Summer School 7: The Great Depression, the New Deal and how it changed our economy

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0:19Welcome back, everyone, to Planet Money Summer School. Economic history of the world. The only way to make your summer feel like it's 5 ,000 years long. In a good way, of course. We have only two episodes left before Labor Day. like every history class you've ever taken, we have to pick up the pace if we're going to finish. So today we tackle the big one, the moment so often referenced by Planet Money that we made a jingle about it. We're going back to the Great Depression. Lesson seven, the Great Depression, the New Deal, and how it changed economics. I'm Robert Smith. Usually transforming an economy can take decades, centuries even, but the Great Depression rapidly transformed the relationship between government and business.

1:08Today, we'll trace how the 1930s altered the very nature of money itself and how we went from the worst moment for workers in the United States to one of the best. Joining us again is our U.S. financial history professor from Providence College, Sharon Murphy. Hey, Sharon. Hey, thanks for having me back. When we last left the United States of America in our economic telling of history, they were just starting to feel like they had gotten their act together. We're talking about the early 1900s here. They finally had one paper currency, the U.S. dollar. They had come up with a central bank, the Federal Reserve, and they really thought, what could possibly go wrong?

1:46Yeah, exactly. They really felt like they figured out the boom and bust cycle. This isn't going to happen again. 1920s, coming out of World War I, United States was virtually untouched by the war. We really, our economy's just, you know, doing great. They also had this sort of economic philosophy known as laissez-faire capitalism. We probably all heard this in our history courses. What is that exactly? So it's the idea that you want as little government involvement in the economy as possible. The economy will take care of itself. Everything will go better. if you just leave it alone. Looking back, we, of course, know that everything wasn't perfect in the economy of the 1920s.

2:30Leading up to the Great Depression, what was the problem lurking underneath that would end up causing it? So the Great Depression, I would say, is a confluence of issues. But one of the underlying things was really debt. There's a lot of debt in the economy, consumer debt, government debt. everybody's buying appliances, buying cars. Buying stocks. Buying stocks, yes, and going into debt for that as well. On top of that, we have vast wealth inequality. So this wealth inequality, this oversaturation in the market, the debt, all of these kind of came to a head in 1929. Sounds like a musical cue to me.

3:14Great Depression. We're going back to the Great Depression.

3:22After the break.

3:50Vanguard.com slash audio. That's Vanguard.com slash audio. All investing is subject to risk. Vanguard Marketing Corporation Distributor. This message comes from Greenlight. Ready to start talking to your kids about financial literacy? Meet Greenlight, the debit card and money app that teaches kids and teens how to earn, save, spend wisely, and invest. Start your risk-free trial at Greenlight.com slash NPR. Welcome back to Planet Money Summer School. In the fall of 1929, the U.S. stock market dropped by half. This marked the beginning of the worst economic crisis in modern U.S. history. I wanted to just play a bit here from our sister podcast at NPR, ThruLon.

4:36It was panic. Sixteen and a half million shares of stock sold in a single day. The tremendous crowds which you see gathered outside the stock exchange are due to the The greatest crash in the history of the New York Stock Exchange. ThruLine featured oral histories from the Great Depression. This one is from the writings of Dorothy Height, a college student who ended up living in Harlem. I looked with great anticipation into going to New York. And then when I got down to New York University, I found there were so many men there. And they were all selling apples. Little man, what now? Well, you can always sell surplus apples, five cents apiece on the street corner.

5:17They were five cents, but no one had five cents to buy one. I realized there was such pain in Harlem because you had whole families that were being evicted at any time. You could go down the street and there would be a whole family sitting whose every possession was placed on the street just because they didn't have the money to pay the rent. You'd see little babies and little children and their parents trying to deal with what was an impossible situation. An excerpt from NPR's ThruLine podcast, Lives of the Great Depression. When faced with economic crises in the past, governments often just waited them out.

5:58Things would get better eventually, right? But no one had seen anything like the Depression. Businesses closed, banks collapsed, eventually 25 % unemployment. Think about that. One in four people out of work. And this was happening all over the world. Presidents and prime ministers around the globe didn't know what to do. But it began to dawn on smart people that there was something that was making the Great Depression worse. Something that had been the bedrock of economics. That money was based on gold. The gold standard. David Kestenbaum and Jacob Goldstein pick up the story in this Planet Money episode from 2015.

6:36The world was falling apart. Stock markets were way down. Unemployment was way up. Banks were collapsing. And the gold standard was becoming a big problem. So just to review, the way the gold standard worked was that every major currency in the world was backed by gold. In the U.S., you could take$20.67, and the government had to give you an ounce of gold. In England, it was£4.86 for an ounce of gold. That was fixed. And in normal times, people didn't even really think about trading in their money for gold. They were perfectly happy with their paper dollars and their paper pounds. But of course, 1931 was not normal times.

