This period looks a lot like 1929-32
Here we go again?
We trim this long 2008 op-ed from the Prudent Bear of August 25. The writer is the author of Great Conservatives.
by Martin HutchinsonThe parallels between the 1929-32 downturn and now are becoming apparent. The Great Depression became such through egregious policy errors. Repetition of those errors is becoming increasingly likely and in some respects is already happening.
One area where the mistakes of the 1930s are being replayed is protectionism. The Doha round of trade talks has been killed. And the South Korean and Colombian trade treaties with the United States seem unlikely to make it though Congress (though there may be some chance of progress after the November election).
More ominously, world trade has in the last few months reversed its rapid growth since 2000. If the world economy goes into a prolonged downturn, China, India, and Russia are not committed to free trade; to the extent that they, and not an enfeebled United States and Britain, are steering the world economy, protectionism will surely increase and prosperity suffer accordingly.
A second error in the United States that hampered recovery was the Herbert Hoover tax increase of 1932. While I am convinced that Hoover’s increase from 25% to 63% made the Great Depression worse and more prolonged, and that the drop in top marginal tax rates from 70% to 28% played a major role in the growth of the 1980s, I’m not sure modest moves in marginal rates have any great effect.
Probably the only George W. Bush tax cut of impact was cutting personal tax on dividend income from 35% to 15%. Like almost all Bush initiatives, this one was botched. A more sensible approach would have been to allow dividends paid to be deductible from corporate income for tax purposes; this would have put the tax shelter industry out of business, and leveled the playing field between debt and equity for capital planning purposes.
Reversal of the Bush tax cuts, a modest increase in social security contributions at high income levels, and a reversion of the capital gains tax rate to 20% are unlikely to be too damaging. But if the economy sinks, swelling the budget deficit to $1 trillion, then to balance the budget Congress under any president might raise taxes on high incomes, creating problems of evasion and disincentive, suppressing productivity gains and driving capital out of the country.
The third similarity that contributed greatly to the Great Depression was the failure of the Fed to create new money after the failure of the Bank of the United States in December 1930. They kept interest rates low but credit tight, so money supply declined as banks failed and the public lost its deposits, also seen in Japan in the late 1990s. This time around, credit constraints have been extremely loose, but interest rates could be raised.
Now monetary policy may even be losing its grip. Growth in the St. Louis Fed’s Money of Zero Maturity, which had been over 20% per annum in the six months to April, has slowed since then to only 5% per annum, without any rise in interest rates above their current negative real level or any visible tightening in monetary policy. This may indicate a sharp deceleration in the US economy, making money demand inadequate to absorb money supply.
The fourth similarity between the present and the early 1930s is the revived faith in government.
John Maynard Keynes believed that the market economy had died in 1914 so high-minded bureaucrats like himself are needed to run the economy. As public choice theorists have subsequently proved, this approach depends on a moral purity and economic perceptiveness that does not exist. Hence it damages both the economy itself and civil liberties.
In the 1930s, economic recovery was almost prevented altogether by government meddling, from Hoover’s Reconstruction Finance Corporation, through Roosevelt’s Glass-Steagall Act, de-capitalizing investment banking, to the farm subsidy monster, to the National Recovery Act. The result was an economy in which private enterprise did not recover till the early 1950s, and some of the public sector excrescences are with us still. Only a few of the public sector innovations, notably bank deposit insurance, did more good than harm, even while distorting the market.
In the United States, since the 1930s the only substantial company to be bailed out had been Chrysler in 1979. This year we have seen bailouts of Bear Stearns, Fannie Mae and Freddie Mac, with the automobile industry next.
As anyone with experience of the British economy in the 1960s and 1970s could tell you, this won’t work. British Leyland, the automobile company, was bailed out repeatedly by the taxpayer, only to lose more and more money until finally in the 1980s Lady Thatcher put most of it out of its misery.
Government bailouts prevent the Schumpeteran process of creative destruction, diverting resources from productive taxpayers and bond market investors to the worst losers in the economy. Political pull becomes the only reliable approach to obtaining resources (subsidies).
After a decade of irresponsibly cheap money distorting price signals, and producing bubble after bubble without improving living standards except at the very top, the Federal Reserve has enabled the left to claim that capitalism “doesn’t work”.
The other parallel to the 1930s, of course, is the emergence of well armed autarkic states seeking to expand at our expense. However that is only peripherally an economic problem.
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