Saturday, June 22, 2013

Why we don't need a new New NEW Deal - Part 1

The last time the American economy was in such dire straits was over 30 years ago; perhaps 70. Do the lessons of the Great Depression perhaps hold any explanations, let alone solutions? Let’s recall a bit what happened all those years ago (it might even feel familiar):
• From September 1929 to July 1932, the Dow Jones Industrial Average (DJIA) fell from a high of 381 to 43, an 88% decline. In our time, that would be like the Dow falling from 15,000 to 1,800.
• Some of the most dramatic moments occurred in late October 1929, on the 24th (‘Black Thursday’: almost 13 million shares, or approximately 3 times the daily average, traded for a 6-point drop in the DJIA) and the 29th (‘Black Tuesday’: 16+ million shares traded for a 30-point drop).
• The market didn’t recover its pre-crash level for 25 years.
• Chronic unemployment soared from a historical average of 5% to over 15% for almost a decade, peaking at 25% in 1933.
• Industrial production was cut in half.
• Business construction dropped 84%.
• Bank failures spiked from a historic average of 700 per year to 1,350 in 1930, 2,293 in 1931, 1,453 in 1932; 4000 commercial banks failed in 1933.
• The crisis rippled worldwide and contributed to the rise of Hitler and Mussolini in Europe.
• Four years into the Roosevelt presidency, in 1937-38, the economy sank into recession for a second dip.
• Only World War II in the 1940’s resulted in increased production and put an end to high unemployment, at a terrible price; millions of lives lost in the war, all production being channeled into armaments with little left over for consumer goods or comforts. True prosperity would not return until the late 1940’s or later.

The lessons to be learned from this calamity are indeed applicable to our present-day crisis. But the conventional wisdom about the Great Depression – that it was caused by the excesses of free markets that must necessarily lead to crisis by virtue of capitalism’s inherent contradictions, abetted by the laissez-faire policies of a Republican president Herbert Hoover, and that the government-expanding New Deal policies of Democratic president Franklin Delano Roosevelt were the necessary and proper remedy which saved us from a worse fate – is entirely wrong.
The stock market crash of October 1929 was the direct result, not of free-market capitalism, but precisely of government interference in the market, transmitted via the political signal that the Smoot-Hawley Tariff bill, a protectionist monstrosity, would be made law. The market correctly estimated that this bill would substantially constrain international commerce, reducing the current market value of financial and other assets. The search for the right revaluation was a panicked activity; but that panic was rationally justified.
The subsequent government responses to the initial crisis dug the country increasingly deeper into the hole.

A Crisis of Intervention
Remember the Great Depression of the 1920s? Of course you don’t, because it didn’t happen. It might be because President Warren Harding ignored his Secretary of Commerce Hebert Hoover’s advice to intervene in the recession of 1921, and that recession quickly recovered and was forgotten.
Herbert Hoover was no laissez-faire leader. In the early ‘20s, before either was president, Hoover collaborated with Franklin Delano Roosevelt in the American Construction Council, an attempt to turn the construction industry of the entire nation into one giant cartel. He participated in the drafting of the Railway Labor Act of 1926, a major step to collectivizing labor relations. He believed that high wages in an economy cause general prosperity, rather than – the other way around – that prosperity produces higher wages. From this premise much of Hoover’s efforts as president would be targeted at maintaining pre-crash wage rates for those workers who still had jobs. Economic theory states that artificially attractive prices cause shortages. In this case, it lead to a shortage of jobs: unemployment.

After the crash, President Hoover (1929-33) intervened aggressively in the economy. Hoover:
• Summoned the leaders of the largest corporations and business associations to a series of conferences for, in his own words, “the coordination of business and governmental agencies in concerted action.” They acted in large part to maintain existing wage rates and continue expansion. Real wages for employed workers increased for most of Hoover’s term, peaking at 11% above 1929 levels in 1931 and still a ‘healthy’ 8% in 1933 while unemployment simultaneously soared to 25% (in other words, nice work if you can get it; God help you if you can’t).
• Urged public works programs in response to the crisis. The Division of Public Construction of the Department of Commerce was created in December 1929. Hoover urged state governors to follow suit at their level.
• Intervened in different directions at different times in commodity markets. When the Federal Farm Board’s policy of price supports resulted in overproduction of wheat, cotton, wool and other products, thereby collapsing prices and bringing devastating losses, Hoover changed course to order acreage to be plowed under, taken out of production, and to destroy ‘excessive’ livestock.
• Authorized construction of Hoover Dam on the Colorado River, at a cost of $915 million (equivalent of roughly $45 billion of today’s dollars).
• Signed the Smoot-Hawley Tariff into law in 1930.
• Weakened bankruptcy laws in favor of debtors and eroding the property rights of creditors.
• Imposed an immigration ban which effectively reduced legal immigration from Europe by 90% overnight. He deported as many as 20,000 ‘undesirable’ aliens per year.
• Publicly assailed speculators and coerced the New York Stock Exchange to curtail short selling; campaigned against ‘unpatriotic’, ‘traitorous’ hoarders (or put another way, demonized frugal, risk-averse citizens who claimed the right to their property and thereby exposed unsound credit policies and institutions).
• In February 1931, signed the Employment Stabilization Act, creating the Employment Stabilization Board. Unemployment soared to 25% in 1933 and didn’t fall to pre-depression levels until 1940.
• Massively increased government expenditures at a time when revenue to the treasury was falling, resulting in the largest peacetime deficits to date in American history. Federal expenditures rose 30% in 1930 alone, from $4.2 billion to $5.5 billion.
• In 1931, created the President’s Organization on Unemployment Relief, effectively inserting the federal government for the first time into a sphere that had previously been considered the responsibility of private charities and religious organizations.
• In 1931-32, created the Reconstruction Finance Corporation, intended to centrally and comprehensively direct and manage the banking, lending, insurance and finance industries.
• Reduced the hours worked by government employees without reducing their salaries.
• Cancelled oil-drilling permits on publicly-owned land, in an effort to restrict supply and maintain a ‘minimum fair price’ for the petroleum industry.
• In May 1931, closed Federally-owned forest land to new logging, in order to defend timber prices.
• Urged the Federal Reserve to relax its lending and discount standards (in other words, engaged in artificial credit expansion). See: Glass-Steagall Act of 1932.
• Signed the Federal Home Loan Bank Act, creating the Federal Home Loan Bank Board, since 1989 the Office of Thrift Supervision, intended to promote home ownership.

One of the few of Hoover’s acts which could be qualified as pro-limited government and individual property rights was his income tax rate cut of 1930, from the stratospheric height of 5% to 4% (a cut of 20%) for individuals, and 12% to 11% for corporations. Prior to the 1930’s, the income tax had not taken anything like its modern bite in the daily lives and livelihoods of citizens.
However, in 1932 he reversed course and raised income taxes as well as prior wartime excise taxes and sales taxes on hundreds of consumer goods. The surtax on the highest incomes went from 25% to 63%. When businessmen suggested to Hoover that the tax regimen was detrimental to the general economic health and that the government would do better to cut expenditures by $2 billion, Hoover brushed them aside.

Read Part 2 of Why we don't need a new New NEW Deal HERE.