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From 1866 to 1875, the United States ran trade deficits; from 1876 to 1940, the United States ran consistent trade surpluses. During World War I, the United States became the world’s leading creditor nation as well as the world’s leading exporter, fulfilling a prophecy made in 1902, at a eulogy for the assassinated President McKinley, by his secretary of state, John Hay, who had served Lincoln as a top aide: “The ‘debtor nation’ has become the chief creditor nation. The financial center of the world, which required thousands of years to journey from the Euphrates to the Thames and the Seine, seems passing to the Hudson between daybreak and dark.”
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Following World War I, Britain owed the United States $4.7 billion and France owed $4 billion (France also owed Britain $3 billion). Other European countries owed the United States $3.2 billion; they owed Britain $8.1 billion and France $3.5 billion. At the same time, Germany owed enormous reparations to Britain and France, whose own economies had been weakened by war. Germany could not pay for those war debts by exporting goods to the United States, because of high American tariffs and superior American productivity in industry and agriculture. Like Germany, primary-product exporters such as Britain’s dominions and the countries of Latin America owed huge debts. And like Germany, to service their debts these commodity-exporting countries needed either to run large trade surpluses with creditor nations or to attract new lending. But at a time when Europe and Latin America needed to export more to the United States, imports as a share of American GDP fell.
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Instead of accepting more imports, the United States ran chronic trade surpluses with the rest of the world.

The United States reconciled its two roles as the world’s leading exporter and the world’s leading creditor by recycling some of the money it earned from trade surpluses in the form of private loans and investments abroad. Because isolationist pressure prevented the federal government from acting to help stabilize postwar European finances, representatives of the US banking community closely associated with the House of Morgan devised the Dawes Plan in 1924 and helped create the Bank of International Settlements (BIS) in 1929. The Dawes Plan was negotiated by the Chicago banker Charles G. Dawes and Owen D. Young, chairman of the board of General Electric, which had been created by J. P. Morgan, while the BIS was negotiated by Young and Morgan’s son J. P. “Jack” Morgan Jr. and his alternate, Morgan partner Thomas Lamont. The Dawes Plan arranged for US private loans to Germany to help it pay its reparations to Britain and France. To promote it, J. P. Morgan managed $110 million of a $200 million loan.

The Dawes Plan led to a $100 million loan by the US government to Germany, followed between 1924 and 1929 by $6.4 billion in loans, 75 percent of which went to governments. Around half of American lending went to Europe, a quarter to Latin America, and a sixth to Canada. The scale was comparable to the post-1945 Marshall Plan; indeed, US private and public lending exceeded America’s current-account surplus in the 1920s.
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Together with America’s new role as the world’s leading lender, the establishment of foreign subsidiaries by major US corporations created an alliance of economic elites in favor of a more internationalist foreign policy. In 1900, American foreign direct investment had chiefly funded agriculture in the Caribbean and Central America and foreign raw materials extraction. By 1929, over half of US overseas investment was carried out by the financial community, especially the House of Morgan and other New York banking interests, and the emerging oligopolistic corporations that dominated automobiles, electrical appliances, chemicals, and rubber.
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The New York financier Otto Kahn observed: “Having become a creditor nation, we have got now to fit ourselves into the role of a creditor nation. We shall have to make up our minds to be more hospitable to imports.”
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Owen Young complained to Commerce Secretary Herbert Hoover in 1926, “I am sincerely troubled by our national program, which is demanding amounts from our debtors up to the breaking point, and at the same time excluding their goods from our American markets, except for those few raw materials which we must have.”
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But the majority of businesses in the United States, including much of the manufacturing sector, were small enterprises that feared import competition, particularly if their labor-intensive strategies might be undercut by cheaper foreign labor. Following World War I, the Republican majority in Congress and the Republican administrations of Harding, Coolidge, and Hoover prevented the United States from taking part in the League of Nations and from signing a treaty with Britain to protect France against future attacks by Germany. They increased protection with the Emergency Tariff Act of 1921 and the Fordney-McCumber Tariff of 1922, which the French Finance Ministry denounced as “the first heavy blow directed against any hope of effectively restoring a world trading system.”
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President Calvin Coolidge declared: “Those who wish to benefit foreign producers are much more likely to secure that result by continuing the present enormous purchasing power which comes from our prosperity that has increased our imports over 70 percent in four years than from any advantages that are likely to accrue from a general tariff reduction.”
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FROM THE NEW ERA TO THE NEW DEAL