7:13People were saying, you know what? I don't trust my paper pounds. I'm freaked out. I want gold. The stock market crashed in the U.S. Banks are going under. I'm worried the whole financial system might crash. So everybody started trading in their cash and demanding gold. And this was a big problem because at some point, the Bank of England is going to run out of gold. So Montague Norman, who is running England's central bank, has to stop this. And the only way to stop the rush of people converting their pounds for gold is to raise interest rates. Why raise interest rates? Well, if you raise interest rates, that's an incentive for people to hold on to their paper currency.

7:51People will say, OK, I won't trade it in for gold. If I keep it in the bank in England, I can earn all this interest. And this is why economists today look back and say the gold standard was such a disaster. In times of crisis, you want to be doing the exact opposite of this. You want to be lowering interest rates to make it easier for businesses to borrow money and hire people to get the economy going. This is what we do now when we hit recessions. Liaquat Ahmed wrote a book about this era called Lords of Finance. So you had this perverse system whereby in the middle of the Great Depression, with 15 percent unemployment, countries were raising interest rates.

8:29And that is essentially what converted what was a terrible depression into the Great Depression. This is Montague Norman's dilemma. He has to raise interest rates to keep gold in his country. But by raising interest rates, he's causing the Great Depression. Of course, Montague Norman does have another option, right? he could just say, we're off the gold standard. You can no longer trade in four pounds and 86 pence for an ounce of gold. This would solve his problem. He wouldn't have to worry about the Bank of England running out of gold, so he wouldn't have to keep raising interest rates. But for Montague Norman, the idea of going off the gold standard was insane.

9:04England was the world's biggest economic power, and in his mind, Britain's economy rested on the gold standard. So what does Montague Norman do, faced with this choice between two impossible paths, go off the gold standard? or choke the economy by raising interest rates, what does he do? He collapses. The sort of pressures of the job got to him, and he collapsed one day. Like loses consciousness? Yeah. I mean, he just couldn't get out of bed. And I don't quite know what all of the symptoms are of a nervous breakdown, but he basically couldn't function and would have terrible headaches. And so his doctor told him that you're going to have to leave the country and go on a rescue.

9:46This is the most important central banker on the planet at the time. Yeah, during the worst financial crisis. I suppose he was worried that if he did the wrong thing, he was going to bring the entirety of civilization to a halt. Well, that's exactly, you know, he thought that the entire, the future of Western civilization was in his hands. So with the future of Western civilization in his hands, Montague Norman gets on a ship and takes a trip to Canada. He writes in his diary, quote, feeling queer. And then while he's gone, actually while he's on the ship on his way back home to England, the people he's left in charge, they decide, you know, we said we weren't going to do this, but we have to do it.

10:25We have to abandon the gold standard because if we don't, we, the Bank of England, we're going to run out of gold. And they have to notify the boss, Montague Norman. So they send Montague Norman this cable in code. Remember, he's on the ship coming home. And the cable reads, sorry, we have to go off tomorrow and cannot wait to see you before doing so. And Montague Norman, he actually thinks this just means, oh, my friend's going to be out of the office when I get back. But, of course, what the cable means is we're off the gold standard. They're not leaving work early. They're taking one of the most radical steps in the history of finance.

11:00And not only is England catapulting itself into this crazy new world where money is just paper, they're also setting up what will be a chain reaction around the world. So to understand this, imagine two people in London the day before England goes off the gold standard. Both have 20 pounds in cash money. One of them goes to the bank that day and trades in his pounds for gold. He gets about five ounces of gold, just like it's always been. The other guy, he holds on to his paper money. All right, next day, Montague Norman's colleagues at the Bank of England drop the bomb. Boom, England's off the gold standard.

11:35What that means in practice is that when England cuts those strings tying the pound to the gold standard, the pound drops in value. So this guy who traded in his pounds for gold, he made a smart move. He did great. His five ounces of gold are now worth more than 20 pounds. He just made money by getting rid of his pounds before England went off the gold standard. The other guy, the guy who kept his pounds, he's the sucker. And obviously nobody wants to be a sucker. So people all over the world see England go off the gold standard. England, the mightiest economy in the world. And they worry, will my government do the same thing?

12:11Am I going to be the next sucker? So as their economies get worse, they start turning in their paper money for gold, including people here in the United States. Because of undermined confidence on the part of the public, There was a general rush by a large portion of our population to turn bank deposits into currency or gold. This is FDR's first fireside chat on March 12, 1933. The U.S. has just had the mother of all bank runs. People are afraid that banks are going to fail, so they're yanking their dollars out. And they're also worried that the U.S. will follow England and abandon the gold standard.

