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New Republic: A Lesson From The Great Depression

by John B. Judis

ohn B. Judis is a senior editor of The New Republic and a Visiting Scholar at the Carnegie Endowment for International Peace.

In the 1930s, as the world plunged into depression, there were two political factions that insisted nothing could be done: Marxists, who saw the depression as the death knell of capitalism, and laissez-faire economists, who believed that the only way to revive the economy was to let the depression takes its course like a bad storm at sea. Imagine my surprise in the wake of Thursday's stock market crash to find a similar attitude toward the current downturn among liberals and mainstream economic thinkers.

In a column in The Washington Post, Ezra Klein said the "right question" to ask about the economy was, "Where will the recovery come from?" He responded that "no one has an answer," but also asserted that the recovery "won't come from the United States." Financial Times columnist Gillian Tett said pretty much the same thing on PBS's News Hour. "They're out of ammo," Tett said of the federal government. "I mean, they have already used all the fiscal measures they could in the last two or three years. And they're pretty much back to where they can go, as far as they can go in terms of the monetary policy measures."

I got news for Klein and Tett (which sounds like a law firm). If a real recovery occurs in the next four or five years, it will come about the same way a recovery took place after the 1930s: from a huge infusion of government spending. It won't, one hopes, require the justification of war, but it will have to consist in the fiscal equivalent of war. If we don't do that, we may not escape this slump for the rest of the decade — and neither will Great Britain and other countries that have also convinced themselves that reducing government is the best course of action.

THE ECONOMICS ARE familiar by now, but under attack from the right and insufficiently understood in the center, including at one of our woe-befallen, politically compromised rating agencies. There are two types of recessions: the short-term, cyclical wage-price recessions that prevailed after World War Two and that were manipulated by monetary policy, and the deeper recessions, or depressions, like those that occurred in the 1890s or 1930s. What is happening today is more similar to past depressions. It was brought about by a financial crash, which creates a backlog of private debt, coming on top of a slowdown in industrial production caused by global overcapacity. The result has been a paralyzed private sector.

There are three kinds of measures that are needed to "solve" this kind of recession: first, short-term measures that revive consumer and investment demand; second, measures that will stimulate new domestic outlets for private investment; and third, steps that prevent the demand government creates from being siphoned off primarily in imports. For the first purpose, the best kind of measures are those that create jobs for the unemployed — whether in the public or the private sector — and that eliminate or reduce debt directly, for instance in housing or school loans. Tax cuts are not as effective because, given the level of private debt, consumers are likely to save rather than spend them. With interest rates already near zero, Federal Reserve monetary measures are also not very effective.

There is a copious amount of historical evidence that cutting spending — and cutting government jobs — is more likely to deepen a downturn. Start with the United States, Germany, and Great Britain in the first years of the Great Depression; the United States in 1937; and Japan in 1997. In each of these cases, cutting spending made things worse. To be sure, large deficits can harm an economy; but not when capacity is idle, unemployment is high, interest rates are not rising, inflation is non-existent, and a government's currency and Treasury bills are still widely in demand.

Why, then, do policy-makers and pundits think otherwise? Some economists and conservative politicians have swallowed the laissez-faire Kool-Aid, and simply don't get it. In some quarters, rampant confusion prevails. But with a liberal like Klein, I suspect that despair — what Kierkegaard called "the sickness unto death" — over getting Congress to agree to a dramatic boost in government spending is really behind his thinking there is no economic solution. However, following the lead of my colleague Jon Chait, I would distinguish between what needs to be done economically, and what can be done politically. What needs to be done is fairly clear; what can be done is not. But I think the political effort is worth making.

The first consideration has to do with the sheer gravity of the situation. What is at stake goes beyond an abstract rate of unemployment, or the prospect of a Republican White House in 2012, or even the misery of the long-term unemployed. From the beginning, this recession has been global. Germany has to take leadership in Europe, but the United States is still the world's largest economy, the principal source of consumer and investment demand, and the banking capital of the world. If the United States fails to revive its economy, and to lead in the restructuring of the international economy, then it's unlikely that other economies in the West will pull themselves out of the slump.

