The Worst Economy Since the Great Depression

Every time I hear some administration whiz kid parrot that phrase, incorrect as it is, I want to run for my copy of Thomas Sowell's Economic Facts and Fallacies. The administration is big on comparing the current recession with the Depression. We've blogged about this before. President Obama, like most liberals of his generation with an inflated sense of self, wants to make history before he understands history.

As the philosopher Santayana wrote, those who cannot learn from history are doomed to repeat it.

The Federal Reserve, under the chairmanship of Ben Bernanke, has continued a long policy of cheap money--keeping interest rates low on the theory that it will encourage economic expansion and avoid the peril of deflation. The connection between high unemployment and sagging consumer prices in the 1930s has led the Fed to conclude that it can lead the nation out of the current recession by money supply management.

That's all well and good. Monetary policy is one of the Fed's principle roles. But Art Laffer makes the case that taxes were the real demon that doomed the U.S. during the Depression and will destroy what remains of our economy if we allow it.

Most high school history students know how the 1930 Smoot-Hawley tariff turned a recession into a rout. By enacting the largest peacetime trade tax in the history of the Republic, it forced foreign governments to retaliate and enact their own tariffs against U.S. products.

As the economy further spiraled downward, government tried to make up the shortfall by raising other taxes, accelerating the decline. One thing about Congress in the good old days: As Mr. Laffer pointed out in a recent Wall Street Journal piece, when Congress raised taxes it didn't try to hide it:

• In 1932 the lowest personal income tax rate went from less than half of 1% to 4%
• The top marginal tax rate went from 25% to 63%
• The death tax more than doubled from 20% to 45%
• The gift tax went from 0 to 33.5% with the stroke of a pen

And the economy went from decline to free fall.

Enter FDR, who gets a total pass for his mismanagement of the economy during the Depression. His solution was to administer more of the same toxins that were killing the economy:

• That death tax went from 45% to 60% in 1933
• Not satisfied with that, Roosevelt saw the 60% and raised it 10 more points a year later to 70%
• The gift tax rose to 45 and then to over 52% in losing battle to pay for the New Deal
• By 1936 the highest marginal income tax rate hit 79%--a stunning 216% increase in 4 years!
• Finally, with nothing left to raise, FDR and Congress created a 1% employer and 1% employee tax on all wages up to $3,000

The result: a second economic collapse in 1937.

But wait! There's more! Don't forget about state and local taxes. From 1929 through 1932 they rose from 7% of GDP to 12%--on top of all of the federal tax increases, as documented by Mr. Laffer.

The result was a penury that lasted for another 20 years until 1953 when the Dow Jones Industrial Average and the unemployment rate (factor out the effects of World War II) finally returned to pre-1930 levels. This is documented in Amity Shlaes study of the Depression, The Forgotten Man.

It is worth noting all this because the current administration has a boundless faith in its own ability to centrally plan, direct and manage the economy. This was the fatal flaw that both a Republican, Herbert Hoover, and a Democrat, Franklin D. Roosevelt, made. Both were experienced technocrats who thought they could do the thinking for an organic economy that could largely manage itself if left alone.

President Obama and his apparatchiks seem to be making the same mistake. From stimulus packages, to nationalization of key industries to the healthcare takeover he is building a debt that can lead to only one place: higher taxes. In doing so his legacy may be not in restoring the economy through management wizardry, but in making the U.S. a permanent debtor nation.

Just thought you might like to know.

The Great Depression Revisited?

While there are some similarities to the Great Depression of the 1930s and our current economic problems, there are also some significant differences. [For a good understanding of the economic policies that contributed to and helped prolong the Great Depression, see Amity Shlaes' "The Forgotten Man," published by HarperCollins in 2007].


A previous post discussed some of the similarities. But here are some of the signal differences that make the two events quite dissimilar:

1. Unemployment in October 1929, the start of the Depression, stood at 5%. Within five years the unemployment rate was 23.2%. A staggering 364% increase in joblessness. We've not seen anything to even suggest we're in for that kind of job loss.


2. In October 1929, the Dow Jones Industrial Average was 343. By November 1934 it closed at 93--a long, precipitous 73% drop. Free markets will periodically reset and correct themselves. But a confluence of events during the Great Depression put the economy into a free falling death spiral from which it took years to recover.


3. In 1929 the Federal Reserve System was still in its infancy and its eventual role in managing the nation's money supply was yet to be defined. Today, the Fed has significant experience as a central bank and money manager, and has played a key role in stopping the bleeding in the current recession.


4. The government's answer to the Great Depression was the New Deal--public policy that combined central economic planning, government largesse, and massive government public works spending. Currently, the government's response has been largely to intervene in the financial and industrial sectors but only for the purpose of maintaining the viability of those sectors as free enterprise. One of the things that helped prolong the Depression was the government's direct intervention in the industrial sector, competing for capital with private enterprise and further weakening job growth and productivity.

There are also many misconceptions that remain about the Great Depression. One is that President Herber Hoover was a laissez-faire Republican who tried nothing to slow the Depression. Although he was not the interventionist that FDR proved to be, Hoover was the consummate technocrat who believed that the federal government had a role to play assisting "Main Street." His earlier accomplishments included spearheading successful federal flood relief efforts in the South and water projects in the West. As U.S. Commerce Secretary he oversaw the expansion of the Department.

Actually, Hoover did attempt to intervene in the economy. He raised taxes and signed the disasterous Smoot-Hawley Tariff Act--both very un-Republican things to do. Raising taxes confiscated valuable capital at the time the private sector needed it most to pay bills, hire labor and invest. Smoot Hawley ignited a global trade war that closed foreign markets to U.S. manufacturers, putting yet more people out of work. But a case can be made that much of FDR's New Deal, rather than solving the Depression, actually prolonged it.

Another misconception is that World War II pulled the nation out of the Depression. Actually, two reliable economic indicators, the Dow Jones Industrial Average and the unemployment rate never returned to pre-Depression levels until 1953--20 years after the inauguration of President Roosevelt.

Just thought you might like to know.

The Great Depression Revisited?

There has been a lot of commentary in the news over the last several months comparing our current economic turmoil to the Great Depression of the 1930s. There are a number of similarities to the two situations. But there are also a number of significant differences.

For a terrific second look at the Great Depression you could not do better than picking up a copy of The Forgotten Man, by Amity Shlaes. Liberals today want to blame 20 years of financial deregulation (under both Democrat and Republican presidents, by the way) for our current woes. Conservatives want to blame liberal tendencies to use the free market for social engineering (think Freddie Mac and Fannie Mae).

Writing about the Depression, Shlaes says that "...neither the standard history nor the standard rebuttal entirely captures the reality of the period." The same can be said for the current recession.

Other similarities between the two periods:

• Both were preceded by a severe downturn in the financial markets
• The downturns in each case were preceded by several years of terrific growth--the "Roaring '20s " and the "irrational exuberance" of the early to mid part of this decade
• Both downturns were fueled by overuse of leverage--margin trading in the 1920s and a variety of no money down mortgage products, designed to put people who might not normally qualify for loans into homes and fueled by the Federal Reserve's cheap money policy.

However, there are also a number of significant differences that make the current situation vastly different from your grandfather's Depression. But these are facts for another day.

Just thought you might like to know.