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Kalamitous Krugman

August 29, 2009 3 comments


In a recent New York Times Op-Ed entitled “Till Debt Does Its Part,” Nobel Prize-winning economist Paul Krugman rebuffs those few reactionary souls who argue that all this debt we are incurring is a bad thing. He assures us,

…don’t fret about this year’s deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it’s not because the economy can’t handle the extra debt. Instead, it’s the politics, stupid.

Sometimes you really have to wonder what the standards are for winning a Nobel Prize. We have an economy built on consumer debt which relative to disposable income increased from a low in 1945 to its peak in 2007. As the Daily Reckoning further notes, we have $20 trillion in excess debt to work through over the coming years. Yet while on the private side, we need to pay for our sins, liquidate our debts, allow malinvestments to go belly up and start over on more solid fiscal ground, apparently the public sector can just keep on trucking.

As the sage Mr. Krugman notes,

Right now deficits are actually helping the economy. In fact, deficits here and in other major economies saved the world from a much deeper slump. The longer-term outlook is worrying, but it’s not catastrophic. The only real reason for concern is political. The United States can deal with its debts if politicians of both parties are, in the end, willing to show at least a bit of maturity. Need I say more?

Explain this to me exactly. When are deficits a help to an economy in distress? If the whole reason we are in economic distress is because of a glut of debt, then why is the answer to pour more gasoline on the fire? Any company that still functions in any semblance of a free market knows that if it can’t service its debt, it will be forced to make difficult decisions, potentially opting for bankruptcy. It cannot continually slop at the trough of the debt market.

But Krugman seems to think that the government can have its cake and eat it too. Where a sober person might argue that in hard times, a government must tighten its belt, like a business or a man, Krugman seems to think that incurring more and more debt, in essence stretching out the inevitable painful liquidation whilst creating another debt/currency crisis down the road is better. Why have one financial crisis when you can have two or three stretched out over a longer period of time? You get the sense that Krugman’s agenda is more political than economic sometimes.

Which brings me to my next point. Krugman believes the only reason for concern over the debt is “political.” Proud of this claim, Krugman states, “Need I say more?” Well yes, I think you need do so. Our currency, and the debts run up by our government denominated in our currency are backed by the full faith and credit of the United States government; which is to say our money and debt are backed by our economy, our people. If we are in for a prolonged period of negative private sector growth, high unemployment and increased intervention in all aspects of life, especially our economy, how can Krugman make the assumption that the ability to continue adding to our debt solely rests on the “maturity” of the politicians? Can Barney Frank snap his fingers and suddenly make the world buy our paper?

If the politicians wish to be “mature” they can remove themselves from the private sector, slash spending and taxes, let whole swaths of industry go belly up and allow people to foreclose on their homes and pay off their debts. Alternatively, if the politicians wish to be immature, they can do so through intervention and coercion.

Krugman as one might expect opts for the latter, immature route. Mind-numbingly, he proclaims:

If governments had raised taxes or slashed spending in the face of the slump, if they had refused to rescue distressed financial institutions, we could all too easily have seen a full replay of the Great Depression.

As I said, deficits saved the world.

In fact, we would be better off if governments were willing to run even larger deficits over the next year or two. The official White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years. If that’s at all correct — and I fear that it will be — we should be doing more, not less, to support the economy.

Krugman, going along with his Keynesian (read socialists) brethren, forgets about the failures of all of the interventionism even before his idol FDR ever got into power during the Depression, in addition to the disastrous results of similar policies (which he of course advocated) over the last two decades in Japan. These frauds continue to peddle the same illogical government gobbledygook that prolonged the Depression, all the way to “cash for clunkers”, the modern day equivalent of FDR’s forced killing of crops and slaughtering of pigs.

Mr. Krugman seems to think that interventionism is what saves economies. Might I ask then, why not intervene from the start? If the state is so good at managing crises, why not let it manage all industry in good times as well? Is the free market only sufficient when the Dow is rising? And if deficits are the cure-all, then why do nations ever default on their debt? Why is Zimbabwe the way Zimbabwe is? Could it be that perhaps the central planners are not so divine after all?

