What Charles Darwin’s Origin of the Species was to science, Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations was to economics.  Published this week (March 9) in 1776, The Wealth of Nations explained, and justified, the capitalist economic system under which we still operate today.

Smith’s two most famous theories describe how “the division of labor” and “the invisible hand of the market” contribute to a nation’s wealth.  Smith uses a pin factory to explain the division of labor, in which “One man draws out the wire, another straightens it, a third cuts it, a fourth points it …” and so on.  Thus making a pin is divided by many distinct operations, which might produce, Smith theorizes, 48,000 pins a day, meaning that if 10 men work in the operation, each man might be said to have made 4,800 pins that day.   Had each man tried to make pins by himself, Smith writes, he might not have produced a single pin.

Thus dividing the labor multiplies the capacity to produce things, which makes diversification more likely, which results in many different trades and industries.  That, in turn, leads to “exchanging,” in which, for example, pin makers trade excess pins for other goods that they need but can’t themselves produce.

This exchange mechanism, Smith explains, is a function of the value of goods and services, which itself is determined by the amount of labor that went into those goods and services — and by their availability.  “The market price for every particular commodity is regulated by the proportion between the quantity that is actually brought to market and the demand of those who are willing to pay the natural price of the commodity,” he writes.  In other words, supply and demand.

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This week (Jan. 5) in 1914, Henry Ford, the head of the Ford Motor Company, stunned the business world by announcing that, henceforth, Ford employees would not only share in the car company’s profits, they also would be paid the unheard of sum of five dollars a day.  That doubled their previous wage.

Ford’s fellow captains of industry were not amused, calling his wage hike bad business, misplaced altruism and a terrible precedent, but Ford — who was anything but an altruist — saw the move as both a cost-cutting measure and one that would increase productivity.

Recall that Ford previously had introduced the moving assembly line in which stationary workers, repeating the same function over and over, assembled cars using standard, interchangeable parts. This was a quantum leap in operational efficiency and greatly reduced production time, but it had a down side.  The work was mind-numbingly boring, and since it required no real skills, employees had no pride in their work.  As a result, absenteeism was a chronic problem as employees either frequently called in sick or simply quit.  Such a high turnover rate was also expensive, both because it was disruptive and because money had to be spent retraining replacement workers, many of whom also were soon calling in sick or quitting.

But after Ford announced the five dollar wage, a princely sum in 1914, workers flocked to Ford’s plant.  Absenteeism plummeted, costs went down, productivity increased and sales of Ford’s famous Model T skyrocketed.  By 1916 the Ford Motor Company had sold nearly a million cars and earned profits of $60 million.

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While it is true that the stock market crash in October of 1929 was a major cause of the Great Depression, what really spread panic, fear and depression throughout the U.S. economy — and by extension the global economy — was not the collapse of America’s securities trading system, but the collapse of its banking system.  And to many historians that tailspin began this week (Dec. 11) in 1930 when New York’s Bank of the United States closed down.

But first the background.  Although unprecedented numbers of Americans had invested in the stock market by 1929, and therefore were devastated by its crash, the amount of money invested in stocks was nothing compared with the amount deposited in banks. Yet the banking system at the time was even more confusing and precarious than the trading system.

For one thing, there were more than 25,000 different banks in America in 1929, most of the “Mom and Pop” variety, and they were alarmingly undercapitalized.  Worse, as with the stock market, there were few uniform regulatory guidelines, constraints or protections. As a result, even in good times banks failed regularly, and because there was no such thing as branch banking, the small banks in rural communities — where their financial soundness often depended on the vagaries of agriculture — could not depend on better-funded central banks in metropolitan areas to rescue them in bad times.

Thus there was no financial “firewall” to protect against the spread of panic. A run on a bank, or banks, in one part of the country often spread to other parts.  Also, in order to preserve liquidity and attempt (usually in vain) to satisfy the withdrawal demands of their panicked customers, banks quickly sold off assets, thereby depressing their value and contributing to the deflationary spiral that marked the Great Depression.

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