Just before the 1929 crash, the American banker and diplomat Norman Davis wrote in alarm: “History teaches us that whenever a newly-arisen, asset-rich nation refuses to open its markets to other countries or fails to effectively channel its financial resources to the development of the world economy, the result is growing conflict between the old order and the new. In the past, these conflicts have led to war, and to the division of the world economy into blocks demarcated by protectionism. Today’s intensifying international economic frictions and the mounting protectionism in the United States are both warning signs that the world is once again faced with such a crisis.”
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In the “New Era” of the 1920s, the United States resembled the China of the 2000s. Both the United States in the early twentieth century and China in the early twenty-first were only partly industrialized. In each country, a huge gap existed between the industrial regions and the agricultural hinterland. In each country, rapidly growing profits for the industrial sector were accompanied by the suppression of the wages of industrial workers and growing inequality. Each country followed a mercantilist strategy in international trade, maintaining trade surpluses in manufactured goods and accumulating hoards of foreign reserves—gold in the case of the United States and dollar-denominated financial assets in the case of China. In both cases, the combination of limited imports with inadequate domestic demand, resulting from low wages for labor and agrarian poverty, created a mismatch between overbuilt manufacturing capacity and national and global consumer demand.

In each case, domestic and global imbalances contributed to a global economic crisis—the Great Depression of the 1930s and the Great Recession that began in 2008. During the Great Recession of the twenty-first century, many economists argued that China needed to shift from a beggar-thy-neighbor export-oriented development strategy to a new economic model based on trade liberalization, higher domestic consumption resulting from higher wages for urban workers and state-sponsored rural development, and social-insurance programs that would reduce the need for individual Chinese to hoard savings for retirement and medical treatment.

There was a historical precedent for such a dramatic shift in economic strategy for a giant, newly industrialized economy. It was America’s New Deal. But to go from the New Era to the New Deal, the United States had to endure the ordeal of the Great Depression.

The true conservative seeks to protect the system of private property and free enterprise by correcting such injustices and inequalities as arise from it. . . . I am that kind of conservative because I am that kind of liberal.

—Franklin Delano Roosevelt, 1936
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B
y eleven o’clock on Thursday, October 24, 1929, there was frantic selling in the New York stock market. “Black Tuesday” followed on October 29. The Dow Jones Industrial Average plunged by nearly 13 percent, as sell orders paralyzed the ticker tape system of Wall Street. The collapse of the stock market left individual stocks by mid-November at half of their earlier price.

The stock market declines in the fall of 1929 resulted from attempts by the Federal Reserve to prick a dangerous stock bubble by raising the discount rate (the interest rate at which banks borrow from the Fed) in a series of steps, from 3.5 to 4 percent in February to 6 percent in August. The last rate increase was followed by “Black Thursday.”

At first many assumed that the Depression was an ordinary cyclical recession. In May 1930, President Herbert Hoover said: “I am convinced we have now faced the worst.” But at the end of 1930, a wave of bank failures swept through the United States. In 1931–1932, more than five thousand American banks failed.

On May 11, 1931, the failure of Austria’s largest bank, Creditanstalt, triggered a wave of financial crisis throughout Germany and Central Europe. Many US banks had much of their capital in German securities and were affected by the rippling collapse of the German financial system. In order to provide Germany with temporary relief from the burden of reparations payments imposed on it by the victors of World War I, Hoover ordered a one-year moratorium on debts to the United States by America’s World War I allies. But this was too little and too late to prevent the German banking system from toppling, to the benefit of Adolf Hitler’s National Socialist Party.

