Smoot Point

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Jude Wanniski, who recently died, will be remembered as the trumpet of supply-side economics on the editorial pages of the Wall Street Journal in the late 1970s and as the author of “The Way the World Works” (1978). What I remember most was an intriguing theory of what caused the Crash of ’29.

The standard theory is that it was an unsustainable boom that ran out of gas. Wanniski didn’t think so. Indeed, he started his account of it, printed in the Wall Street Journal of Oct. 28, 1977, by asserting dogmatically that the market is fully priced at all times, because it reflects everyone’s expectations of the future. When markets collapse, he asserted, something has changed these expectations – something like political news.

I think the market is “fully priced” only in a tautological sense. But Wanniski thought otherwise and therefore went looking for an outside cause. In a 1988 interview he said he had gotten an idea from Gottfried Haberler that it might have been the Smoot-Hawley Tariff. Wanniski rushed off to the library and cranked in the page for the New York Times, Oct. 24, 1929, which chronicles the events of October 23.

He notes two stories: one about the market and another about the tariff negotiations in the Senate, where an anti-tariff coalition was struggling to hold off the demands for sharply higher import duties.

“On October 23, an hour before the market closes, disaster strikes: The market declines a stunning 21 points after news is out that the anti-tariff coalition has broken apart on the question of carbide rates.” The carbide rates themselves are relatively unimportant; the vulnerability of the anti-tariff forces is the key. Yet the remarkable coincidence again goes unremarked in the next day’s newspapers.

On Oct. 24, “the anti-tariff forces suffer another setback; casein tariffs are raised 87%.” Again, casein is not the issue; it is the political strength of the pro-tariff forces.

This is Black Thursday.

On Friday the market stabilizes, but over the weekend Sen. Smoot predicts the bill will survive, and Sen. Borah, a tariff opponent, says he thinks so too. On Monday the Dow Jones Industrials drop 38 points, and on Black Tuesday, 30 more points, on the highest volume in history. The Crash is on.

Fast-forward to mid-1930. “On June 13, the Senate approves by two votes the measure to increase tariffs on more than 1,000 items and sends the bill to Hoover. On this news, the stock market breaks 14 points to 230, precisely where it was on the bottom on Black Tuesday, October 29.”

What is remarkable about Wanniski’s account is that he says the cause and effect were not associated at the time. Nobody wrote in the newspaper that the market had crashed because of the success of the pro-tariff forces in the Senate. Wanniski did not develop his theory by interviewing old speculators, or digging through old letters and diaries, but by looking at the New York Times. That is, by simply reading the newspapers, he saw a causal effect that no one at the time reported.

It could not have been something that nobody noticed. For an event in the Senate to cause the Dow Jones Industrial Average to collapse, a whole bunch of people would have had to act, and some other people would have noticed them act- ing. People would have talked about it. Indeed, thousands did act, people did talk about it, and the episode went down in history – and until Wanniski’s book 49 years later, apparently nobody made the connection he did.

All this seems improbable to me.

Wanniski’s account might be presented in at least two ways. One is his way, which is that the entire fall was due to these political events, and that the market was as rationally priced at the bottom of the fall as at the top. That is, the reason for the entire move in the market was missed by everyone at the time. Another way to present it is to assume that the market was already overbought, that it was ready to fall, and that the Senate action triggered something that was going to happen anyway. That is a more modest claim, and more plausible.

The Wanniski theory has other problems. Foreign trade was a relatively small part of the U.S. economy then: 4-5% of output, something like that. It was smaller than today. If it fell in half, the GDP would drop maybe 2-3%. That’s too small to be the entire explanation for the Great Crash. Also, in hindsight (and all this is in hindsight) the event that deepened the Great Depression was. the financial crisis in Europe in mid-1931. This had to do with debts and war reparations, and the links of currencies to gold. Trade was peripheral to it. .

If you ask people today the cause of the Great Depression, many will point to the Smoot-Hawley Tariff, not to foreign debt, reparations and gold payments. The modern explanation emerges from a modern political point of view about trade. I share that point of view, and so the explanation is politically friendly. But that does not mean it is true.

I’ll believe Wanniski’s theory – the modest version – when the historians verify it. Until then, put me down as intrigued, and agnostic.

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