Lesson on Economics

Part 1: Lessons from the Great Depression (1st of a 6 Part Commentary From American Solutions)
By Adam Waldeck on July 2, 2009 4:32 PM
"This is the worst economy since the Great Depression." We always hear it. But is it true? What's different? What's the same? What can we learn about the Great Depression so that we can avoid another one?These are all questions that require serious study, and serious knowledge about economics. We'll (American Solutions) be rolling out all 6 parts for the next couple weeks. Here's Part One: We constantly hear that our current economy is the "worst since the Great Depression," however there's rarely a discussion about what the Great Depression was. In a nutshell, can you explain what happened during the Great Depression and the 3 main lessons we can draw from it?Our current economic situation in no way compares to the magnitude of the Great Depression with respect to the most important macro economic variables. In the Great Depression, for example, national income declined 36%, unemployment reached 25% and approximately 40% of all banks failed between 1929 and 1933. While our current economic crisis is certainly a cause for concern, it is not on the scale of the Great Depression. The Great Depression was an unmitigated catastrophe. Nevertheless, there are many public policy parallels that are eerily reminiscent of the period leading into the Great Depression and it is precisely these counter productive economic policies that Americans need to understand. While the magnitudes may differ, the directions government policies take us are in the similar direction with few exceptions. For example, in the 1920s, the federal government pursued an active policy of steering U.S. agriculture through an avalanche of subsidies, import protection, special credits, etc. Our farm mortgage sector became heavily indebted and deliberately targeted to the world export market by government policy. Banks in agriculture regions making loans to these farmers absorbed enormous levels of risks and were vulnerable to any adverse exogenous shock. The Smoot-Hawley Tariff in 1930, one of the most protectionist tariffs in world history (average dutiable rates increased from 38% to 60%), was the hard shock that tumbled over these government placed dominoes. This tariff was catastrophic in its effects, because scores of foreign governments retaliated and ceased buying US exports (largely agriculture at this time). The volume of exports declined approximately 65% from 1929 - 1932 and net farm income declined 70%. Thus, these two policies, economic steering and high tariffs wiped out the farm sector of America. The consequence: massive spikes in farm mortgage delinquencies and foreclosures throughout the Midwest and southern United States. Banks in these regions, encouraged to make those loans to those farmers during the 1920s, were now in financial crisis. Thousands of rural farm banks collapsed every year creating an enormous credit and banking crisis of contagion that eventually spread into cities and larger banking structures. As a note, the same phenomena occurred throughout most of Europe because their governments also pursued roughly the same policies at the same time:(1) farm subsidies and special protections(2) economic steering, by sector, through government planning (3) abnormal bank risk exposure to a central banking system(4) tariff wars (5) waves of bank failures and financial crisis(6) central bank incompetence and eventual abandonment of the international gold standard(7) large fiscal deficits and tax increases
Government created central banks worldwide had failed in their functions and allowed the fractional reserve financial structure to implode. It is truly amazing the level of "gross incompetence" of central bank leaders at this time. The US money supply collapsed by about 30% from October 1929 to March 1933 because of a severe secondary deflation. The same collapse occurred with the weighted average world monetary aggregate M1 (the top 7 national currencies. Look at what we have here: monetary failure and massive tax increases on imported goods from the tariff wars of Smoot-Hawley. In addition, in an attempt to balance the budget with tax increases, the 1932 Revenue Act doubled income taxes while in a major recession! To say that bad government policies destroyed much of the US economy is clearly an understatement. Everyone should take note of the truth in supply side economics: tax increases do not necessarily raise government revenues. In fact, they more often than not kill economic activity and the government's ability to collect revenues. Because of these tax increases, tariff revenue and income tax collections dramatically declined and the federal government ran even larger budgetary deficits and as a result expanded the national debt. My treatise, Lessons from the Great Depression, explores these connections and other destructive government policies in much greater detail.In addition to monetary implosion and an abrupt halt to international trade; President Hoover also pursued an active policy to prop up wage rates with the White House Wage Rate Conferences from 1929 to 1931. The government coerced large private industries to maintain their wage rates even in the face of mounting unemployment. Hoover did this as an extended favor to labor unions. It has been estimated that these artificially high wage floors increased the unemployment rate during this period by approximately 10 percentages points! Franklin Roosevelt would later pursue many of the exact same policies as Hoover, only magnifying them. During the Great Depression, Roosevelt imposed minimum wages twice, and this caused hundreds of thousands of people to lose their jobs on each occasion (NRA and FLSA). He increased income and corporate taxes on multiple occasions, created entirely new taxes that did not exist before such as Social Security taxes (which reduced the demand for private sector labor). He created legal business cartels to conduct central economic planning (NIRA), and encouraged unions with special privileges to artificially raise wage rates (Wagner Act). Like Hoover, Roosevelt pursed an aggressive government make-work jobs programs (that did not create any new net employment) (WPA). As a result, unemployment stayed at double digit levels throughout the entire Great Depression; while government ran huge budget deficits and accumulated enormous national debt. Any wonder why it was called the "Great Depression" or that it lasted so long? Our current financial/economic crisis has many similar traits. First, it is started with a home mortgage crisis. In the late 1970's the Community Reinvestment Act forced banks to lend to unqualified borrowers. Banks absorbed greater risk exposure by lending to people who could not afford their payments. Sound familiar? Just substitute the word "farm" for "home" in the mortgage crisis and you get the picture. Second, the government sector enterprises, Fannie and Freddie spun off from the FHA, bought nearly a trillion dollars worth of home mortgages on the secondary market. Under pressure from HUD in the 1990s, these GSEs' lowered their credit standards and encouraged "creative financing" with sub-prime instruments. Few policy makers in government seemed to recognize or even care about the dangerous consequences that result from putting millions of people into homes they could not afford. The sum total of this steering, subsidies and government regulatory distortion was extraordinary and non-transparent risk exposure wildly out of proportion with free market standards. Fannie and Freddie repackaged these rotten assets and resold them all over Wall Street exposing the rest of the market to those bad assets and created collateral damage. Sound familiar? Third, the Federal Reserve also deserves blame here as well since it consistently maintained artificially low interest rates after 2001. In its attempt to prop up the housing market, misguided fed policy disguised and then amplified the actual risk exposure throughout the financial system. Fourth, the federal government is now wild and reckless with its finances as well. The astronomical budgetary deficits ($1.7 trillion) and exploding national debt can not be defended in any rational economic way. Sound familiar? Buying off a plethora of special interest groups for reelection purposes is now the routine politics that is bankrupting America. Thus, let me go on the record and say it loud and clear: government is responsible for causing the entire financial crisis. Finally, the proposed solutions of the Obama Administration: higher taxes, more spending, more debt, more regulations, central economic planning and nationalizations, greater restrictions on trade, more favors to unions and higher minimum wage laws, will only make this economic crisis worse. Sound familiar? The Obama economic policies are modeled after proven failure of central economic planning of the market. Eighty years ago, America tried an aggressive experiment with economic fascism in the Hoover and Roosevelt New Deal policies. The result was the Great Depression! As for me, this is way too close for comfort.