Archive

Archive for the ‘laissez-faire’ Category

The Lesson of Warren Harding Revisited

February 10, 2010 Leave a comment

Though I have written extensively about the Recession of 1920, it is worth revisiting it per Glenn Beck’s show last night.  Beck rightly pointed out that the policies of decreased taxes and decreased government spending implemented by both Harding and Coolidge paved the way for the dramatic economic growth of the roaring 20s. What Beck didn’t mention was that prior to this period of unprecedented economic expansion, President Warren Harding had inherited one of the worst recessions in American history.   This Recession of 1920-21 is another one of the dirty secrets glossed over in the Progressive history books.

By late 1919, America was facing inflation in prices as measured by CPI of 20%.  Between 1920 and 1921, unemployment doubled from 5.2 to 11.7%.  During this same period, from their peak in June of 1920, prices declined by 15.8% on a year-over-year basis, a 50% greater deflation in prices than during ANY 12-month period during the Great Depression.  So what was Harding’s proposal to deal with this mess? To understand how to get out of recession, Harding looked towards how we got into it in the first place.

For America was coming out of World War I.  Government was controlling huge swaths of the economy, as it had mobilized land, labor and capital towards war production and away from normal commerce as dictated by consumer demand.  In addition to the mass of resources that needed to be reallocated according to market forces, the economy had been further distorted due to the policies of the Federal Reserve which had inflated the money supply by 71% from 1913-1919 (while the physical volume of business had only increased by 9.6%), and whose policies had led to an increase in prices of a staggering 234% between 1914 and 1920.  Prices needed to readjust according to the reallocation of resources.  In addition, not surprisingly, due to the costs of war, the federal budget had grown to $18.5bn.

One will note the parallels to our economic situation today.  Just as war led resources to be allocated away from where an unfettered economy would have directed them, so too did the artificial boom fueled by the Federal Reserve and various government policies lead resources to be misallocated towards assets such as houses and stocks during our most recent boom and bust cycle.  While unsustainable businesses and concomitant rises in prices developed in the private sector, the government too drastically increased.

Harding understood the root cause of recession.  As he noted in his inaugural address:

The economic mechanism is intricate and its parts interdependent, and has suffered the shocks and jars incident to abnormal demands, credit inflations, and price upheavals. The normal balances have been impaired, the channels of distribution have been clogged, the relations of labor and management have been strained. We must seek the readjustment with care and courage…All the penalties will not be light, nor evenly distributed. There is no way of making them so. There is no instant step from disorder to order. We must face a condition of grim reality, charge off our losses and start afresh. It is the oldest lesson of civilization.

And so what was his big Keynesian stimulus plan to bring the economy back from the abyss?  He argued during his Republican nomination speech:

Gross expansion of currency and credit have depreciated the dollar just as expansion and inflation have discredited the coins of the world. We inflated in haste, we must deflate in deliberation. We debased the dollar in reckless finance, we must restore in honesty. Deflation on the one hand and restoration of the 100-cent dollar on the other ought to have begun on the day after the armistice, but plans were lacking or courage failed. The unpreparedness for peace was little less costly than unpreparedness for war. We can promise no one remedy which will cure an ill of such wide proportions, but we do pledge that earnest and consistent attack which the party platform covenants. We will attempt intelligent and courageous deflation, and strike at government borrowing which enlarges the evil, and we will attack high cost of government with every energy and facility which attend Republican capacity. We promise that relief which will attend the halting of waste and extravagance, and the renewal of the practice of public economy, not alone because it will relieve tax burdens, but because it will be an example to stimulate thrift and economy in private life.

And so, shockingly Harding practiced what he preached.  Regarding deflation, the Federal Reserve jacked up interest rates from 4.75% in January 1920 to 7% in June 1920, and held this rate through the aforementioned major drop in prices through May of 1921.  Harding slashed the federal budget from $18.5bn in 1919 to $6.4bn in 1920 all the way down to $5.1bn in 1921.  Meanwhile, the government actually ran surpluses during these years, allowing them to pay down the debt by $300mm from 1920-21.  The Chief Economist of Chase National Bank of the era, Benjamin Anderson summed Harding’s philosophy and his attack on the recession as follows:

The idea that a balanced budget with vast pump-priming government expenditure is a necessary means of getting out of a depression received no consideration at all. It was not regarded as the function of the government to provide money to make business activity. It was rather the business of the US Treasury to look after the solvency of the government, and the most important relief that the government felt that it could afford to business was to reduce as much as possible the amount of government expenditure, which had risen to great heights during the war; to reduce taxes—but not much; and to reduce public debt.

Nor did the government increase public employment with a view to taking up idle labor. There was a reduction in the army and navy in the course of these years, and there was a steady decline in the number of civilian employees of the federal government. This policy on the part of the government generated, of course, a great confidence in the credit of the government, and the strength of the gold dollar was taken for granted. The credit of the government and confidence in the currency are basic foundations for general business confidence. The relief to business through reduced taxes was extremely helpful.

