The Capitalism Myth: The True Causes of the Great Depression

A common tendency of new social movements, religions, and other dogmas is that they create a myth to explain events, whether past, present, or future, that provides a consistent and comprehensive picture which its believers find highly convincing and satisfying. These kinds of myths appeal to believers because of their simplicity, coherence, and their ability to explain many aspects of the world we live in. It is not the intention of the creators of these kinds of myths deliberately to deceive people, but that is often the result of their efforts to make sense of the world according to their beliefs, while reducing its vast complexity to a simple and comprehensible order. After all, the great majority of the theories that have been propounded about life, or some particular aspect of it, such as human life, have turned out to be false, whether in whole or in part.

Perhaps the oldest and most common examples of these kinds of myths are creation myths that present a simple story to explain how the world or Universe was created – how its visible components like the Sun, moon, stars, animals, plants, and human beings came to exist, how geological features such as oceans, mountains, and volcanoes were formed, and why the world, or certain features of it, is as it is.

Can science be considered as a collection of myths that aim to make sense of the world? There is, of course, an important difference between science and myth, namely, that science claims that its myths, or theories, are true. Another difference is that science, rather than ignoring the complexity of the world, as most myths do, attempts to account for this complexity by studying it in minute detail. But it is no less true that myths also claim or claimed to possess the attribute of truth, and many of them are clever, or at least plausible. Regardless of the way one answers this question about science and myth, it is clear that science has been much more successful in explaining the phenomena of the world than other myths, and therefore it has largely displaced many previously-accepted local myths as a way of explaining events and understanding the world. However, I do not wish to delve further into this topic in this essay.

Some myths continue to endure, an example being Greek cosmology, which was adopted by the ancient Romans after they conquered the Greeks, and continues to enthrall and captivate readers even today, despite the fact that we no longer believe in their gods as the ancient Greeks and Romans did. Modern comic superheroes are variations of the Greek gods – flawed and emotional human-like creatures, each of whom is usually endowed, in addition to immortality, with a specific superhuman power or attribute, and who often use their powers for the good or ill of humanity. In addition, just like the ancient Greeks and Romans believed of their gods, they are intimately interested in and concerned with the affairs of humanity.

All religions and ideologies have their myths, which present their particular version of reality by combining fact and fiction in accordance with their beliefs about the world. The communists reinterpreted human history according to the theory that was propounded by the founders of communism, which also predicted a certain inevitable future course of events. The sway of the Communism Myth has fortunately diminished, following its failure correctly to explain both human behaviour and the course of historical events, as well as, contrary to the lofty promises made by its founders, its failure to provide a better material life for the many people who came under its sway and its totalitarian control.

Perhaps because of the ideological void left by the discrediting of this myth, we are now witnessing the rise of a new myth, the Capitalism Myth, which is rapidly gaining converts and believers in its veracity. Moreover, it is making converts of many individuals who are otherwise intelligent and reasonable, a power that was also possessed by the Communism Myth, which seduced many intellectuals during the nineteenth and twentieth centuries. It is important to discredit this myth by showing that many of its assumptions, beliefs, and predictions are completely false because, if it is left unchallenged, it will grow, like a malignant tumor, and weaken or destabilize those societies that fall prey to its malicious influence and its sirens’ promise of greater freedom and prosperity for all.

Here is a succinct statement of this myth:

Capitalism, writes economist James Doti,

is not a pretty sight. Capitalists motivated by greed seek their own gain by maximizing profits. The forces of the marketplace, however, convert this private vice into public virtue. Thus, living a life based on greed . . . can do quite well . . . to better society and benefit our fellow human beings.[1]

The Capitalism Myth exists in a number of different versions, depending on the person that is propounding it.[2] But there are features that are shared by most or all of these different versions, which can thus be considered as variations on a common theme. Among these shared features are the following:

(1) Left to itself, capitalism produces the greatest prosperity for the greatest number. In other words, free-market capitalism is the best possible economic system. Even if it has some flaws, it is certainly better than any other economic system that has been tried in the course of human history.

(2) Government intervention in the economy is bad because it distorts, reduces, or eliminates the natural incentives that motivate individuals and companies to produce products and provide services that benefit and enrich society and make our lives easier and more comfortable, while producing or providing them in a more efficient, and therefore less costly, manner.

