Wall Street, the Great Depression, Hoover, Roosevelt, and the Unintended Consequences of Presidential Action

Across the political spectrum, leaders have been evoking Franklin Roosevelt lately. It's not distinct legislation that he and Congress generated that interests them. It is Roosevelt's leadership—his ability to consolidate political power and anchor the nation in a crisis. Vice presidential candidate Sarah Palin sought to sound presidential when she told Katie Couric that "there has to be action, bipartisan action." Joe Biden tried so hard to convey Roosevelt's power that he actually fell into anachronism, telling listeners that FDR "went on TV" to talk to a panicked electorate—when FDR's medium was the radio.

Cleveland parents stand in line with their children in quest for food portions.

But it's also possible that the very act of shifting power to the executive contributes to depressions rather than prevents them. Evidence old and new suggests that's what happened in the 1930s.

It started when FDR was still a governor in Albany, and Herbert Hoover occupied the White House. Hoover had initially made his name steering populations through crises, feeding starving Belgians during the First World War and, later, stewarding the South through the great flood of the Mississippi. As commerce secretary, Hoover always criticized his president, Calvin Coolidge, for using his office too sparingly. When the crash hit on his own watch, Hoover therefore jumped to act, using the office, or doing what he could to undermine Congress. Hoover signed off on a Republican tariff and created the Reconstruction Finance Corp. Around about the equivalent of now in the 1929 crisis—the autumn of that year—he summoned business leaders to Washington and persuaded them not to drop wages, the traditional next step during a downturn.

Some Hoover measures helped, in minor ways. The RFC supplied liquidity to a cash-short banking system. But other Hoover steps hurt. As I write this, the spotlight of concern is shifting to Europe and its flailing markets. Hoover's tariff seemed to confirm to Europe precisely what Mussolini and Hitler were telling it—the United States will shut you out. The condition upon which Hoover agreed to Smoot-Hawley was to take away power from Congress, with a new tariff commission calibrating rates. In exchange for hurting Congress and lobbyists, he hurt the world. Hoover also tended to blame to stock market. Like the Bush administration's own Chris Cox of the Securities and Exchange Commission, Hoover sought to stop short selling and berated traders as traitors to stability. This may have halted such sales, but it depressed regular stocks. In losing shorts, owners lost a crucial markets barometer.

It is the perversity of Hoover's wage policy, however, that Depression scholars have been warning about lately. Hoover insisted that industrial leaders keep wages high. Business complied—real average hourly earnings in manufacturing actually increased from 1929 in 1931, even as production dropped by nearly half. The action at the time seemed counterintuitive to business—in the last downturn, 1920 and 1921, wages had dropped. Now, however, companies pushed those wages higher partly because they believed, as Henry Ford was preaching, that wage increases might generate productivity gains to make the move worth it. But corporate leaders also acted, as UCLA's Lee Ohanian has shown, out of fear, because Hoover made it clear he was the only thing between them and unionization. In 1932, Hoover also signed the Davis-Bacon Act, which increased upward pressure on wages by insisting that public-sector jobs receive prevailing wages. Hoover bullied industrial America into a corner where it could do nothing but lay people off. Hence, there were 2 in 10 unemployed instead of 1 in 10. Ohanian concludes that Hoover's wage policy "accounts for much of the depth of the Depression."

Where Hoover used suasion, Roosevelt tended simply to snatch power. In his first inaugural address, FDR explained that he would use "broad executive power to wage a war against the emergency, as great as the power that would be given to me if we were in fact invaded by a foreign foe." When it came to labor prices, FDR and the New Dealers formalized Hoover's error in the form of the National Recovery Administration. The NRA gave big firms advantage over small fry and applied its own upward pressure through a minimum wage. In the previous depression, unemployment had lasted under two years. This time, 2 in 10 were still unemployed five years post-crash.

Roosevelt was even more aggressive on the monetary side. Before FDR, executives tended to stay away from questions like the gold price—J. P. Morgan, the young Federal Reserve, or the Treasury, at the very most, handled that. But in 1933, FDR took the country off the gold standard and even nullified promises to pay in gold in private contracts. He also launched a special executive program through which he would steer the gold price personally—from his bed, at breakfast time, while his advisers watched. One morning, FDR told his group he was thinking of raising the gold price by 21 cents. Why that figure, his entourage asked. "It's a lucky number," Roosevelt said, "because it's three times seven." As Henry Morgenthau later wrote, "If anybody knew how we really set the gold price through a combination of lucky numbers, etc., I think they would be frightened."

FDR was right in a global sense—there wasn't enough money in the economy. But Morgenthau was even righter—the manner in which FDR acted mattered as much as or more than the action. Wall Streeters such as James Warburg tried to explain to the White House that the inability to estimate exactly how far a president would go in a crisis was itself a problem. Warburg also explained that even bad market news was better than none. Another observer reported Roosevelt's reaction: "J. W. wants me to fix a definite price of gold, etc., as people now can't make future contracts," Roosevelt had said. "That's poppycock. The bankers want to know everything beforehand and I've told them to go to h—-," transcribed the economist Irving Fisher. In the end it was not the crash of 1929 or even the sharpness of the economic contraction of the early 1930s that made the depression so great. It was the duration.

What matters in the context of today is simply awareness that there's a tradeoff. When Henry Paulson, or for that matter President Bush, takes emergency action, the first reaction of markets will tend to be applause. But upon consideration, markets will drop, out of concern that the number of unknowns has widened. The scope of the $700 billion bailout package is a case in point. A chief executive can talk about reducing fear—Roosevelt's famous statement that "The only thing we have to fear is fear itself." But the same executive can also generate such fear.

Amity Shlaes, senior fellow in economic history at the Council on Foreign Relation, is author of the national bestseller The Forgotten Man: A New History of the Great Depression (HarperPerennial).