Get Lessons from the Depression Right

Headlines and concerns about the country’s economy fill the media. Unemployment, recession, depression, jobs, stimulus – all are terms that our nation’s citizens have grown used to hearing. In reality though, today’s problems within the American economy are nothing new. They have all happened in the past – and given the nature of the past, insight to these problems is available should we have the courage to grasp it. Quite surprisingly, though, we have yet to do so. It is critical this trend reverses – that we learn from history, else the future grows dimmer for this generation and the next.

Perhaps no better “class” of people have overlooked the experiences of yesteryears then the so called “intellectual” class – those PhD’s who name themselves economists. The greatest failure amongst the economists of today is the failure to answer the simple question, “Where do economic recessions come from?” Without answering this question, we cannot address the solution. Sure, there are plenty of so called answers offered up – but most of these do not pass logical muster. Some economists say that it is because “people are not spending enough” and since people are not spending enough -then government must step in and do the spending for the people. In fact, it is argued that government must spend money even if it does not have the money. This is the argument for deficit spending – an argument that stems from the failure to realize the cause of the problem to begin with.

Before we move into what the real cause is, it is important to understand first why people often believe that the economy “gets bad” because of this flawed reasoning – that people just aren’t buying enough out there. After all, we can see that the economy is doing poorly. We can see that people are hurting. And we can remember what we saw not long ago – that people were much better off while they were also spending much more. We can see these things. But what is often missed is precisely that which is not seen. In economics, that which goes unseen makes all the difference.

The real cause of economic recessions does not rest with some sort of lack of spending – for if this were the case, then the medicine is for every one of us to spend everything we have and own – all of our savings – on anything we can buy. Don’t fret about tomorrow – for the economy’s health, the sooner we become spendthrifts the better. Absurd advice on a personal level typically is even more absurd on a national one. What goes unseen is the amount of money which was previously “printed” from thin air by centralized government, giving the illusion that more resources are available in the present. And this monetary policy is key.

Economic recessions are truly caused because of an increase in the supply of money – and there is no better mechanism which can increase the stock of money than centralized government. When the nation’s money supply goes up, interest rates fall. Cheaper interest rates tend to entice individuals to accept loans – or utilize new credit. What now becomes seen in the economy is more investment, more construction – or more “capital intensive” projects which are inevitably initiated. Elected politicians love the “boom” – not only can they take credit for the prosperity, but they can also finance all of their big spending programs by borrowing over and above the level of tax revenue on hand. In short, politicians get re-elected.

But something has also gone unseen. The only way that new money can be created -the only way that the money supply can be increased in such a fashion – is from government simply printing it from thin air. This is public counterfeiting. Only no one can readily see the government’s counterfeiting. No one can see the arm of its central bank injecting these doses of “fake” capital into the banking sector. And here it is realized that the entire chain of events which follows – the new investments, construction, and all of the new projects which are built with this cheap credit – all of it rests upon counterfeiting from the government. There was never any demand for such a boom in the first place – as businessmen and entrepreneurs were simply deceived into believing that the pool of savings had gone up. But the new money injected into the economy did not come from savings – it came about by government decree. Now, not only must these malinvestments go under, but many people become unemployed – all at the same time. This is the destructive force of not the economic recession, but the boom that was caused by the government’s counterfeiting money. Once the boom is initiated by increasing the supply of money, the recession is inevitable.

The stock market crash of 1929 typically marks the era which begins the Great Depression. But why did this initial downturn in the stock market lead to over a decade of depression? Here is the experience we can study, that we can learn from. In short, the government’s active responses – first under Herbert Hoover, and later under Franklin Roosevelt – helped prevent the market place from clearing the debt, and the malinvestment which was created during the preceding boom of the “Roaring ’20s”. Between 1921 and 1929, the supply of money in the United States was increased by over 60 percent. The newly established Federal Reserve unleashed a fury of cheap credit counterfeit – and the banking system created loan after loan out of thin air – much of this cheap credit finding its way into stocks, bidding up their price to extraordinarily high levels. In this context, we can see that stocks no longer represented a company’s earnings (from real savings and investment placed into their stocks), but the higher stock prices merely represented the amount of counterfeit money injected into Wall Street. Once the credit runs thin, or at least begins to slow its rate of expansion, the boom finally ends – in sudden and sharp ways.