(3) Government programs or policies like welfare, unemployment insurance, health care, minimum wage, and so on destroy or gravely weaken the individual initiative or motivation that is the motor of a free-market economy. Hence, they should be reduced or eliminated in order to minimize their harmful, demoralizing, and distorting effects. Those who do not or cannot find work are lazy, incompetent, or selfish parasites that want to ride through life on the sweaty backs of those who work; therefore, these undesirable qualities should not be encouraged by government handouts. Moreover, private charities, churches, associations, organizations, and other humanitarian agencies are able to meet all the needs of those who are in need, or at least those needs that should be addressed, and therefore government welfare programs are unnecessary.

(4) Government regulations are not necessary because, besides adding unnecessarily to the costs of businesses and thus hindering their growth or development, the considerable incentives that exist in a free market, together with the free choice of consumers, are sufficient, in and of themselves, to ensure that the participants will never lie, deceive the public, or try to sell useless or badly-manufactured products; and even if they do, they will be swiftly punished for their dishonesty or mistakes by a loss of revenue and profits.

(5) Allowing competition in every industry or field of human endeavour is the best way to increase efficiency, reduce waste and redundancy, and lower costs. In other words, the more competition there is, the better, for competition is the purifying mechanism that will produce affordable plenty for the greatest number of people and will, in the long run, eliminate poverty all around the world. Competition can be likened to the process of refining metals, which eliminates impurities and dross, leaving the pure, unadulterated state of the metal.

(6) Since monopoly is bad, and since a government-run agency is, by definition, a monopoly; and, moreover, competition is good, it follows that any government program, department, or initiative will necessarily be less efficient, innovative, and adaptable, while being more costly, than when it is operated by a privately-owned company. In other words, it is better to privatize as many government programs and departments as possible, rather than leave them in the inefficient control of the government.

(7) Due to the inviolable and logically sound principle of comparative advantage, all countries should specialize in producing only those goods in which they enjoy a comparative advantage over other countries, and then exchange their products with each other in order to maximize people’s well-being. Hence, all trade barriers, including tariffs on imports, quotas, restrictions on the free movement of labourers from one country to another, and so forth, should be eliminated, or minimized as much as possible.

(8) Because individuals are the best deciders of what is best for them, they should be allowed to spend their money in whatever way they think is best, without the government deciding for them or telling them what to do. Hence, it follows that taxes should be minimized, and government should limit itself to providing its citizens with the basic structure of a civil society, which are national defense, the police, and a fair, effective judicial system. In a limited number of cases, governments may be justified in funding, constructing, and operating large infrastructure projects such as roads, airports, and bridges; but it will be found that even these will be better provided by the private sector, since private companies do not suffer from the bloated bureaucracies that exist in all government departments.

(9) Capitalism, when it is fully implemented, will produce an increase in individual freedom because, in order to function properly, the capitalist system requires that people be free to do as they think is best.

(10) Although monopolies may be bad, government efforts to prevent them (antitrust laws) make a bad situation even worse. Hence, no efforts should be made to restrict the size of corporations, since it is a basic economic law that the bigger a corporation, the greater are the savings due to its inherent efficiencies of scale.

(11) Labour unions are both bad and unnecessary: bad because they distort the operations of the free-market system by introducing artificial distortions like the minimum or union wage, which is usually higher than the actual market wage, and they destroy or weaken the incentive to work harder than everyone else, since one of the aims of unions is to make it difficult to fire employees; and unnecessary because competition between the owners or managers of capital will force them to be kind, fair, solicitous, and benevolent towards their workers, especially towards skilled workers, if they want to keep them in their employ.

(12) Capitalism, although it caused some hardships for people at the beginning of its long and glorious march towards progress and material prosperity for all, has been a shining example, in contrast to the often dark and dismal history of our species, of humanity at its best: hard-working, orderly, productive, ingenious, risk-taking, and self-sacrificing in the single-minded pursuit of the noble goal of improving people’s lives, whether one’s own or those of others.

(13) It is bad government policies, and not, as is commonly believed, human greed and reckless speculation, that were the cause of financial crises like the Great Depression and the 2008 financial crisis.

This list of capitalism’s many virtues can be summarized as follows: because the free market is good, anything that interferes with its operations is necessarily bad, including government interference of any kind. The believers in the Capitalism Myth regard government as the enemy that limits freedom, hinders progress, reduces prosperity, discourages initiative and innovation, takes away from people their hard-earned income, and unfairly penalizes and punishes the true heroes of capitalism – the entrepreneurs, business people, and corporate executives who, together, through their hard work, ingenuity, sacrifice, and willingness to take large financial risks, make our lives vastly better than we could have done ourselves, without their considerable but frequently unacknowledged contributions to the welfare of humanity.