And as the experience of the 1930s testified, a prolonged global downturn can have profound political and geopolitical repercussions. In the U.S. and Europe, the downturn has already inspired unsavory, right-wing populist movements. It could also bring about trade wars and intense competition over natural resources, and the eventual breakdown of important institutions like European Union and the World Trade Organization. Even a shooting war is possible. So while the Obama administration would face a severe challenge in trying to win support for a boost in government spending, failing to do so would be far more serious than the ruckus that Tea Party and Republican opposition could create over the next year.

The second consideration has to do with public opinion. In the United States, skepticism about government is the default position. But it coincides with support for specific initiatives and is put aside during crises when it appears that private initiative is insufficient. That happened during the world wars, the mid-1930s, and in the months following the financial crash in September 2008. The Obama administration won support for its stimulus program by convincing the public that the economy was in critical condition, but since then it has backed off and argued instead that a recovery was in place. In August 2010, Treasury Secretary Tim Geithner published an infamous op-ed in The New York Times entitled, "Welcome to the Recovery." Even as it has become clear that a recovery is not taking place, the administration has continued to insist that it is — only more slowly than expected. That's understandable — saying that the recovery has not occurred is tantamount to admitting failure — but it also undercuts any attempt to win over the public to ambitious government initiatives.

Could the public be won over? During the first stage of the debate over raising the debt ceiling, administration officials privately expressed doubt about whether they could ever convince the public that the debt ceiling needed to be raised. Instead, they focused on getting Wall Street to pressure the Republicans. But even without an administration effort to sway the public, support for raising the debt ceiling doubled during July, as the public became aware of the consequences of not raising the limit. Could a noisy administration campaign — led by the president and based on the idea that there is a national and global crisis that requires extraordinary measures — win support for a new stimulus program? Perhaps not, but given the gravity of the situation, it should at least be attempted.

Of course, winning over public opinion does not necessarily lead to winning over Congress. But, again, it is not inconceivable. In the spring of 2010, the administration was able to budge Republican opposition on financial reform by waging a public campaign. And if the administration doesn't finally succeed in winning over an intransigent Republican party to a program designed to create a recovery, it will have drawn the kind of sharp contrast that the public will be able to understand in the event that the Republicans do win, and continue on their current path of cutting spending.

Other administrations have sharply pivoted when their policies haven't succeeded: Franklin Roosevelt changed course in 1938 after his budget cutting created a double-dip recession; Richard Nixon became a born-again Keynesian in 1971. But I fear that, under its veneer of optimism, this administration, like some of its supporters in the commentariat, has given up on trying to change public opinion, and, by extension, on pulling America and the world out of the Great Recession. It's not a matter of theory with them — they haven't become radical Marxists or followers of Friedrich Hayek — but of political despair.

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Uh oh, think that kind of talk borders on heresy in here. Reducing spending doesn't work? The govt should spend more? Blasphemer!

:-P

The problem is that for every expert there is an equal and opposite expert: for every bit of evidence that says  cutting spending caused the double-dip in 1937, someone will say that  they should have cut spending earlier etc. Economists, politicians etc are like the generals who are always ready and able to fight the last war, until the next one comes along. What worked in the past when nations weren't as interdependent economically may not be the best solution now - that is, if people actually could agree on what worked in the past.....

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Here's another article I just read: maybe we're calling this the wrong thing?

The Second Great Contraction

CAMBRIDGE – Why is everyone still referring to the recent financial crisis as the “Great Recession”? The term, after all, is predicated on a dangerous misdiagnosis of the problems that confront the United States and other countries, leading to bad forecasts and bad policy.

The phrase “Great Recession” creates the impression that the economy is following the contours of a typical recession, only more severe – something like a really bad cold. That is why, throughout this downturn, forecasters and analysts who have tried to make analogies to past post-war US recessions have gotten it so wrong. Moreover, too many policymakers have relied on the belief that, at the end of the day, this is just a deep recession that can be subdued by a generous helping of conventional policy tools, whether fiscal policy or massive bailouts.

But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.

A more accurate, if less reassuring, term for the ongoing crisis is the “Second Great Contraction.” Carmen Reinhart and I proposed this moniker in our 2009 book This Time is Different, based on our diagnosis of the crisis as a typical deep financial crisis, not a typical deep recession. The first “Great Contraction” of course, was the Great Depression, as emphasized by Anna Schwarz and the late Milton Friedman. The contraction applies not only to output and employment, as in a normal recession, but to debt and credit, and the deleveraging that typically takes many years to complete.

