Saturday, July 20, 2019

Lessons from the Great Depression: What Really Ended the Great Depression? (Part 3 of 3)

Click here to read the original Cautious Optimism Facebook post with comments

7 MIN READ - Keynesian economists warned President Harry Truman in 1945 that a rapid cutback in World War II spending would set off Great Depression 2.0. Instead, in another of what would become a near-century long track record of wrong predictions, the U.S. experienced the greatest annual expansion of private GDP in its history.


As government war spending ramped up in 1942 and 1943, official GDP records reflected a near vertical trajectory of economic growth. Looking at the numbers it would seem the U.S. economy was entering new, higher dimensions of prosperity annually.

U.S. nominal GDP: 1941-1945
1941: $129.3B
1942: $166.0B (+28.4%)
1943: $203.1B (+22.3%)
1944: $224.4B (+10.5%)
1945: $228.0B (+1.6%)

1941-1945 inflation-adjusted change in GDP: +52% 
(Source: BEA and

However keeping in mind that GDP is mathematically calculated by adding all consumer spending, private business investment spending, government purchases, and net exports (Y = C + I + G + Nx), massive government war materiel purchases artificially inflated the GDP results. If we isolate only consumer and private investment spending, the resulting private GDP picture looks closer to stagnation:

U.S. nominal private GDP 1941-1945
1941: $100.5B
1942: $100.8B (+0%)
1943: $107.3B (+6%)
1944: $117.8B (+10%)
1945: $132.4B (+12%)

1941-1945 inflation-adjusted change in private GDP: +14%
(Source: BEA and

(Note: Only government *purchases* are included in GDP calculations. Simple transfers and payments—such as Social Security, Medicare and Medicaid payments or salaries of government employees—aren’t counted. Thus changes in government spending typically have less impact on GDP movements, with World War II being a major exception since so much government spending during the early 1940’s was on armament purchases)

Weak private GDP performance more accurately portrays the plight of the private sector during the war. The average citizen spent very little because the economy was producing so few consumer goods, a harsh reality reflected by everyday rationing.

Life during the war meant enduring shortages of everyday consumer items like gasoline, tires, sugar, meat, silk, shoes, cotton, leather, nylon, butter, coffee, poultry, milk, eggs, vegetables, and canned foods to name a few. To illustrate how inadequate this list is consider that the federal government set up over 8,000 rationing boards to delegate how scarce consumer items would be distributed.

In 1942 rationing boards declared the butter allotment would be 12 pounds per person per year. Coffee was limited to one pound every five weeks (less than a cup a day). In 1943 meat was limited to 28 ounces per person per week. Canned food was reduced to 28% below normal consumption.

In 1943 all recreational driving was banned although this restriction might have eventually become self-fulfilling since production of consumer automobiles had already ground to a halt.

These are just a few examples.

Rosie Riveter may have been gainfully employed in wartime factories, but at home she could buy nothing but scarce necessities.

For this reason, while on paper some economists consider the Great Depression over by 1941, other economists view the Great Depression as a slump that lasted until 1946 when taking private-only GDP and consumer well-being into account (the COCEA wholeheartedly agrees with the latter view).

Finally the U.S. enjoyed full employment during the war, with jobless levels falling to under 3%. However one must also mathematically adjust for conscription. Nearly 12 million men were drafted out of the labor force and sent to fight overseas, so one can hardly consider World War II a model of private sector voluntary civilian employment.


As the war neared conclusion in 1945, President Harry Truman was already consulting with his advisers on how to reduce the federal government’s enormous military budget. In 1945 federal spending was 47% of GDP and Washington had racked up a national debt equal to 120% of GDP—a record then and ever since.

By this time Keynesian economists ruled academia and the intelligentsia, and they offered no shortage of dire and ghastly warnings against a sudden drawdown in government spending—predicting it would hurdle America back into Great Depression 2.0. Truman and Congress, they argued, must continue borrowing and spending at the same wartime rate if recovery was to persevere. In the words of one of America’s most famous Keynesian economists:

“[If government cuts spending] there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has faced.”