Considering this long and impressive list of benefits, it is not at all surprising that the Capitalism Myth has succeeded in winning converts to its banner in ever-increasing numbers. But there is a very curious fact about capitalism, a fact that even its staunchest supporters do not deny or try to hide. I will call this fact the “Capitalist Paradox”:

If free-market capitalism is such a wonderful system, and if, as its advocates claim, it produces only or primarily good, without any bad or harmful, effects, then why has it never been adopted before, and why are people and countries all over the world not rushing to implement it as quickly as possible?

This sobering consideration should lead us to question the supposedly miraculous benefits of free-market capitalism, as well as the postulates of the Capitalism Myth. Modern medicine has been adopted all around the world because it is good and, for the most part, provides effective treatments and cures for people’s health problems. The fact that free-market capitalism hasn’t been adopted as widely and unreservedly is a sign that it isn’t the unmitigated good that writers like Milton Friedman, Friedrich Hayek, and Ayn Rand would have us believe it is. Without realizing it, these fervent apologists of free-market capitalism have contradicted themselves. For if, as they argue, human beings are rational creatures who know their best interests, which is their argument for minimal government taxation and interference in their lives, then the fact that they haven’t adopted capitalism without numerous checks, restraints, and correcting measures means that this “best of all possible economic systems” probably has significant problems – problems which they, in their blind admiration for this ideology, have completely overlooked.[3]

The main problem with the Capitalism Myth and why it is wrong is that it is founded on a number of false premises. These include, but are not limited to, the belief that human beings are rational creatures, that unbridled competition is always beneficial, that people have perfect and complete knowledge of all things and at all times, that there exists perfect labour mobility, that people, being rational creatures, are not susceptible to irrational panics and enthusiasms, and that selfishness and greed are good because they motivate people to work harder in order to enrich themselves, while at the same time benefitting other people.

If human beings were actually the rational creatures that philosophers and their numerous imitators, including the majority of economists, have assumed they are ever since Aristotle defined the essential human characteristic – the thing that distinguishes us from all other animals – as rationality, then the many wonderful claims made by the Capitalism Myth would probably be true, and the glorious events which it predicts would come to pass, thereby ushering humanity into a Golden Age of Prosperity and Economic Plenty. But if human beings were truly rational creatures, then there would never have been any wars, countries would not have built and continue to maintain nuclear arsenals, people would not commit crimes, since they would reason that the severe punishments are not worth the risks involved in committing them, women would never have abortions because they would always take the necessary precautions to prevent fertilization if they do not want to become pregnant, no one would smoke, take drugs, overeat, consume alcohol excessively, or engage in other foolish or reckless behaviours, and so forth. The fact that all of these and other bad, foolish, irrational, senseless, and harmful actions have been, are, and will continue to be committed in the future is ample evidence that human beings most certainly are not the rational creatures posited by the Capitalism Myth. Although this myth may be true of some intelligent species that has yet to exist on the Earth, it most certainly does not apply to human beings.

This was the same mistake that was made by the communists, whom the advocates of the Capitalism Myth hate with a virulence that is matched only by their hatred of government in all its many different forms and manifestations. Albeit in different ways, both the communists and laissez-faire capitalists have made human beings out to be much better than they really are: less selfish in the case of communism, and more intelligent and less irrational in the case of capitalism. These two groups of idealists failed to understand the true nature of human beings, as well as the true determinants of our actions; and because of this failure, these two vaunted theories have failed to produce the results which their adherents believed would assuredly result from their implementation.

There is a saying now in Russia: Marx was wrong in everything he said about communism, but he was right in everything he wrote about capitalism.[4]

To draw the logical inference that, since communism failed, it necessarily follows that its opposite, which is free-market capitalism, is right, is to make the error of believing that reality behaves in accordance with the simplistic logical categories that were posited by Aristotle to describe all things in the world: since A (communism) is false, it follows that not-A (free-market capitalism) is true. But the world is much more complex than this overly simplistic logical categorization of economic affairs would lead one to believe. For it can happen, as in this case, that both A and not-A are wrong, an outcome that cannot occur in the unreal world of pure logic. And yet, as hard as it is to believe, this simple summation more or less describes the thought processes of many a blind and deluded economist, who dogmatically believes that the economic theories one was taught in school accurately describe the economic behaviours of billions of people in many different countries, many of which behaviours were never studied by the simpletons who developed these economic theories.

Rejecting communism does not oblige one to accept the tenets of free-market capitalism. For communism was an attempt to control every feature of people’s behaviour and of society in general, which led to the stifling repression of their freedom. Communism was an extremely oppressive form of government that has little in common with democratic societies, where the people are free to choose their leaders, their occupations, where they will live, and other aspects of their lives, and voice their opinions publicly without the threat of reprisals or punishment. Between these two extremes – the totalitarian control of communism and the unbridled license of free-market capitalism – most sensible people would agree that what is necessary is a pragmatic approach that is not based on the rigid adherence to certain so-called fundamental principles, whether they are communist, capitalist, or are derived from some other ideology or religion.