Why argue about semantics? Well, imagine you have pneumonia, but you think it is only a bad cold. You could easily fail to take the right medicine, and you would certainly expect your life to return to normal much faster than is realistic.

In a conventional recession, the resumption of growth implies a reasonably brisk return to normalcy. The economy not only regains its lost ground, but, within a year, it typically catches up to its rising long-run trend.

The aftermath of a typical deep financial crisis is something completely different. As Reinhart and I demonstrated, it typically takes an economy more than four years just to reach the same per capita income level that it had attained at its pre-crisis peak. So far, across a broad range of macroeconomic variables, including output, employment, debt, housing prices, and even equity, our quantitative benchmarks based on previous deep post-war financial crises have proved far more accurate than conventional recession logic.

Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a “Great Recession.” But, in a “Great Contraction,” problem number one is too much debt. If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions.

For example, governments could facilitate the write-down of mortgages in exchange for a share of any future home-price appreciation. An analogous approach can be done for countries.  For example, rich countries’ voters in Europe could perhaps be persuaded to engage in a much larger bailout for Greece (one that is actually big enough to work), in exchange for higher payments in ten to fifteen years if Greek growth outperforms.

Is there any alternative to years of political gyrations and indecision?

In my December 2008 column, I argued that the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years. Of course, inflation is an unfair and arbitrary transfer of income from savers to debtors. But, at the end of the day, such a transfer is the most direct approach to faster recovery. Eventually, it will take place one way or another, anyway, as Europe is painfully learning.

Some observers regard any suggestion of even modestly elevated inflation as a form of heresy. But Great Contractions, as opposed to recessions, are very infrequent events, occurring perhaps once every 70 or 80 years. These are times when central banks need to spend some of the credibility that they accumulate in normal times.

The big rush to jump on the “Great Recession” bandwagon happened because most analysts and policymakers simply had the wrong framework in mind. Unfortunately, by now it is far too clear how wrong they were.

Acknowledging that we have been using the wrong framework is the first step toward finding a solution. History suggests that recessions are often renamed when the smoke clears. Perhaps today the smoke will clear a bit faster if we dump the “Great Recession” label immediately and replace it with something more apt, like “Great Contraction.” It is too late to undo the bad forecasts and mistaken policies that have marked the aftermath of the financial crisis, but it is not too late to do better.

Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.

http://www.project-syndicate.org/commentary/rogoff83/English

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The concept that the 30's depression in America was solved by increased spending by Roosevelt still has the jury out.  In Britain where little state expenditure was forthcoming, there was a gradual revival caused by the development of new industries like Cars, Electricals and Chemicals.  Those areas of traditional industry (Coal, and Shipbuilding) continued their decline.

Regardless, the formula of the central state expending and therefore reviving is seriously flawed in the modern world.  Keynes argued tha\t demand management was a useful tool and talked of pump priming, deficit budgeting, the accelerator and the multiplier.  Sadly, in 2011 all this would do in the US is suck in imports from China.  Secondly, Keynes was talking about a time when the balance between public and private expenditure was hugely different from that in 2011.  Nowadays the state is up to its eyeballs in debt whilst it is the private sector that requires genuine stimulation.  This can only happen by transforming the tax regime, incentivizing entrepreneurs, removing nuisance restrictions and generally encouraging the rewards for risk

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If the current tax burden in the US is so great that private industry can not flourish, then why are other countries with substantially higher tax burdens but otherwise similar economies doing better than us?  

From the evidence thats thus far been presented, many non-construction companies are currently turning notable profit, but are still not hiring.  Instead they're keeping that new money in the bank and not reinvesting.  This suggests that a factor other than the affect of taxation on profit is retarding growth (like poor confidence in the market).  

Further, if you cut taxes and it fails to sufficiently stimulate the economy enough to a) increase revenue and b) create new jobs then you're going to 1) have to increase borrowing, thus augmenting the problem you were trying to solve, or 2) be required to make that much deeper cuts to spending, most likely severely hurting tens of millions (in the US, at least) of willing to work unemployed who rely on benefits to afford food and lodging.