But history tells us that this sudden recession in 1929 did not have to lead to a prolonged depression. Just 10 years prior to this episode, the country went into recession as well. In 1920, the stock market crashed – harder than it did in 1929. In fact, prices fell much more sharply, and in a shorter amount of time -yet the country did not whither in unemployment and depression for years afterwards. The difference between the two events, the two stock market crashes of 1920 and 1929, was the government’s reaction to them. After the 1920 stock market crash (built upon inflated credit from going to World War One), the federal government under Warren Harding cut its budget. Not only did it cut spending, it cut spending significantly – by over 50 percent – while also cutting taxes. These spending cuts from government freed up vital resources to the market economy. There were no stimulus plans or make-work programs put into place, and by and large the government kept to its constitutional restraints. By 1921 – within 10 months -the country’s economy was growing again.

Turning to the period after the 1929 crash, and we can see that this was indeed not the case. Hoover and then Roosevelt put into place perhaps the greatest government make-work programs the United States had ever seen – and grew the federal budget considerably.

Not only were these fiscal policies placed into effect, but the government also continually pumped even more money into the economy, trying to dope up the markets with more counterfeit (it should be noted, despite all of these doping measures, the total money supply actually contracted after 1929, as the rate of bank failures exceeded the rate of money-printing from the Federal Reserve). Bad and shaky investments from the boom period were kept afloat from government bailouts, and insolvent banks were propped up by government-created credit. The result was Depression, as prices on the market were restrained from reflecting where consumer demand was and where it was not. In addition, not only were prices fixed and economic calculation distorted, but a great deal of national uncertainty was established. Entrepreneurs and business commerce was hampered, as individuals in these fields could not determine what the government might do next.

Applying these lessons from 1920 and 1929 – their causes and their results – is crucial to solving the problems of today’s recession, which has been prolonged by the same flawed reactions that Hoover and Roosevelt adopted.

Unfortunately, many policy-makers can only see the economy in one dimension -the government throttling forward or backward with its monetary or fiscal “stimulus” tools, revving the engine, or pushing the brake. Increasing credit through printing money, or engaging in deficit spending to “stimulate consumption”. But the economy is not one dimension, simply going forwards or backwards. The economy is actually two- dimensional. There is not simply how much to produce, but what to produce. And there is not just what to produce, but when to produce it. The what and the when – as well as the “how much” – are all distorted when the government tampers with the price of interest rates. When people begin building gluts of houses which no one actually demanded, the economy is growing sick. Everyone can see the houses being built, everyone can see the euphoria of the boom, but no one can see yet that there will be no one to fill these houses on completion. So to react to this malinvestment – and the recession that comes from it – by dosing the economy with even more cheap credit is like treating the heroin addict with more heroin. Keep the patient doped-up so he doesn’t understand which way is right and which way is left, delaying the pain of healing further down the road.

Our current economic well-being hinges on these lessons from the past. Must we believe that deficit spending must continue, must we believe that interest rates held to nothing, that savings is not required – we will prolong the recession. It is not too late to stave off continued depression – but these plans of stimulus, and monetary easing must come to an end. Interest rates must be allowed to rise, and reflect what the market can supply and demand. And of course, higher interest rates forces government to slow its spending spree. Entrepreneurs and businesses must be permitted to act with their own property, freed from the shackles of bureaucratic orders. But above all else, serious reductions in government spending must take place -else economic ruin will take place. Though economic times are uncertain, one thing is not. If we continue the path of money-printing and deficit spending, the nation faces grave hardship. History does not sugar coat the answer.

Guest columnist McGeehan is a graduate of the U.S. Air Force Academy. He served in the House of Delegates from 2008-10, and is chairman of the Republican Party in Hancock County. He is employed by Frontier Communications in Wheeling, and lives in Chester. He is the author of the book, “Printing Our Way to Poverty-The Consequences of American Inflation.”