Another way to consider laissez-faire capitalism is as an economic version of Jean-Jacques Rousseau’s naively optimistic but false belief that human beings are naturally good, but they are corrupted by living in societies. Laissez-faire capitalists believe that, left to themselves, human beings will produce the best of all possible economic worlds, and that any attempt by the government to improve, restrain, correct, or otherwise direct their actions has the perverse effect of corrupting both them and the operations of the free market. However, just as Rousseau was wrong about human nature and behaviour in general, free-market capitalists are wrong because their understanding of human behaviour is incorrect and incomplete.

In the remainder of this essay, I wish to consider the last of the aforementioned tenets of the Capitalism Myth, namely, the belief that it was misguided government policies and decisions that were the primary cause of the Great Depression, as well as financial crises like the one that occurred in 2008.

In his 1966 article “Gold and Economic Freedom,” [Alan] Greenspan explained how America’s Great Depression was not the result of capitalism but of a credit boom manufactured by the Federal Reserve.

When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. . . . The “Fed” succeeded . . . but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market—triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in breaking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed.[5]

Those who believe in the Capitalism Myth uncritically accept this kind of explanation because it vilifies the object of their hatred, namely government. But let us examine it more closely.

For the sake of argument, let us assume that the Federal Reserve did indeed behave as Alan Greenspan asserts.[6] What Greenspan is saying is that the government, by increasing the money supply, was responsible for all the actions, both bad and good, that resulted from this decision. So, for example, if a person decided to purchase a new car with the low-interest loan that was made possible by the government’s policy of keeping interest rates low and thereby expanding the money supply, and that person caused an accident which killed or injured oneself or other people, then clearly that was the government’s fault, since the person would not have been driving the car that was involved in the accident if the government had not foolishly and recklessly decided to increase the money supply in order to maintain liquidity in the economy and prevent a credit shortage. For Greenspan’s argument is no different from the example we have just considered: the government increased the money supply, some investors decided to purchase stocks with the money they were able to borrow at low interest rates, and because there were a large number of these investors, stock prices increased dramatically, creating an investment bubble, which, when it burst, led to a collapse in stock prices, which caused a panic that rippled through the rest of the economy, which led to bank failures when depositors tried to withdraw their savings, in part to pay for their stocks which they had purchased with borrowed money, which led to a drop in consumer and business confidence, which made people spend less,[7] which caused the Great Depression. Quod erat demonstrandum, as the famous Greek geometrician wrote at the end of his mathematical proofs.

There are any number of things which these reckless and greedy speculators could have done with the money they borrowed instead of using it to speculate on the stock market: they could have bought flowers for their wives and toys for their children; they could have spent it on a nice meal in a fancy restaurant; they could have purchased new furniture or appliances for their home; they could have taken a vacation; they could have bought new clothes for themselves and their family; they could have started a new business; they could have put the money in a piggy bank or buried it in the ground; or they could have simply not borrowed the money in the first place. Had they done any of these other things, then their collective actions would not have produced an unsustainable rise in stock prices which, after the bursting of the rapidly inflated stock bubble, precipitated the Great Depression.

But instead, they chose to spend it on purchasing more stock shares because they were greedy and they wanted to make money without actually having to work for it. Even if it was the government’s fault that they had access to this money which, according to Alan Greenspan, the government should never have allowed them to access because these grown-up and supposedly rational adult men and women were not capable of using it in a responsible manner, it was certainly not the government’s fault that both banks and other financial institutions and buyers concocted the extremely foolish and risky scheme of purchases on margin, which allowed individuals to purchase stocks by paying, in many cases, only ten percent of the nominal value of the stocks, meaning that individuals could purchase ten times the nominal value of stocks with a given amount of money, a situation that magnified the decline when stock prices began to go down. This was simply a form of gambling that greatly increased the possibility of a panic when stock prices began to fall.

During 1927 outstanding margin loans increased by $800 million to $3.6 billion—a rise in percentage terms that nearly matched the 28.75 percent registered by the Dow Jones Industrials [in that year].[8]

To use a favourite Randian metaphor, the government did not hold a gun to the heads of these speculators and force them to go to the bank, borrow money, and use it to purchase stocks on margin. This was something which they did of their own free volition, unimpeded and uncoerced by the government. Thus, far from demonstrating that bad government policies were the primary cause of the Great Depression, government bigots like Alan Greenspan the Greenhorn have actually demonstrated the need for government regulations in order to curb such reckless and irresponsible behaviours, and thus prevent the calamitous economic events they may precipitate.

