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The lesson of the 1930s that Obama refuses to learn
Gerard Jackson
Inspired by FDR, Obama and his fellow Dems promise a "New Deal" economic program that will pull the country out of recession and put it on the road to sustained economic growth. What dangerous nonsense. Democrats, particularly Obama and his advisors, haven't got a clue as to what really happened during the '30s. This is because they are a pack of intellectual sponges rather than thinkers. (And please, don't mention Bernanke).
If it were otherwise they would have taken the time and trouble to investigate that greatly misunderstood period in American economic history. What I hope do here is provide a brief — all too brief, unfortunately — summary of the reasons why America found itself mired in a deep recession for some 12 years.
While running for president Obama proposed higher taxes (He now seems to have changed his mind on taxes) and a massive increase in government spending to get the economy moving again. But raising taxes and government spending is exactly what Hoover and Roosevelt did. Did the economy recover. Of course not.
By 1931 Hoover was desperate to counter the growing deficit so he raised taxes in December of that year. (Let’s call Hoover’s action the Blue Dog option of "fiscal responsibility"). In 1932 Congress passed the Revenue Act which introduced a huge range of taxes. Yet the economy still didn’t recover. As for the deficit, instead of being wiped out by tax increases, tax revenue actually fell.
During this period the fiscal burden of government rose significantly. Needless to say, the economic activity remained severely depressed. Roosevelt was every bit as bad as Hoover, raising taxes significantly in 1935. And what was the result of his tax increases. The economy remained depressed while federal expenditure steadily rose throughout the depression. As for the deficit, it averaged 3.6 per cent of GNP during this period and unemployment averaged 18.6 per cent.
One should imagine that a political leader armed with these indisputable facts might draw the conclusion that taxes should never be raised during a recession. Moreover, such a leader might even conclude that cutting taxes is the way to go — but not Obama. Instead of categorically stating to the public that there will be no tax rises during his presidency he exhibits ambivalence, hinting that higher taxes might be more appropriate sometime in the future. (This is just the kind of political leadership that markets love. No wonder they are so volatile). Paul Samuelson, one of the Democrats' favourite economists, emphatically stated that
...dollars of tax reduction are almost as powerful a weapon against mass unemployment as are increases in dollars of government expenditure. Such a program may involve a larger deficit than would an expenditure program. But it also means that there is no expansion of the government’s sector of the economic system. (Paul Samuelson, Economics, 10th edition, McGraw-Hill 1976, p. 245).
America's leading Keynesian advocates tax cuts as an anti-recession measure yet Obama and his advisors have — so far — turned their faces against it. Could it be that they are motivated more by a desire to bring about a greater "expansion of the government's sector of the economic system" rather than in turning the economy round?
For eight years the Democrats made a great song and dance about the Republicans' reckless spending habits (and rightly so) and a growing deficit, exclaiming at every opportunity just how vital a budget surplus was for a healthy economy. But there is nothing special about deficits or surpluses and the idea that the latter is some kind of safeguard or guarantee against recession is absurd.
Those who believe this nonsense ought to be reminded of the fact that there was a surplus in 1929, but that didn’t stop the Great Depression. The government also had a $3.5 billion surplus in 1960, just as the economy slid into recession. What ultimately matters with respect to fiscal policy is spending. This should be borne in mind when the Democrats announce even more huge spending programs.
Prior to Hoover recessions-depressions were allowed to work themselves out. In other words, previous administrations had the good sense not to interfere with the adjustment process that eliminated malinvestments created by monetary expansion. The unprecedented actions of the Hoover and Roosevelt administrations in refusing to allow the market to adjust wage rates to the new monetary conditions stopped the adjustment process in its tracks, and in doing so they deepened and prolonged the Great Depression. Three economists at the time got straight to the heart of the problem:
...difficulties are viewed largely as the inevitable aftermath of the world’s greatest experiment with a "managed currency" within the gold standard, and, incidentally, should provide interesting material for consideration by those advocates of a managed currency which lacks the saving checks of a gold standard to bring to light excesses of zeal and errors of judgment. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 56).
In 1932 Hoover was proudly boasting that America had "the highest real wages in the world". And this was when unemployment had reached 23 per cent and was still rising. That the rise in real wage rates brought about by a massive deflation just may have had something to do with rocketing unemployment simply did not occur to him, an observation that is supported by his memoirs.
Hoover's belief in the fallacy of the purchasing power of wages theory led him to defy the need for wage rates to adjust to the deflationary conditions*. In 1929 the two-way division between employees and corporations was 81.6 per cent and 18.4 per cent respectively. Thanks to his meddling the employees share had shot up 99.4 per cent by 1933 resulting in payrolls falling from $32.3 billion to $16.7 billion and unemployment reaching a horrifying 25 per cent.