To be fair, Krugman, digressing notes:

But what about all that debt we’re incurring? That’s a bad thing, but it’s important to have some perspective. Economists normally assess the sustainability of debt by looking at the ratio of debt to G.D.P. And while $9 trillion is a huge sum, we also have a huge economy, which means that things aren’t as scary as you might thinkHere’s one way to look at it: We’re looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn’t sound like an overwhelming burden.

Even though all this debt we’re adding on might not actually be so great, we have a huge economy. Ah, the panacea of the huge (albeit shrinking) economy – an economy based on consumption, services and debt, the hallmarks of any economic powerhouse. He also argues that a rise in debt/GDP of 40% is OK, since this debt will only be 5% of federal revenue, which doesn’t sound so overwhelming. So essentially, because it’s only 5% of a massively-sized federal government which will have ever-decreasing tax revenues necessitating continued debt financing (to pay for more boondoggles), we should be OK to pay off our debt (with devalued dollars I suppose?).

What might our lenders think about that? Krugman has an answer for this too.

Now, this assumes that the U.S. government’s credit will remain good so that it’s able to borrow at relatively low interest rates. So far, that’s still true. Despite the prospect of big deficits, the government is able to borrow money long term at an interest rate of less than 3.5 percent, which is low by historical standards. People making bets with real money don’t seem to be worried about U.S. solvency.

I would challenge the assumption that the US government’s credit will remain good. As Krugman notes, our debt/GDP is going to rise significantly, “The official White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years,” and as I mentioned government is intervening in the economy on an unprecedented scale, but relax, our friends in the Far East will continue to bankroll us. Krugman should take a page from Milton Friedman’s playbook (along with those of Hayek, von Mises and Bastiat) and remember that there is no such thing as a free lunch. All government can do for “revenue,” is directly tax, or indirectly tax through issuing debt (taxing future generations and/or devaluing the currency) or printing money.

While Krugman argues that the people “making bets” don’t seem worried about our solvency, as numerous publications have noted, the Chinese are buying less treasuries and stockpiling commodities (however short-lived the Times may think it will be), indicating that they are diversifying out of dollar-denominated assets. Meanwhile, the government has had to take the drastic measure of purchasing its own Treasuries, with the Fed committing to buy $300bn in notes (i.e. printing $300bn) and also monetizing the debt more discretely. In other words, the government has had to keep its own borrowing costs down artificially, making up for the lack of demand of its primary dealers by bidding for its own debt. But look at the YTD yield curve for the 10-Year Treasury, and tell me that the markets aren’t reacting at all to our fiscal recklessness:


Moreover, just because rates haven’t spiked by 500bps in the last year, does that mean that market participants really aren’t scared about our solvency? Markets can stay irrational for long periods of time, just look at the housing bubble or any of the other bubbles which after the fact have seemed so obvious. Further, I would argue that creditors like China are being perfectly rational. The Chinese are trying to shift their money towards assets with real tangible value like commodities, while doing as little as possible to spook the government debt markets, because doing so would hurt the value of their own paper. If they flooded the markets with Treasuries, all of their dollar-denominated assets would plummet in price. It’s not in their interest for there to be a run on the US government yet. But that doesn’t mean that they won’t slowly but surely make their exit from US paper assets, leading to higher borrowing costs for our government and less confidence in our dollar. As I mentioned, there is no free lunch.

Krugman notes that other governments that have practiced similar profligacy like Belgium and Italy never faced financial crises in the early 1990s, but there are obvious notable differences. We are the biggest economy in the world. We were the most prosperous one. We have the world’s reserve currency. We are not accustomed to the kind of fiscal stagnancy faced in Europe. I just do not see that Krugman’s comparisons hold water. A more apt comparison in my eyes would be the US versus the British Empire circa its collapse.