12:46So a lot of people are trading in their dollars for gold. People are hoarding cash and gold. And FDR is really upset about that. Let me make it clear to you that the banks will take care of all needs, except, of course, the hysterical demands of hoarders. And it is my belief that hoarding during the past week has become an exceedingly unfashionable pastime in every part of our nation. But FDR is actually about to make a move that will take all those unfashionable gold hoarders and turn them into winners. Everybody who's not hoarding gold, FDR is about to turn them into suckers. Here's Barry Eichengreen.

13:26He's an economist at the University of California, Berkeley, and one of the world experts on the Great Depression and the gold standard. He's preparing to take the U.S. off the gold standard. He's preparing to say we will no longer pay out gold at a price of$20 an ounce. You know what's amazing to me? He doesn't say, look, I know a lot of people are really attached to the gold standard. It sounds like it makes sense, but it doesn't make sense that I'm taking you off it. He doesn't say that at all. It's sort of in code. Yeah, he is kind of tiptoeing around the issue. And that's for two reasons, I think.

14:04Number one, to say the gold standard was a disaster and we are abandoning it for something better. Stay tuned for what that is. Wouldn't have been confidence inspiring. But the other part of the answer is that Roosevelt was kind of still grappling toward a full response to the crisis. In fact, FDR's top economic advisors are saying to him, do not go off the gold standard. They basically felt the same way as Montague Norman. Gold is the rock. It's holding everything together. But the U.S. is in the same bind that England was. If you stay on the gold standard, you've got to keep raising interest rates, which is strangling the economy.

14:43There is one guy advising FDR to leave the gold standard, a guy Liakit Ahmed says was definitely not part of the economics establishment, a guy named George Warren. FDR has been talking to this one crank, George Warren, who was a professor at Cornell, who he'd met because George Warren had helped him deal with some of his trees on his estate at Hyde Park. His trees? Yeah, he had a problem with some of his trees. You know, they were, I don't know, they were suffering from some disease. You don't imagine calling an economist in when you have that problem. Well, he was an agricultural economist, and Cornell had a very famous school of agricultural economics.

15:25You're right that he's known as an expert on cows and chickens. Exactly. So this expert on cows and chickens had actually published a huge monograph on how the gold standard affected commodity prices in the economy. And he said, you've got to leave the gold standard. It's the only way. And FDR took his advice. FDR comes into the room in the White House, and all his advisors are gathered around, and he announces, by the way, we're off the gold standard. He had introduced the decision to go off gold as an amendment, a sort of minor clause, and so I think it was the Agricultural Adjustment Act. He snuck it in.

16:08He snuck it in. And he sits there in this room with all his advisors and says, I know you think I can't do this, but here it is. We passed this thing. And they all exploded. And Dean Acheson resigned over it. He was the assistant secretary of the Treasury. And one guy, one of Roosevelt's advisors, told him that, you know, this is going to be the end of Western civilization. And Roosevelt is just kind of winging it here. He has this idea from the guy who helped him with his trees that now that he's off the gold standard, his hands are freed and he can fix this thing he thinks is a key problem, falling prices.

16:47This is what economists call deflation. And we've talked about this a lot on the podcast. Deflation means prices are dropping. And this can lead you into this thing called the deflationary spiral where prices start falling. So businesses, they have to cut people's wages. People are getting lower wages so they don't spend as much money. So that means prices have to fall some more. And this just keeps going on and on, back and forth in this downward spiral. And imagine a business. Say I'm thinking of opening a shoe factory. I need to borrow money to get started. But borrowing money seems scary because it's going to be really hard to pay that money back if the price of shoes keeps dropping, if I'm going to have to charge less and less each year for shoes.

17:25So I don't borrow the money. I don't build the factory. And I don't hire anyone. So FDR looks at this and he thinks, I've got to stop prices from falling. I've got to push prices up. And the price of gold, it's linked to the price of everything else. So FDR starts raising the price of gold. He has the government start buying more and more gold so that the price of gold goes up and up and up. And Liakit Ahmed says Roosevelt does this over breakfast. You know, he would have his whatever boiled eggs and toast and he'd be lying in bed and these guys would come in. And he'd say, so how much should we raise the price of gold today?

18:04And one day he said, let's do it by 21 cents. And the other said, why 21 cents? He said, well, seven times three. And, you know, that sounds like a good number. My lucky number. Lucky. Yeah. I mean, it's completely absurd. There was no economic rationale, although he sort of conveyed the image that this was a very well thought out, sort of well conceived plan. So this works. It did work. And the U.S. got out of the Great Depression almost, you know, most economists now agree 90 percent of the reason why the U.S. got out of the Great Depression was the break with gold. After all, there is an element in the readjustment of our financial system more important than currency, more important than gold.