A few more facts should cast further light on the economic conditions of the time. In 1929 pre-tax corporate profits were $9,770 million and post-profits were $8,337 million, for 1930 they were $3,225 and $2,348 respectively; for 1931 they were —$846 million and —$1,365; 1932 they were —$3,100 and — $3,489. And 1933 was ridiculous; profits reached a meagre $99 million only to be reduced by taxation to —$444 million. In 1932 the St. Louis Chamber of Commerce was driven to state:
When governments seek to maintain the high levels of taxation they reached in good times in these days of seriously impaired income the impending specter of higher taxes constitutes one of the chief deterrents of business recovery.
As we shall see, Roosevelt and his advisors did not learn a damn thing from Hoover's misguided policy of trying to restore prices to their 1929 level. Starting from March 1933 the American economy began to rally as confidence began to return, the banks reopened and inventories fell below a sustainable level and orderly buying by retailers started to emerge.
The Fed's index of production (1923-25) rose from 60 in March 1933 to 100 in July. Any student of depressions will immediately recognise these movements. What is not generally understood is that the anticipated coming of Roosevelt's destructive NRA (National Recovery Act and just one of the many of Roosevelt's alphabet soup agencies) further stimulated production as business accelerated production to avoid the NRA's business codes that would increase operating costs.
The NRA came into force in July and August, causing the Fed's production index to drop to 72 by November. From July 1933 to December industrial production dived 28 per cent. Roosevelt's economic illiteracy had raised labour unit costs by 54 per cent in the same period. His administration seemed incapable of grasping the link between wage rates in excess of the value of the labour's product and heavy persistent unemployment. One of the tragic consequences of the destructive NRA codes was their devastating effect on the black workforce. Charles Frederick Roos, who was director of research for the NRA at the time, wrote:
As a result of the NRA's failure to establish racial differentials in many regions, and especially in the South, white men were given preference for the new jobs crated by shorter hours, and, in some instances, white men even replaced Negroes. In fact, estimates have been made indicating that, directly or indirectly because of minimum wage provisions of codes, about 500,000 negro workers were on relief in 1934. (Charles Frederick Roos, NRA Economic Planning, The Principia Press, Inc., 1937, pp. 172-73).
Roos was disgusted by the refusal of the Roosevelt administration to take action on behalf of those black workers whose jobs had been destroyed by the NRA.
Hoover and Roosevelt were not alone in thinking that economic laws are something that can be safely legislated away. Under the 'Leon Blum New Deal' France took the Hoover-Roosevelt route with the same tragic consequences. No sooner was Blum elected in 1936 then he caved in to union demands for destructive wage increases. The disastrous increase in labour costs caused a violent business reaction.
Realising the shocking economic and social consequences of his economic actions, he tried to relax, if not undo, much of his drastic labour legislation. It was too late. What was a tragedy in America became a calamity in France with the most dire consequences for the rest of Europe. Despite claims to the contrary (H. W. Arndt, Economic lessons of the Nineteen Thirties, Frank Cass and Company LTD, 1972, pp. 135-151) real wages in France had steadily advanced from about 1930. The1936 catastrophic increase in money wages saw them leap by nearly 70 per cent; by 1939 they were approximately double the 1929 level.
Having taken a very brief look at the economic illiteracy and political follies of those characters that gave us the Great Depression it's time to return to Obama's inability to learn anything from history. It follows from his promise to swamp the country with his own brand of alphabet soup that he and his advisors believe massive government spending is necessary for an economic recovery, even though it has never worked in the past.
But if this is so, it also logically follows that the opposite policy must be contractionary. Paul Samuelson certainly thought so. In 1943 he confidently predicted that once the war was over and government spend dived mass unemployment would return on the scale of the 1930s. (Incidentally, Keynes made no such prediction).
So what happened? Between 1945 and 1947 the US government slashed Federal spending from an annual $95 billion to $36 billion per year — a $59 billion cut in two years. This was a staggering 62 per cent reduction . Instead of America spiralling into a depression with 8 million unemployed it began the longest period of growing prosperity in its history
The effect of the war was to overcome Roosevelt's anti-growth industrial codes and unleash a colossal amount of withheld capacity that crushed the Axis Powers and which unlocked the enormous pent up demand that the Hoover-Roosevelt policies had created. (On withheld capacity see William H. Hutt, The Keynesian Episode, LibertyPress, 1979).
It is clear that Obama is totally ignorant of economic history and the history of economic thought. It is equally clear that he has a statist bent to his character that is in every likelihood ineradicable. The economic consequences of this character defect will be the subject of another article
*"[A]ll of the bank credit inflation of 1922 to 1929 was wiped out in the short space of the three years following 1929". (C. A. Phillips, T. F. McManus, R. W. Nelson, Banking and the Business Cycle: A Study of the Great Depression in the United States, The Macmillan Company, 1937, p.168)
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 8 December 2008