Did the New Deal Work?
by Gerald O’Driscoll
Issue 125 - February 4, 2009

I must enter the debate on whether the New Deal really worked or not, especially the statement that “everybody thinks getting off gold was important to recovery. “

The post-World War I monetary system was not a classical gold standard, but a Ricardian gold-exchange standard. It was a complete mish-mash. It mixed central-bank discretion with the trappings of a gold standard. The Europeans, the British especially, would not accommodate themselves to their reduced circumstances (in real terms). It didn't mean that a classical gold standard was not an excellent system. Why did gold work in the 19th century and not the 20th? Answer: it wasn't the same system!

Importantly, there was no recovery after everyone got off the gold standard. Henry Morgenthau lamented that unemployment at the end of the 1930s was where it was when the Roosevelt Administration assumed power. He knew the New Deal had failed (Unemployment peaked at just under 25% in 1933 and was just over 19% in 1938). Markets are resilient and Roosevelt thwarted them at every turn (a process begun by Hoover, for which Roosevelt properly criticized him in his campaign). The danger is that Barack Obama will follow George W. Bush and do the same (repeating Roosevelt's mistake in raising the ante on Hoover's interventionism).

Again, recovery only began when the New Deal began to unwind. No other depression in modern history lasted so long because never had a government intervened so much. The "cure" was worse than the disease.

Years ago at a now-forgotten monetary conference, economic historian J. R. T. Hughes gave a brilliant presentation on why all attempts at explaining the Great Depression failed. No one theory can explain the magnitude and duration of the event. On contemporary mainline monetary historians, I prefer Michael Bordo overall. Peter Temin's recent critique of real business cycle theory is devastating.

We are now faced with a bursting of a bubble caused by excessive monetary ease, low interest rates (negative in real terms), and all sorts of artificial stimulus to housing and consumption. The "solution" is to replicate all the policies that produced the crisis, and then add some new ones. A recession is the adjustment an economy goes through as a result of bad policy. The current one is especially severe because the policies were so bad.

We are all poorer than we thought we were. How can government policy eliminate that fact? It can transfer resources to favored groups from politically weak groups. That may partially insulate the former groups at the expense of the latter. I know of no system of morality in which that is justified.

Gerald O’Driscoll is a Senior Fellow at the CATO Institute and a widely quoted expert on banking and monetary policy. Previously the director of the Center for International Trade and Economics at the Heritage Foundation, O’Driscoll was senior editor of the annual Index of Economic Freedom, co-published by Heritage and The Wall Street Journal. He has also served as vice president and director of policy analysis at Citigroup, and vice president and economic advisor at the Federal Reserve Bank of Dallas.