-Paul Samuelson, Economics Science Nobel Laureate
 “After the War, Full Employment” (1943)

His co-author Harvard Economics Professor Alvin Hansen, who in the early 1940’s was the most influential American Keynesian economist (in fact dubbed “the American Keynes”) also urged:

“When the war is over, the government cannot just disband the Army, close down munitions factories, stop building ships, and remove all economic controls.”

And there was no shortage of bleak projections from other Keynesian bureaucrats, economists, and journalists, all calling for federal spending not to be slashed:

-In August 1945 the Office of War Mobilization and Reconversion forecasted a spring 1946 unemployment rate of 12%.

-In September 1945 Business Week predicted postwar unemployment of 14%.

-In December 1945 Economist Isidore Lubin (Labor Department) predicted 6-9 million unemployed (9-14%) in 1946.

-Also in December 1945 Economist Robert Nathan (War Production Board Planning Committee Chair) predicted 9-10% unemployment come spring of 1946.

-In 1945 economists Leo Cherne (Research Institute of America) and Boris Shishkin (AFL economist) predicted a 35% postwar unemployment rate.

Fortunately for America, Harry Truman ignored them all. More concerned about America’s staggering postwar national debt, he slashed federal spending from $106.9 billion in 1945 to $66.5 billion in 1946, and again to $41.4 billion in 1947. In nominal terms the budget was cut by 37.8% in 1946 and a total of 61.3% by 1947. 

In real terms the cuts were much larger, 47.3% in 1946 and an extraordinary 70.2% reduction by 1947 (source: Census Bureau).


Truman’s cutback of federal spending by nearly half in 1946 and 70% by 1947 was the worst fiscal nightmare Keynesians like Paul Samuelson and Alvin Hansen could have ever dreamed of, and the aftermath should have been much worse than even their own forecasts of double-digit unemployment. So what happened in the end?

Looking strictly at raw GDP again, American economic activity fell from $228 billion in 1945 to $192 billion in 1946 in real terms, or down 15.8%. And a contraction of 15.8% would indeed represent the greatest decline in GDP during any single year in American history—truly a great depression.

So why don’t we read about The Great Depression of 1946 in history books? 

Because the drop is exaggerated by huge declines in government purchases. 

Looking at purely private sector GDP (private consumption + private business investment + net exports), real GDP surged from $131.6 billion in 1945 to $156.2 billion in 1946, a gain of 19%. An increase of 19% represents the greatest expansion in private economic output during any single year in American history—truly an economic boom.

That’s right, instead of the apocalyptic Great Depression 2.0 predicted by Keynesian economists, the private economy experienced the single greatest year of growth in American history—then or ever since. That's about as bad a call as any economists have ever made.

Private business investment alone rose a staggering 126% that year, another record by far.

Unemployment followed the same trend. Instead of 10%, 14%, 25%, or 35% joblessness as predicted, the USA remained at full employment throughout with the unemployment rate standing at 3.6% in 1946 and 3.6% again in 1947. Remarkably the labor market remained tight even with 12 million men in uniform returning to civilian life.

Economist Michael Sapir, who compiled employment data for Congressional review in his 1946 paper “Actual Developments vs Washington Forecasts” in the “Review of Economic Forecasts for the Transition Period,” offered an apt mea culpa by concluding:

“For this quarter [1Q46] total civilian… …unemployment was predicted at a level of 8.1 million, three times the actual figure, 2.7 million.”

And in a huge understatement summarized…

“…It cannot be claimed that this is a very good record!”

Nevertheless Keynesians were undeterred. Despite their theory falling flat on its face, they quickly pivoted to a new explanation for the unexpected boom. By late 1946 they had all synchronized to a different theory that massive government borrowing and spending had cultivated “pent-up demand” which then exploded in an orgy of spending when wartime rationing ended.

Many of the same economists who had predicted Great Depression 2.0 in 1945 were engaged in full-fledged historical revisionism in 1946:

“The country came out of the war rich in monetary assets and monetary savings and desperately short of consumers' durables, houses, business plant and equipment. This laid the groundwork for a vast postwar prosperity.”

-Alvin Hansen
“The Postwar American Economy Performance and Problems”

“We have a postponed consumer demand, enterpriser ambitions, and purchasing power which hold the potential of some years of great activity.”