According to Anderson, how did the recession end?

…we took our losses, we readjusted our financial structure, we endured our depression and in August 1921 we started up again. The rally in business production and employment that started in August 1921 was soundly based on a drastic cleaning up of credit weakness, a drastic reduction in the costs of production, and on the free play of private enterprise. It was not based on governmental policy designed to make business good.  (See Benjamin Anderson’s Economics and the Public Welfare or his gratisThe Return to Normal“)

Now we can debate fiscal and economic policy all day, but across the spectrum, it should be clear to all that a government that intervened and created the conditions for economic crisis will not be able to solve it.  If government’s can create prosperity when the private sector is imperiled, then why would Americans be against government central planning when all is rosy?  Do the rules of economics not apply during downturns?

If we can agree that recessions are the result of resources being improperly allocated, then we can also agree that the only way to return to economic health is to allow for their reallocation according to the market.  This involves allowing nonproductive business ventures to go belly-up, prices to naturally fall where they have unjustifiably risen and reduction in the size of government allowing resources to be released to entrepreneurs to reverse the ills of the artificial boom and spur growth.  All measures that impede the natural cleansing of an economy will only ensure pain and suffering like that witnessed over the last few decades in Japan.  Harding had things right and it would do our lawmakers good to follow his lesson: central planning and government control creates problems; innovative Americans are the only ones who can solve them.

Advertisements

The Recession of 1920 – Causes, Responses and Insights

January 11, 2010 Leave a comment

In my study of political economy, one of the most overlooked yet fascinating historical episodes I have come across is the Recession of 1920-21. A handful of free-market economists have tackled this crisis, and I decided to throw in my lot with them and pursue the subject further myself.

Below is the abstract for my critique of the acutely sharp downturn (so you know what you’re getting into) and the embedded paper in Scribd format. Scribd however is a bit screwy in its formatting of the paper, failing to capture various diagrams for example, so I strongly suggest instead reading the Word doc downloadable HERE.

Enjoy!

Abstract: Many attribute our current recession to the evils of unbridled capitalism. In response, our leaders have embarked on the typical Keynesian recession prescriptions in order to stimulate the economy and lead the nation out of the economic doldrums. Unbeknownst to most Americans however, prior to the Great Depression, policymakers used different tools to help guide the country out of recessions. Herein we examine the causes, responses and insights gleaned from the Recession of 1920-21, the last downturn in which leaders relied on the age-old policy of laissez-faire, combined with massive reduction in government and encouragement of deflation.

Stossel Does Atlas Shrugged, Asks "Who is Wesley Mouch?"

January 7, 2010 4 comments

In tomorrow’s episode of John Stossel’s new show on Fox Business, he will address the question, “Who is Wesley Mouch?” in speaking to the parallels between Atlas Shrugged and contemporary America.  As one might expect, in my view it seems as if almost all businessmen (given their predilection towards using government to destroy markets to their own advantage) in one way or another embody the qualities of Wesley Mouch.

One exception who will be on Stossel’s program is John Allison, an executive at BB&T Bank, who staunchly opposed TARP, has repeatedly refused to use the law to plunder the property of others and as one might guess is an ardent Austrian-school libertarian.  In a scene reminiscent of the smoke-filled rooms of Atlas Shrugged, Allison divulged at an NYU lecture this past fall that the Feds threatened to go in and audit any bank that wouldn’t take government funds, forcing healthy banks to comply so as to cover for the fact that the government was only propping up a select few sick ones (at the expense of the solvent I might add).

In response to Stossel’s call in the aforehyperlinked column for suggestions for a follow-up show on “crony capitalism,” I posted:

John,

If you want to talk about crony capitalism, it may pay to have Burton Fulsom who wrote “The Myth of the Robber Barons” on the program.  I think the key is to delineate between political entrepreneurs and market entrepreneurs, something which he does astutely in that book.

Political entrepreneurs seek to use government decrees to profit, largely by cartelization, monopoly advantages and other barriers to entry, while market entrepreneurs generally seek to win profits in the market by merit – by producing the best product at the cheapest price.

More generally, the Mouch problem lies in the fact that while initially businessmen extol the virtues of little regulation, low barriers to entry and minimal governmental interference generally, once they become successful, out of self-interest they support any and all legislation that will cement their position in the market.  They support all of those things anathema to the free market that they had used to their advantage in the first place. 

This is akin to the economic plight of America as a whole.  While up until the early 20th century (though some libertarians will argue that it was really only up until the time of Lincoln), America functioned under a largely laissez-faire economy, with the wealth and progress generated by this economy, we forgot about the virtues that led to our success and rewarded those tending towards failure.  We created a welfare state from the riches of a relatively free state, throwing under the bus the very principles that elevated to us to our position as a great nation.