By the time the stock market hit bottom in July 1932, the Dow had lost almost 90 percent of the value of its high point in September 1929. From 1929 to 1931, 15 percent of American banks went out of business. At the beginning of 1933, US employment in industrial production had dropped to half of its 1929 level. National income dropped from $83.3 billion to $40 billion between 1929 and 1932. By the time Hoover left office in March 1933, unemployment had increased to 24.9 percent. In the ultimate sign of the failure of American capitalism, 100,000 Americans applied for six thousand job openings in the Soviet Union.
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The Depression discredited the Republican Party, which had dominated American politics since the Civil War, and brought to power a new coalition of Democrats and progressive Republicans led by America’s only four-term president, Franklin Delano Roosevelt (the Constitution was amended, in 1951, after his death to limit presidents to two terms). Just as the Civil War and Reconstruction had been the Second American Revolution, so the New Deal and World War II were a Third American Revolution. In the course of a decade and a half, the New Deal modernized America’s political and economic institutions to better realize the potential prosperity made possible by the second industrial revolution based on electricity and the internal combustion engine. On the foundations laid by New Deal liberals from Roosevelt to Lyndon Johnson, the American middle class experienced its greatest expansion in numbers and growth in prosperity.

WHAT CAUSED THE GREAT DEPRESSION?

What caused the Great Depression? Following earlier recessions and depressions, there had been rapid recoveries. The persistence of the Depression has been blamed on both short-term policy mistakes and long-term structural weaknesses in the American and global economies.

The Depression is sometimes blamed on the passage of the Hawley-Smoot Tariff, which was signed into law by Hoover on June 17, 1930. In a televised debate about the North American Free Trade Agreement (NAFTA) in 1993 with the former independent presidential candidate Ross Perot, Vice President Al Gore displayed a photograph of Senator Reed Smoot and Representative Willis Hawley and blamed the Depression on the tariff that bore their names. According to Jude Wanniski, a proponent of conservative “supply-side economics” in the Carter and Reagan years: “The stock market Crash of 1929 and the Great Depression ensued because of the passage of the Smoot-Hawley Tariff Act of 1930.”
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Richard Cooper, who served as undersecretary of state in the Carter administration, wrote: “The seeds of the Second World War, both in the Far East and in Europe, were sown by Hoover’s signing of the Hawley-Smoot tariff.”
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The Hawley-Smoot Tariff became law in June 1930, with the support of farmers and labor but over the objections of financiers and 1,028 academic economists who signed a petition against it. The bill had been moving through Congress in the summer of 1929 before the crash of the stock market and it was not a response to the Depression, just as it was not a cause.

The tariff became the highest in American history only because duties were set in terms of dollars, not shares of a product’s price, so that when prices of imports collapsed during the Depression, the tariffs rose to levels that the bill’s drafters had not intended, to a peak rate of 59.14 percent on dutiable imports. Had prices remained at 1929 levels, the average tariff on dutiable imports would have been 41.6 percent, a level exceeded by US tariffs for 51 years out of 94 between 1821 and 1914.
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While there was some foreign retaliation against the tariff, this did not cause global trade to collapse. US exports were no more than 7 percent of GNP in 1929. Between 1929 and 1931, US exports fell by 1.5 percent of GNP, while US GNP declined by 15 percent.
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The volume of world trade shrank by two-thirds from the last quarter in 1929 to the first quarter in 1933. The global collapse in trade that came after the passage of the tariff was the result of a sudden, universal drop in demand, not of retaliation against American protectionism. A similar collapse in trade occurred in 2008–2009 at the beginning of the Great Recession, in the absence of tariff wars.

Economists from Milton Friedman on the right to Paul Krugman on the liberal left have dismissed the idea that the Hawley-Smoot Tariff caused or worsened the Depression.
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If the tariff had any effect on the US economy, it was probably a slightly positive one, by substituting domestic for foreign production.
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The demonization of the Hawley-Smoot Tariff persists as a cliché in American discourse because of the fear of American internationalists that the United States will revert to its pre-World War II isolationism and protectionism. In the same way that “Munich”—British prime minister Neville Chamberlain’s agreement with Hitler in 1938—was invoked by the American foreign policy elite as a symbol of appeasement, so “Hawley-Smoot” became a symbol of the protectionist economic strategy that the now-hegemonic United States repudiated following World War II.

Other explanations of the Depression are taken more seriously by scholars. In the 1960s, Milton Friedman argued that the Great Depression was purely the result of the failure of the Federal Reserve to loosen the money supply.
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Others emphasize the decision of the United States to remain on the gold standard after Britain and other countries had abandoned it, a decision that limited America’s flexibility in monetary policy. Yet other economists and historians have criticized explanations of the Depression in terms of mistakes by Federal Reserve or Treasury technocrats because those explanations neglect real factors such as the trade and income imbalances emphasized by many thinkers of the time.
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Theories that attributed the severity as well as the triggering cause to mistakes by government policymakers gained in appeal among academic economists after the revival in the late twentieth century of free-market conservatism. By putting the blame for the prolongation of the Great Depression entirely on mistakes by technocratic policymakers, these theories implied that there had been nothing wrong with the structure of American capitalism in 1929.