Regardless, I want to return to the fundamental point that going into more debt to solve a problem caused by too much debt makes no sense. One might argue that sometimes debt can be beneficial and not cause long term harm. One might cry that parents are right to take out a mortgage on a house to raise their children. If the family can reasonably expect to generate the cash flows to retire this debt over time, then this will certainly be fine. But the US is like one giant family of drug-addled deadbeats looking to buy a mansion in the Hamptons, having already foreclosed on its subprime mortgage, maxed out all of its credit cards and traded in its Rolexes to the local pawn shop. And its only cash flows are those it can obtain by plundering its citizenry.

Debt is OK if you can reasonably expect to pay it off. To incur even greater debt in the face of debt that you will already be unable to service is downright immoral and will lead to severe consequences for the people.

These deficits in and of themselves are also not productive. They represent a stealing of wealth from future generations. As I mentioned, the only way to pay down the debt will be to tax future Americans, either directly or indirectly through inflating the money supply and thus devaluing the currency. Further, regarding what the debts are actually being used to finance, as I have argued in accordance with sound Austrian economics, the deficit spending for bailing out failing ventures stops the market from naturally adjusting, and leads to less productive if not downright destructive “jobs,” and labor being diverted from the private sector.

So in some respects again, Krugman is right that our politicians need to be mature. But the people get the government they deserve, and as of yet though there have been some bright signs, the majority of people don’t seem to want to deal with the pain that mature servants would bring them today for a brighter tomorrow.

It is worth noting that in Krugman’s delusion, he actually makes a redeeming comment:

Over the really long term, however, the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.

He actually has me for a second, until the subsequent stanzas:

That shouldn’t be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.

But that won’t happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to “pull the plug on grandma.”

Keep it classy, Paul.

Spending Is Not Stimulus President Obama

February 6, 2009 2 comments


Today amid cheers, President Obama showed his true colors when it comes to his plan to deal with the recession (soon to be a depression). Valiantly fighting off all takers on his stimulus, Mr. Obama exclaimed:

Then there’s the argument, well, this is full of pet projects. When was the last time that we saw a bill of this magnitude move out with no earmarks in it? Not one. (Applause.) And when you start asking, well, what is it exactly that is such a problem that you’re seeing, where’s all this waste and spending? Well, you know, you want to replace the federal fleet with hybrid cars. Well, why wouldn’t we want to do that? (Laughter.) That creates jobs for people who make those cars. It saves the federal government energy. It saves the taxpayers energy. (Applause.)

So then you get the argument, well, this is not a stimulus bill, this is a spending bill. What do you think a stimulus is? (Laughter and applause.) That’s the whole point. No, seriously. (Laughter.) That’s the point. (Applause.)

Now I understand that President Obama was speaking in front of a group of Democrats, trying to rally his comrades, but this type of message should outrage American citizens. Mr. Obama promised the people change, yet he makes the argument that since there are always earmarks in bills, the government should get a free pass for porking up its latest monstrosity. Apologies to the already suffering American people that have to pay for this.

When it comes to buying a new fleet of green cars, the true politician in Obama comes out, spinning this ridiculous confiscation of private money as job creation. If this creates jobs, why doesn’t the government buy every taxpayer a Prius? Why not throw in some solar panels for every taxpayer too?

Because this money has to come from somewhere of course. This is a textbook example of the broken window fallacy in action. Basically, Obama will be taking taxpayers’ money and transferring it to the auto sector. All of the taxpayers are going to be subsidizing one particular industry. One interest gains at the cost of all others. This is what American democracy has become. It is not about the public good; it is about the good of a specific set of interests.

As to Mr. Obama’s final point that spending bills and stimulus are synonymous, one has to wonder how much longer this country will be able to stay afloat. Can Mr. Obama explain how taking $800 billion or most likely more money out of the private sector, and using some of it for pork, some for income redistribution and the rest for “shovel-ready” projects is stimulative? Can Paul Krugman or Larry Summers point to a situation in which wealth taken from the hands of the people has ever been used more productively by the government?

Government spending has NEVER — not once pushed an economy out of a recession or depression. Even amongst those who acknowledge that the New Deal failed to bring us out of the Depression, most argue that it was only World War II that got the economy back rolling. Yet even this is false, another example of the broken window fallacy that somehow you can mobilize all resources under a command economy, and by allowing the government to channel them towards specific uses (in the case of war, towards bombs and fighter planes) leave yourself better off. As Robert Higgs shows, our productivity did not recover until after the war, when productive forces were released into the free market.