-Edwin Nourse, Chairman, CEA December 1946

“Even with the decline in government spending, aggregate demand was sufficient to maintain full employment... Consumption increased rapidly in the face of a decline in GNP. Here lies the main part of the answer to the mildness of the reconversion recession.”

-Robert Gordon (Keynesian economist)
“Business Fluctuations”

“A striking aspect of the postwar economy was the failure of predictions of postwar depression made by most economists. In general, the effect of deferred demand, financed by accumulated liquid holdings, was underestimated.”

-Harold Summers
“The Performance of the American Economy Since 1919”


As we demonstrated in Part 2 of this series on the end of the Great Depression, the investment and employment recovery began over a year before Pearl Harbor when General Motors President William Knudsen convinced Franklin Roosevelt to roll back his most radical and anti-business New Deal policies and allow American industry to produce the “Arsenal of Democracy.” Roosevelt’s death and a Republican takeover of Congress in the 1946 midterms ensured that the New Deal would not return.

To this day Keynesian economists have stuck with “pent-up demand” to explain the enormous and permanent postwar recovery, despite the largest reduction in government spending in U.S. history. In their opinion, federal government borrowing and spending over 100% of GDP on war provided Americans the purchasing power needed to finally get the economy growing. And furthermore, not being allowed to spend their incomes during the war—when soldiers were overseas lacking anything to buy and American workers were unable to spend in face of strict rationing—helped unleash a fury of consumer spending in 1946 when “pent up demand” was at last released into the economy.

Once again the COCEA believes the “pent-up demand” argument is extremely weak and temporally inconsistent.

The Keynesian theory is that consumers were loaded up with income that they had been unable to spend for years, and that 1946’s flood of consumption spending finally bolstered businesses with confidence to invest in and expand their operations. That investment led to more hiring which armed even more consumers with purchasing power and the “virtuous income cycle” was set in motion—standard demand-side theory.

However looking at the actual data (source: BEA) from 1945 to 1946 consumption expenditures rose by 20% in nominal terms ($120 billion to $144 billion), but given the 18% inflation rate that year—unleashed after years of wartime price controls were finally lifted—the real spending growth was less than 2% ($120 billion to $122 billion in 1945 dollars). By contrast, private investment spending rose by 167% nominally and even 126% when adjusted for inflation.

If the Keynesian theory really held true then 1946 should have been a flat year for private investment, because consumer spending rose by only 2%. Yet for some reason other than consumer demand the country experienced a 126% real gain in private business investment. Investment spending preceded consumer spending, a reverse casual relationship from the Keynesian theory and a series of events more consistent with the relaxation of FDR-era regulations and government getting out of the way.

And even if the Keynesian explanation credibly fit the evidence, what sort of solution to depression is it anyway? The conclusion is that when faced with double-digit unemployment (11% in 1937, 15.6% in 1939) the only remedy is to borrow 100% of GDP, spend it on war for four years during which time no one is allowed to buy anything and consumer goods are tightly rationed, the public lives at a primitive, bare sustenance level, and then release everyone to go shopping only in the fifth year?

Such a prescription is not only needlessly arduous and absurd, but it’s discredited by the facts. 

Before the 1930's America had already experienced depressions with unemployment at low and mid-teen double digits (the Depressions of 1837, 1873, 1893, and probably the Depression of 1819), yet somehow managed to recover from them all without a world war and giant public debt imposed on future generations. 

In all of those cases the federal government slashed spending, borrowed virtually nothing, didn’t pay millions to shift from private to public employment, imposed no rationing, and sent no one overseas to die in battle. Yet full employment was achieved in less time in most cases, the worst being after 1837 and 1893 which required seven years (equal to the 2008-2015 Obama-era "recovery").

20 months and 20 articles into this Great Depression series, the COCEA believes the free market alternative narrative is vastly superior: government meddling in the monetary system started the 1929 recession, and an unprecedented intrusion of regulations, tax increases, spending, and trade tariffs turned it into the Great Depression.

The same government intrusions that precipitated the Great Depression didn’t magically end it when applied even more forcefully. Rather it was government finally getting and staying off the backs of American industry that ultimately delivered the long-obstructed recovery.

Additional reading on the Great Depression of 1946 that never happened (Taylor, Vedder, et al) can be read at

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