That complacent late-twentieth-century consensus is more difficult to defend, however, following the crash of 2008 and the Great Recession that followed. The decades preceding both the Great Depression and the Great Recession were characterized by extreme global trade and currency imbalances—chronic American current account and capital account surpluses before 1929, chronic Chinese current account and capital account surpluses before 2008. And before each crash, there was a dramatic increase in income inequality, with many of the gains to the rich from their disproportionate share of growth being used to engage in speculation that inflated bubbles in stocks, real estate, and other assets.

In the years preceding the crash of 1929, a growing number of thinkers and reformers were concerned about the implications of the maldistribution of income for the functioning of the new mass-production economy. Before John Maynard Keynes made the idea of government spending to maintain aggregate demand academically respectable, William Trufant Foster and Waddill Catchings, in a series of influential books in the 1920s, popularized the idea of using relief or public works programs to get purchasing power into the hands of consumers.
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Edward Filene, the founder of the Century Foundation and Filene’s department store, with its Automatic Bargain Basement (later Filene’s Basement), argued that the translation of business profits into stock speculation rather than consumption by workers damaged the economy: “At a time when more buying was the need of the hour, [capitalists] were still calling upon the masses to refrain from buying goods, and to invest their savings in more production; and when industries languished from want of customers, they advised reducing wages, a process which must result in a further falling off of sales.”
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This analysis was shared by Marriner Eccles, the Utah banker whom Franklin Roosevelt appointed as chairman of the Federal Reserve, a post he held from 1934 to 1948. In his memoirs, Eccles argued that insufficient purchasing power by middle- and low-income Americans was the underlying cause of the Depression: “As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth—not of existing wealth, but of wealth as it is currently produced—to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929–30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. . . . Had there been a better distribution of income from the national product—in other words, had there been less savings by business and the higher-income groups and more income in the lower groups—we should have had far greater stability in our economy. Had the $6 billion, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.”
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Employee compensation as a percentage of net income in manufacturing was 77.6 percent in 1923 and 75.3 percent in 1929; as a share of the economy in general, employee compensation was 77.9 percent in 1923 and 72 percent in 1929.
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Because the employee share of compensation did not dramatically decline in the 1920s, some have dismissed theories based on underconsumption and maldistribution. But those theories rested on the claim that, from the beginning of the industrial era several generations earlier, the maldistribution of wealth had contributed to destabilizing cycles of boom and bust, which might have been moderated by greater consumption by the many and less saving and speculation by the few.

A historical event as cataclysmic as the Great Depression need not have had a single cause. An event or trend can trigger an economic collapse that is ultimately caused or prolonged by underlying structural defects of the economy.

“THE MOST GIGANTIC PROGRAM OF ECONOMIC DEFENSE AND COUNTERATTACK”

In his 1932 campaign for reelection, President Hoover declared that “we might have done nothing. That would have been utter ruin. Instead we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put it into action.”
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The journalist Walter Lippmann agreed: “The policy initiated by President Hoover in the autumn of 1929 was something utterly unprecedented in American history. The national government undertook to make the whole economic order operate prosperously. . . . [T]he Roosevelt measures are a continuous evolution of the Hoover measures.”
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Partisan Democratic propaganda convinced later generations that Hoover had been a believer in laissez-faire who did nothing while the economy crumbled. In fact, Hoover believed that government had a duty to intervene in economic downturns. In 1929, Hoover supported and Congress passed a stimulative tax cut, justified in Hoover’s view by an anticipated federal surplus.
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He supported reductions in interest rates by the Federal Reserve. In November 1930, Hoover sent state governors, including New York governor Franklin Roosevelt, a telegram with an exhortation to “energetic, yet prudent, pursuit of public works.” He called on federal agencies to expedite public work projects and sought an additional $423 million from Congress for the Federal Public Building Program.
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Under Hoover the Commerce Department created a Division of Public Construction that increased ship-construction subsidies and asked Congress for additional public-works appropriations.
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