The government cannot plan our economy and allocate resources profitably. Let me repeat this: THE GOVERNMENT CANNOT PLAN OUR ECONOMY AND ALLOCATE RESOURCES PROFITABLY. Not in the Soviet Union, not in Nazi Germany, not in Cuba, not in the United States.

Even if I leave out the moral issue that people should have the right to choose how they use their money, productively or unproductively, and grant that somehow, some way, President Obama can spend the money as the people would, it is a proven fact that we are going to have to issue hundreds of billions of dollars in Treasuries to fund this. As George Melloan notes in the Wall Street Journal today, this will inevitably prove inflationary. Our friends in China and Japan, already strapped for cash given their own economic problems will not be able to subsidize our profligacy much longer. They might even sell some of their existing Treasury holdings to raise cash. As has been noted repeatedly, Ben Bernanke may have to come in and buy Treasuries issued by his own government. Quite a queer concept.

To carry out this plan, helicopter Ben will have to print up more dollars and thus we will see inflation in prices. You can also bet that with the collapse in demand for treasuries abroad, and the government’s inflationary actions, interest rates will rise for all of us. We will suffer from stagflation, and the government will have no way to pay for all of its entitlements without printing more money, generating more inflation and higher and higher interest rates. We will be crushed under our own debt.

While the proper solution to all of this would be to allow ourselves as a nation to deleverage, paying off our debts and liquidating the bad assets, and forcing the government to reduce its spending and cut taxes, instead the President and the congress are sealing our fate to depression. The above steps would be the true stimulus. What the President proposes is no stimulus. As the Wall Street Journal quips, “The spending portion of the stimulus, in short, isn’t really about the economy. It’s about promoting long-time Democratic policy goals, such as subsidizing health care for the middle class and promoting alternative energy. The “stimulus” is merely the mother of all political excuses to pack as much of this spending agenda as possible into a single bill when Mr. Obama is at his political zenith.”

One has to wonder if the reason Mr. Obama keeps telling us that things are going to get worse is intentional, a self-fulfilling prophecy. Perhaps he knows the true history of the Depression, that the more the government intervened the worse things got. He knows that this crisis will allow him to cement his place as President for at least eight years. As is the government’s wont, it will exploit any situation to gain more power.

Every single citizen must realize that in allowing our representatives to pass this bill, we are dooming our children and our children’s children to pay for our mistakes, sacrificing our property without just compensation and allowing our representatives to further imperil our economy. This is taxation without representation. This is immorality. This is the death knell of a once great nation.

Debunking the Myth of the Keynesian Government Boost

January 13, 2009 Leave a comment


As the recession has deepened, many of our economists (namely Krugman, Summers and the like) and elected officials have continuously argued that given the current dire circumstances, the only way to get the economy going is for the government to create demand by spending. The logic is that in a recession, the problem is that we have underconsumption; the magic pill for increasing consumption is government spending, generally in the form of public works projects. If resources like laborers are sitting on the sidelines (having been laid off), why not employ them in jobs building tangible public goods, enabling them to earn a living? Then, the government-spending multiplier will kick in, and the economy will grow again.

Robert Murphy in his refreshingly simple but thorough manner goes about picking apart the Keynesian argument in a recent Mises article. Murphy neatly sums up the Krugmanite point that “putting unemployed resources to work can only help, since prodding workers into producing even items of dubious value is better than letting them sit around watching Let’s Make a Deal.” He cites blogger Mark Thoma’s drawn-out explanation of the logic here. In debunking the Keynesian “idle resources” thesis, Murphy notes,

Even on its own terms, Thoma’s scenario fails because it is unrealistic. It is absurd to think that the government could come up with spending programs that would draw only on unemployed resources. Keynesian “macro” thinking ignores the complex capital structure of an economy. To build a bridge (as in Thoma’s example) requires a lot more than cranes and generic laborers. For example, gasoline will be burned in order to transport the newly employed workers to and from the work site. Nails, screws, steel, lumber, and other resources will be channeled into the new bridge, and at least some of these inputs will be diverted away from other private-sector uses, rather than simply leaving a state of idleness. Within the broad category of “labor” we find a similar situation, once we actually contemplate doing this project for real. If the city of Houston wants to build a new bridge, is it really the case that every last person even remotely involved with the project, will come from the ranks of the unemployed who are within commuting distance of the Houston bridge site? Surely the project will draw on engineers, construction foremen, and other skilled workers, who were still gainfully employed even amidst the recession, and who therefore will not be able to work on as many private-sector projects as they otherwise would have.

