untied states had gone down by a third. The slow throttle had turned into a strangulation.

For every 3 dollars of deposits that people had in 1929, only 2 dollars were left.

For every 3 banks that were open in 1929, In 1933, only 2 were left.

The terrible depression that was left, was a direct result of the bumbling of the federal reserve system.

Their monetary policy stifled any hope of economic recovery.

Then and now...

Sadly, many of the mistakes of the past have had too heavy a hand in shaping the mistakes of todays times.

As the problem then was too little money, our economy handlers offer too much money! The bad policies that create the inflation we are facing today are direct result of the bad policies that gave us too much deflation between 1929 and 1933. Now they are killing the market with too much money! (QE1, QE2, QE3)

and back to then...

People came to believe that free market capitalism had failed. This was the myth created in the political climate of the time that persist to this day, despite the historical facts and work of leading economist proving otherwise.

So something was needed to replace it? No more Free Market Economics for us.

At Cambridge university, in England, a new orthodoxy emerged in the 30's one that has remained powerful to this day.

It owes its influence to one man, I am sure you know the name Keynes. (Keynesian economics)

John Maynard Keynes, was certainly a renowned economist of his time.

He found the great depression as both a paradox and a challenge.

It was a paradox because it seemed to contradict some of fundamental principals that economist had come to take for granted.

It was a challenge, as Keynes constructed a complex hypothesis, which not only explained what had been going on but also offered a way out.

A way to end the great depression and avoid similar occurrences in the future.

The core of his theory, was that what happened to the quantity of money didn't matter. What really mattered, according to Keynes, was a particular category of spending. Autonomous spending, so what kind of spending is that?

It could be investment by business enterprises in building factories, or new machines or adding to inventories.

It can be spending by individuals to build houses

or... most important of all.... it could be deficit spending by a government.

If private spending, was not enough to maintain full employment, then, according to Keynes, government could always step in to make up the difference with spending.

The theory of pump priming was born...

The theory was a godsend to politicians... I mean politicians are always more than willing to spend money, aren't they? Well, provided that they didn't have to raise taxes to high to pay for it.

So here was a solution that told them, not only to spend money but that it was absolutely mandatory that they do so for the success of the country.

And thus Keynesian economics was born in America.

Is it any wonder that government spending has exploded ever since?

Is it any wonder we abandoned the gold standard for a fiat currency?

Or that deficit spending, even without the excuse of war, and on a large scale has become the order of the day?

In America, the new Roosevelt administration adopted the Keynesian approach and authorized massive spending on government projects. It involved increasingly, a greater role of government in the economy. It developed programs, thought to bring financial security to every individual.

In England too, the idea that only government could boost an economy was becoming firmly established thus sealing their fate and tied the two nations with the largest free economies together, away from free markets and towards total, government control.

Though some of these programs may have been useful and needed during the depression, the large scale use of the theory even today would of horrified Keynes.

Keynes died in 1946, it was a shame he could not have made it another decade, for he was the one person of the day, whose name carried enough weight, to have exclaimed that what was good for the 30's and 40's should not be the policies of a very different post-war, post depression world.

I take the firm stance that he would of done so, if only given the opportunity, by fate of living another 10 years.

My stance is given weight by the last article Keynes ever wrote, published after his death.

In that article, he expressed strong reservations about the length to which so of his disciples had been carrying his ideas.

If he had lived another decade, the post war, inflationary period that has taken place ever since, could have completely been avoided.

Instead, student of today are taught his extreme measure policies as perfectly suitable for normal, everyday times. Entire country’s teach his thoughts, which by his own admissions, should not be taken to far or used at all in normal circumstances but students are not taught of his warnings, they are only taught the original theory, this even in place of normal, free enterprise, free market economics, in fact, many who learn his theory come to know it as free market economics, and this is the tragedy that has delivered our country to ruin.

The massive growth of government, that started during the depression has continued ever since.

If anything, it speeds up every year.

Each and every year, there are more buildings built by government, filled with more tax payer funded employees, creating more laws to restrict our free market and using our money to do it.

The great depression convinced the public the free enterprise was an inherently unstable system.

That the depression showed a failure of free market capitalism

That the government had to step in to provide for the stabilization of the economy to provide security for its citizens.

The wide spread acceptance of these views sparked the large scale, big government that we have today.

As many economist knew then, and have proven now, the truth about the depression was very different.

The depression was produced or at the very least, made far worse by perverse monetary policies that were followed by the US authorities.

Far from being a failure of free market capitalism, the depression was a failure of government.

Unfortunately, that failure did not end with the great depression.

Ever since, government has been attempting to "fine tune" the economy.

In practice, just as during the depression, far from promoting stability, the government has been the largest contributing force to instability.

We our the victims of our governments best intentions. If we would like to have a better system, we need to return to our free markets and give the power of the markets back to United States Citizens.