Free-market fanatics like Greenspan, Friedman, and Rand cannot have it both ways. If they adamantly argue that all the participants in the free market should be free to do whatever they want, then, in cases where their actions are free, as the actions of speculators were prior to the Great Depression, these individuals must also bear full responsibility for their actions, which includes being blamed when their collective actions bring about bad or undesirable outcomes. But instead of blaming these individuals, their apologists blame the government whenever things go wrong, which shows that they themselves are wholly irrational in their attributions of blame. By doing so, they illustrate one of the common effects of contempt and hatred, which is to make the hater blame the object of one’s hatred whenever things go wrong or something bad happens. This example shows that, contrary to their beliefs, human beings are not rational creatures, and therefore many of the conclusions which they draw from this mistaken belief are also wrong.

It is time for the world to recognize the falsehood of the Capitalism Myth, lest it lead to a collapse that is comparable in scope and seriousness to the collapse engendered in communist countries by that other false economic and societal doctrine, the Communism Myth.

 

[1] Free Market Revolution: How Ayn Rand’s Ideas Can End Big Government by Yaron Brook and Don Watkins, p. 41. Palgrave Macmillan, New York, 2012.

[2] Because the Randian version of this myth contains some features that are unique to it, I will consider it in a separate essay.

[3] In many of other essays contained in this part of the book, I have considered particular elements of this myth and shown why they are wrong.

[4] The End of Growth by Richard Heinberg, chapter 1. New Society Publishers, Gabriola Island, BC, 2011.

[5] Free Market Revolution, pp. 47-48.

[6] This is not at all certain, since the economic theory called monetarism, which provides the theoretical basis for the now-widely-adopted policy of gradually increasing a country’s money supply in order to prevent deflation and a decrease in total expenditure, as well as to provide needed liquidity in times of economic crisis, was only developed in the 1960s, primarily by Milton Friedman. In other words, Greenspan is engaging in historical revisionism by interpreting past events in light of beliefs and theories that were developed only after these events took place. In The Great Crash 1929, John Kenneth Galbraith notes that the Federal Reserve’s lending rate was around five percent in the period prior to the 1929 stock market crash, a rate that cannot be called excessively low. More precisely, the Federal Reserve raised its rate from a low of 3.5% in 1928 to 6% in 1929. (See On Money and Markets by Henry Kaufman, p. 213. McGraw-Hill, New York, 2000.)

We do not know why a great speculative orgy occurred in 1928 and 1929. The long accepted explanation that credit was easy and so people were impelled to borrow money to buy common stocks on margin is obviously nonsense. On numerous occasions before and since [the book was published in 1954] credit has been easy, and there has been no speculation whatever. Furthermore, much of the 1928 and 1929 speculation occurred on money borrowed at interest rates which for years before, and in any period since, would have been considered exceptionally astringent. Money, by the ordinary tests, was tight in the late twenties. (The Great Crash 1929, p. 169)

As he and others have pointed out, the amounts that could be made by lending this money to stock-market speculators, at least for a time, greatly exceeded the Federal Reserve’s or commercial banks’ interest rate, and hence, raising this rate probably would not have had much effect on dampening speculation.

In addition, to have raised interest rates in order to reduce speculation would have hurt businesses that borrowed money to fund investment and growth, as well as consumers who wanted to make large purchases. It is immensely ironic that when he was Chairman of the U.S. Federal Reserve, Alan Greenspan failed to follow his own advice, as set forth in this article, which shows that it is much easier to criticize those in power than it is to behave differently from them when one occupies the same position as they do.

[7] When the dominant model of behaviour is not to spend money, as it was during the Great Depression, then there is an added restraint or inhibition against spending money. Economists have completely failed to take this important determinant of human behaviour into consideration, which has seriously skewed their calculations and expectations. In other words, their expectations about what people will do in many situations are not at all rational. This is like an engineer who, while designing the optimal shape of a vehicle, fails to take into consideration the important effects of air resistance because the air is invisible. For those who think that I am exaggerating because no one could be that stupid should read the works of serious economists – serious in the sense that their views are taken seriously by other economists and writers who are just as stupid as they are – who have argued that no government intervention was necessary during the Great Depression because, left to itself, the free market would eventually have corrected itself and returned to full employment, as it had following every previous period of declining economic output.

[8] Devil Take the Hindmost: A History of Financial Speculation by Edward Chancellor, p. 198. Plume, New York, 1999.

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