What caused the Great Depression? Many still believe that it was the greed of the unrestricted market, but the facts tell a different story. Three kinds of government interventions played a major role. One: Countries returned to the gold standard in the mid-1920s but the asymmetry of response to gold flowing between them had a significant deflationary bias. It did not take too long for the flawed international monetary system to affect the economies on both sides of the Atlantic. Two: The Fed, after becoming overconfident in their ability to smooth out the business cycle, decided to pop the speculative bubble by selling $393 million worth of securities between December 1927 and July 1928. This act not only triggered a spectacular crash on Wall Street but also had a disastrous spillover on Main Street. Three: What helped the spread and the protraction of the economic downturn throughout the world in the 1930s was the adoption of protectionist policies by most countries.
What deserves our special attention is the disastrous effect of the policies followed by the Federal Reserve Banking system prior to, and at the early stages of, the Great Depression. The fall in nominal interest rates successfully fooled the monetary authorities into thinking that the economy was overheating as a result of cheap credit. The Fed used its power to let some of the steam out and intentionally lowered money supply, firmly believing that this would not affect output significantly. These policies limited the amount of loans offered to businesses and suppressed investment. As expectations worsened and people panicked about their savings, the country witnessed bank failures on a large scale. The Fed ignored the cries for help and many healthy credit institutions sank due to becoming temporarily illiquid. Mistaken assumptions and perverse actions ruined the credit market. The amazing irresponsibility of the Fed left the economy no chances for quick recovery.
Eighty years after the Great Depression we have very few survivors who remember how unscrupulous politicians exploited the fear to force the private sector to surrender its sovereignty over many economic choices. Very few realize how state control over the economy has opened the door for the Marxist belief in the instability of capitalism. How many history teachers in today's American public schools teach the real story of the most important event in the 20th century? What is the number of young people who have at least a vague idea of what really happened during the Great Depression? Both numbers are so small that today we accept direct government interventions in various sectors of the economy as normal. We have thrown away so many of our personal freedoms. And we are so convinced that we have traded them for security provided by benevolent government officials that we do not even remember what these freedoms were.