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the problem isn't so much the size of government (though one spending $4 trillion daily clearly needs to be downsized), the problem is that even "mainstream" economists don't really believe in free market capitalism anymore. they don't believe that the private sector can lead us out of all this. what they don't understand is, if the government wants to get more out of the private sector, then it needs to do less, and get out of the way. it's really very simple. as we've seen, failed stimulus and the printing of dollars doesn't work. what does? out competing everywhere else when it comes to enacting policies that will lure in business and make business as easy and streamlined as possible. opening up our energy resources, lowering corporate and capital gains taxes, eliminating meddlesome delays and red tape.

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Originally Posted by Dødherre Mørktre:
the problem isn't so much the size of government (though one spending $4 trillion daily clearly needs to be downsized), the problem is that even "mainstream" economists don't really believe in free market capitalism anymore. they don't believe that the private sector can lead us out of all this. what they don't understand is, if the government wants to get more out of the private sector, then it needs to do less, and get out of the way. it's really very simple. as we've seen, failed stimulus and the printing of dollars doesn't work. what does? out competing everywhere else when it comes to enacting policies that will lure in business and make business as easy and streamlined as possible. opening up our energy resources, lowering corporate and capital gains taxes, eliminating meddlesome delays and red tape.

I see three problems with this.  

1)  How do you foster competition and innovation when the middle class in most first world countries (the group I presume buys the most crap) is struggling to bring in enough money to keep the lights on?  

2)  The responsibility of a government is to the people, not to the corporations.  While I have no doubt we can all find ample fault with where some of the stimulus money went, I think writing it off as a complete failure is incorrect.  Even if it didn't jump-start the economy, how many Americans were able feed their family and pay their rent because they either got hired by the government or by a company that received a federal contract?  I think this is the more important narrative, yet it seems to be largely ignored.  

3)  You suggest cutting regulation will help business flourish.  I think this is a disastrous idea.  While there are some regulatory laws that meant well but are actually unnecessary (ie the ban on chrysotile asbestos, all asbestos is not created equal!), most of what is on the books is there for a reason.  Also, the countries that we would loose industry to because of environmental law are places like China that have next to no environmental protection (and look at the repercussions of that, during the Olympics there was concern about the air being too dangerous for the athletes to breath!).  The only way to contend with that would be to scrap almost all of our environmental regulation.  About a year or so ago I read an article from the Tea Party Patriots website arguing for just this, naively believing that the invisible hand would be better at punishing companies for harming local communities than the EPA (something that rarely if ever happens).

Also, you lament that few economists believe in a truly free market capitalism.  True, unferreted capitalism is a horribly unstable economic system that invariably leads to its own destruction.  A free market system is supposed to self regulate via competition, however as the goal of a company is to maximize profit it is greatly advantageous to reduce competition.  So slowly start buying their competitors or simply running them out of business (I remember some of the larger companies in the 1800s would temporarily drop their prices to below cost just to kill more vulnerable rivals).  This almost invariable leads to monopoly, where there is no choice in which product you want.  If you need steel, you're buying it from Mr. Carnegie.  And once your rivals are subdued you can raise your price to whatever you feel like, since there is no alternative product for the public to buy.  The only way to prevent this is with regulation (a la Theodore Roosevelt), however once you do this you go from Free Market Capitalism to a mixed economy.

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Originally Posted by Bryant Platt:
True, unferreted capitalism is a horribly unstable economic system that invariably leads to its own destruction.

i'm only going to tackle this statement. what you're talking about is an unregulated free market. and the left does this all the time to describe any form of capitalism not dependent on the government for success, and really, your attitude exemplifies that of the economists i mentioned previously, and their keynesian views on capitalism. capitalism can't be trusted. it's basically as if there's an adversarial mindset against capitalism. anyway, clearly, ad nauseum, an unregulated market isn't something being advocated by the right. obviously, there's a difference between regulation and participation. all i was saying in my original post, is that the government needs to get out of the way, and make doing business easier. not that we should have some form of anarcho-capitalistic system.

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Is this original post trying to compare what happened in the 30's to what is happening now??? Is it also saying that we can spend our way out of this???

Wow.....just wow.....nothing else to say really.........