This issue is essential to understanding the way that the economy works. As I have mentioned before, no bureaucrat can ever plan for productive economic activity because he lacks the specialized knowledge, the ability to coordinate the activities and the profit motive of the business people who provide goods and services. He does not understand the capital structure of the economy. In the end, his central planning as always will fail.

As Murphy notes however, the Krugman’s of the world admit that during downturns, government spending is not about generating efficient economic activity, but rather acting on the assumption

that normal rules don’t apply. Ordinarily we’d welcome an increase in private saving; right now we’re living in a world subject to the “paradox of thrift,” in which private virtue is public vice. Normally we want to be careful that public funds are spent wisely; right now the crucial thing is that they be spent fast. (John Maynard Keynes once suggested burying bottles of cash in coal mines and letting the private sector dig them up — not as a real proposal, but as a way of emphasizing the priority of supporting demand.) [Emphasis added]

I just cannot understand this logic that when things get bad, somehow the laws of economic do not apply anymore. If the government can be so productive in using resources when times are bad, why not use resources when times are good as well? Can a country not prosper without a government boost? As we have seen, this is patently false given the success of all of the nations that have shed the yoke of socialism. Just look at Eastern Europe. In addition, if we as individuals were in financial trouble, would we spend money fast, or be careful in how we spent our funds, if we spent them at all? The same logic that applies to a man applies to the nation. During rough economic times, we need to ENCOURAGE SAVINGS, CUT SPENDING AND LOWER ALL BARRIERS TO POSITIVE ECONOMIC ACTIVITY (NAMELY TAXES). This will pave the way for real economic growth when the market corrects.

Murphy goes on to explain to the recalcitrant Keynesians that it is important to remember how we got into this situation, if we are to figure out the best way out of it. As Murphy puts it, following the low-interest-rate-fuelled boom, which created a mirage of wealth-generating activities ending in bust,

Once people in the private sector realized they had made horrible decisions during the boom years, they needed to stop business as usual and figure out how to make the best of a bad situation. Homeowners who had skimped on their savings for years (relying on booming house prices) had to slash spending to compensate for years of overconsumption, while entrepreneurs needed to decide which activities were likely to be profitable going forward, in light of the new information.

What had to happen is that workers and other resources that had been misallocated into housing construction and Wall Street investment banks, needed to be moved into other sectors. To repeat, this was and is a fantastically complex reshuffling, because even something as simple as producing a pencil requires the contributions of thousands of workers all over the world.

It’s not a simple matter of moving unemployed builders and hedge-fund managers into “booming” sectors X, Y, and Z, because (as we’ve seen above) these newly employed workers will require complementary tools and resources that were not laid off to the same extent. So the issue is, what is the best new outlet for all of these laid-off workers, such that — all things considered — the final mix of output goods best satisfies consumer desires? How can we be sure that channeling them into occupation X won’t actually do more harm than good?

This Austrian analysis of the problem shows that there was a major misallocation of resources that need to be channeled into productive sectors. However, the government is not the best authority to determine how to do this. According to Murphy,

In practice, the people in a market economy solve this fantastically complex problem by making profit-and-loss calculations, which in turn rely on market prices. For example, it is clear that a former Wall Street quant isn’t doing anybody a service by cranking out models that give mortgage-backed securities a gold star for safety. But what should this PhD do now? Should he go into academia and teach thermodynamics (which may very well have been the subject of his dissertation)? Or is his impressive education really a complete waste, and he would — at this point, given the economic realities — provide the most service by working the register at Wal-Mart?