18:54And that is the confidence of the people themselves. The Great Depression lasted for a long time after 1933. But 1933, the year we went off the gold standard, that was the year things stopped getting worse and started getting better. David Kestenbaum and Jacob Goldstein from 2015. Without the gold standard in place, central banks were free to lower interest rates, to stimulate the economy, get more money in the system. And you can see it in the data. After we went off the gold standard, prices started to go up again. The deflationary spiral we talked about had stopped. But President Roosevelt still needed to help jumpstart a stalled economy back to life.

19:34He would do it with a massive set of changes and government investment known as the New Deal, starting in 1933. Sharon Murphy from Providence College is back with us. Hey, Sharon. Hi, how are you doing? So all of a sudden overnight, we are no longer on the gold standard. What is a U.S. dollar then? Well, that's a great question. I mean, it is just trust in the government. That's all it comes down to. I mean, we now have truly fiat currency, fiat coming from the word Latin faith. We don't have anything backing it anymore. You can't trade it for anything anymore. The only thing that gives it any value is the fact that the government says it will accept it for taxes.

20:15Otherwise, it's just a piece of paper. The technical term for this is fiat currency, from the Latin meaning, let it be done, which is part of the magic. If the government says it's worth something, poof, it becomes true. I want to move on now to the New Deal, the set of government programs that Roosevelt launched after he was elected. And I have to say, I always thought it was like a single plan. But when I started to read about the New Deal, it was so many things. You know, they bailed out farms, they built things, they had a public works program, they regulated banks, deposit insurance, unemployment insurance, social security.

20:51It's an impressive list. Yeah, there was no plan in this. FDR, he talked about a new deal for the American people, which is where the idea comes from. But he basically just called in the smartest people he knew from around the country, told them all to come to Washington, put them in a room, and just started throwing spaghetti at the wall. Started, what do we think might work? Some of it was brilliant. Some of it was disastrous. Some of it was in between. And at the center of all, FDR believed very strongly that he wanted to rescue capitalism. There were lots of people saying capitalism has failed.

21:33We need to walk away. And he's saying, no, no, no, we need to rescue it. We need to regulate it. We need to make it more controlled. But we need to find a way to make it work. And so that was really important for him, having both capitalism and democracy, which are both under threat in the 1930s around the world. So he wanted to maintain both of those. So in the midst of all this change in the relationship of the government to the economy comes a British economist, John Maynard Keynes. What was his big theory and how was it used in the US? Yeah, so Keynes comes along and he says, you know what?

22:11We're thinking about this all wrong. The problem with these booms and busts is that every time you get into one, they take on a life of their own. So a boom becomes too big until it blows up. And then the busts, everybody just follows it down and they're cycles. And he said, we can intervene and smooth out these cycles, but we need the government to do it. The government needs to step in to cool the economy when it's getting too hot. and to inject more money into the economy when it's cooling off too much. And remember, at this point, it is now easier for the government to create money out of thin air because there's no more gold standard.

22:57So when no one in an economy is spending any money, the government can go into debt, pick up the spending, create government programs. And once the economy is healthy again, the government can back off a little. This was a huge change for the way the economy was managed. We will return with our professor after the break when we will tackle what this all meant for the American worker. Roosevelt helped save the economy, but workers would still have to take a stand for themselves.

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24:21Long-term projects need long-duration capital. That's where Apollo steps in. With scale, flexibility, and a focus on growth, they're partnering with companies to drive the future, one innovation at a time. Learn more at thinkitnew.com slash renaissance. We are back with Planet Money Summer School. One of the themes we've tried to trace through the economic history of the world has been how workers gain or lose power. And we talked about how after the Black Death in the 1300s, artisans could demand more money. And about how the Luddites in the 1800s tried and failed to keep their jobs. The Great Depression was a huge setback for workers.

25:01With one in four people unemployed, it was hard to negotiate anything. Wages fell by 43%. But part of the New Deal was a law that guaranteed the rights of workers to unionize. And when the economy started to look a little bit better, organized labor made their move. I did an episode with Jacob Goldstein in 2015 about a big strike at an automaker in Flint, Michigan, that changed the power dynamic. It was December of 1936, and a few autoworkers had a plan. They wanted to shut down the biggest carmaker in the world, General Motors. The way they were going to do it was they were going to seize a few key factories in Flint, Michigan, shut down the machines, kick everybody else out, and stay there until the company gave them what they wanted.