What Ended the Great Depession?

Several credible theories exist for what ended the depression of the 1930s and led to American prosperity post World War II.

The economy bottomed in 1933, and this was likely because of a combination of monetary and fiscal policy.

There is a notable correlation between the time countries abandoned the gold standard (or devalued their currencies substantially) and a renewed growth in their output. For example, Britain, which was forced off the gold standard in September 1931, recovered relatively early, while the United States, which did not effectively devalue its currency until 1933, recovered substantially later.

The evidence suggests that the US economy started to improve when expectations for future inflation rose, thus making consumers and businesses more confident to borrow and spend.

Most arguments also point to the deficit spending by the US government prior to and during World War II as the US and its allies built their armies. The 1933 New Deal is often heralded as the start of deficit spending and Keynesian economics, but, while effective,  significant impacts to GDP growth and employment weren’t really seen until rearmament picked up on a massive scale, which was around 1941. Even then, lasting prosperity for the average American didn’t arise until the after the war was over. This, however, was not expected.

After the war when millions of servicemen returned home and war production wound down, there was widespread concern that the US economy would plummet back into depression. Combine massive unemployment with huge government debt-to-GDP ratios and one can see why many expected a large contraction.

But the post-war period, except for a couple recessions, was a time of great prosperity for America. There are likely several reasons that America prospered after the war until the 1970s:

1. Innovations made during the 1930s and WWII were capitalized during the 1950s and on.

2. More integrated application of cheap energy (aka the energy subsidy) led to widespread innovation and a generalized rise in the standard of living. (E.g. kitchen of the future.)

3. Pent up demand for goods that were rationed during WWII was being unleashed. (Although not a ‘good’, this includes the demand for babies, which obviously results in demand for many goods.)

4. Massive government efforts to house returning GIs created a platform for long-term stability, consumerism and the growth of the middle class.

5. Massive government efforts to educate returning GIs helped form the basis of the service economy.

6. Perhaps most importantly, the global destruction of industrial capacity meant that American production had to fill the void. After the war, there was a real reason to produce and build! Industrial Europe and Japan were decimated, but there remained a massive population that needed to be housed, fed, clothed. Providing goods in a global economy with dramatically reduced capacity (and rebuilding global productive capacity) meant that all able hands were needed to pitch in. This resulted in a dramatic improvement in employment data.

You’re probably wondering why I’m writing this. My point is that an emergence out of a depression is only partly fueled by fiscal and monetary policy. I believe that real prosperity requires real demand – free money, government pet projects and tax incentives help stabilize unemployment but don’t create lasting prosperity. Consequently, the world may not be able to plan its way out of the current economic quagmire and back to prosperity. Such a result will likely be derived from a combination of unforeseen economic and social circumstances. Until then, the best we can do is soften the blow with monetary and fiscal stimulus.

Is the recession over or has the depression just begun?