Nobody knows the answer to this question. What happens during the recovery process is that the unemployed whiz kid initially looks for a job paying his former salary. As the months pass, he realizes that this is unrealistic, and he begins lowering his minimum price. Eventually, he finds an employer with compatible desires, and the two agree to a mutually beneficial arrangement.

Imagine that, letting the markets sort out the problems brought about by the government-created boom-and-bust cycle. Murphy notes that the Keynesians are wrong to assume that it is simply an issue of scared consumers causing the economy to contract. He argues:


On the contrary, the economy’s capital structure really was thrown into an unsustainable condition during the boom years, and it takes time for the mess to be sorted out. When the government runs up a deficit to fund “stimulus” projects, all that really means is that it is forcing taxpayers to pay for projects that they wouldn’t buy with their own money.

This is an aspect of the stimulus that really makes my blood boil. If it isn’t bad enough that the government is going to use precious resources inefficiently, and prolong the market-based recovery needed to start real economic growth again, the taxpayers funding these projects also don’t have really any say in them. Sure, we can vote out our elected officials. But as we have seen with all of the bailouts and the TARP money, even when sizable amounts of the populace have opposed government policies, we have not been able to stop them. It is immoral that the politicians can determine how best to use our hard-earned cash, and how much to burden our future generations with debt for these false stimuli. Let’s hope that we can not only vote out the bums during the midterm elections, but supplant them with people that have a sound understanding of economics and the Constitution.

History Repeats Itself

December 13, 2008 Leave a comment

I’ve been doing a lot of re-reading of Murray Rothbard’s, America’s Great Depression recently, and I think that this passage is particularly pertinent:

But the important fact is that the banking system had arrived at a critical impasse. Usually, in the placid course of events, radical (in the sense of far-reaching) economic reforms, whether needed or not, meet the resistance and inertia of those who drift with the daily tide. But here, in the crisis of 1933, the banks could no longer continue as they were. Something had to be done. Essentially, there were two possible routes. One was the course taken by Roosevelt; the destruction of the property rights of bank depositors, the confiscation of gold, the taking away of the people’s monetary rights, and the placing of the Federal Government in control of a vast, managed, engine of inflation. The other route would have been to seize the opportunity to awaken the American people to the true nature of their banking system, and thereby return, at one swoop, to a truly hard and sound money.

The laissez-faire method would have permitted the banks of the nation to close—as they probably would have done without governmental intervention. The bankrupt banks could then have been transferred to the ownership of their depositors, who would have taken charge of the invested, frozen assets of the banks. There would have been a vast, but rapid, deflation, with the money supply falling to virtually 100 percent of the nation’s gold stock. The depositors would have been “forced savers” in the existing bank assets (loans and investments). This cleansing surgical operation would have ended, once and for all, the inherently bankrupt fractional-reserve system, would have henceforth grounded loans and investments on people’s voluntary savings rather than artificially extended credit, and would have brought the country to a truly sound and hard monetary base. The threat of inflation and depression would have been permanently ended, and the stage fully set for recovery from the existing crisis. But such a policy would have been dismissed as “impractical” and radical, at the very juncture when the nation set itself firmly down the “practical” and radical road to inflation, socialism, and perpetuation of the depression for almost a decade.

Do we jump off of the precipice to full on socialism, or do things get so bad that we choose the path to sound currency and liberty? The choice is ours.

Bush and Hoover

December 12, 2008 2 comments


In reference to the potential failure of the auto bailout bill to fail (which it did on Thursday), Dick Cheney it is reported told Senators that it could be “Herbert Hoover time” again. In fact, Cheney was wrong. It is Herbert Hoover time again. Under the Bush administration’s tenure, the government has undertaken an extensive series of measures that Hoover once called his own in the hopes of preventing calamity. Let’s go to the replay booth, courtesy of Murray Rothbard:

  • Hoover repeatedly inflated credit in an attempt to provide liquidity to the system after the market fell precipitously in 1929 (as he had done during the 20s to fuel the boom in the first place).
  • Under the Futures’ Trading Act, in order to counter the activity of speculators a tax of 20 cents per bushel was placed on speculative transactions including puts and calls, and bids and offers, except when made in certain specific markets when authorized by the Secretary of Agriculture. Perhaps more significantly, he also forced Richard Whitney, the head of the NYSE to agree to withhold loans for the purpose of short-selling, and later stock exchange authorities at Hoover’s urging imposed a full ban on short-selling of securities.
  • Hoover held a Conference on Home Building and Home Ownership to promote the widening of home ownership and to lower interest rates on second mortgages.
    The conference resulted in a heavy increase in long-term credit at lower interest rates and aid to low-income housing. Hoover also tried to force insurance companies not to foreclose on insolvent homeowners.
  • Hoover set up the National Credit Corporation, forcing strong banks to pool their money together to extend credit to weaker banks, which they would finance through Federal Reserve assistance of up to $1 billion. The banks would rediscount bank assets that the Federal Reserve couldn’t legally rediscount on their own. When this proved insufficient, Hoover set up the Reconstruction Finance Corporation to disburse Treasury funds to struggling banks, industries, agricultural and credit agencies and local governments. “For the first five months of its life, the lending activities of the RFC lay shrouded in secrecy, and only determined action by the Democratic Congress finally forced the agency to make periodic public reports,” as Murray Rothbard notes. 80% of the loans went to banks and railroads, of which 40% went to railroads because it was felt that if the railroads defaulted, the insurance companies and savings banks particularly would be stung. As well, as John T. Flynn noted, “When the R.F.C. lent money to one railroad to pay rentals to another railroad, it was in effect using public funds to pay dividends to railroad stockholders.” The RFC went into action fairly quickly, but Hoover himself complained because it took six weeks during which time securities continued to plummet in value.
  • Under the Glass-Steagall Act, Hoover significantly broadened the assets eligible for rediscount and permitted the Fed to use government bonds as collateral for notes as well as commercial paper; through the FRB, the government purchased major amounts of securities.
  • The government worked to weaken the rights of creditors by giving debtors more time to come up with payment before having to disburse of their assets.
  • When the government imposed bank holidays, they forced national banks who could have stayed open and functioned sufficiently to close as well.

Bush’s administration has followed Hoover’s playbook to a tee. The government has pumped tons of money into the system (charts courtesy of this St. Louis Fed Report) as Hoover did, and we are now approaching critical mass at the so-called “zero bound,” where only unconventional monetary policy can be used to inflate according to the eminent Mr. Bernanke. The exchange authorities have resorted to imposing restrictions on short-selling in certain securities. The government has encouraged mortgage companies to keep people in their homes, and is devising plans to work to reduce foreclosures through a number of options. The pooling of money from the good banks to buy poor banks with the insurance of the federal government has been done in the wake of Bear Stearns and the Fed and Treasury’s brokering of the deals to merge other financial institutions. The ever-changing TARP program is essentially the modern-day RFC, even down to its secrecy. Just as in Hoover’s time, money is being allocated to certain companies deemed too interconnected to the financial system to let fail. And of course, just as back then the money has been used by banks for reasons counter to what the government had hoped. According to Mr. Bernanke, like under Hoover the Fed has continually expanded its powers to accept securities at the discount window, purchased massive amounts of securities and even resorted to purchasing stock in banks, a step beyond Hoover (which Roosevelt eventually took). The weakening of the rights of the creditors under Hoover amounted to allowing insolvent debtors to keep functioning, something underlying literally all of the bailout plans for both homeowners and corporations being proposed or already enacted. Finally, the episode of the government forcing banks to take bank holidays even if they were financially sound is reminiscent of the banks being forced to receive TARP funds today.

What is even scarier about all of this is that most of what President-elect Obama is proposing in his “New” New Deal is even more far-reaching and radical. The era of Bush and Obama I believe will look exactly like the era of Hoover and FDR. It appears we are doomed to make the very mistakes that led us to the Depression we faced nearly 80years ago, in large part due to our “laissez-faire” Mr. Bush and his administration.

Categories: Bernanke, Bush, Depression, Hoover, TARP