Tuesday, August 19, 2008

How to Kill a Recovery

Amity Shlaes, author of The Forgotten Man: A New History of the Great Depression, lays out the non monetary mistakes made that turned the Crash of '29 into the Great Depression. They sound a lot like Obama's economic platform:

Giving in to protectionism - In Herbert Hoover's time, Sen. Reed Smoot and Rep. W.C. Hawley proposed a tariff that was to raise effective duties by as much as half. More than a thousand economists signed an open letter warning that the duties would "raise the cost of living and injure the great majority of our citizens."

Blaming the messenger - Punishing the stock market for the 1929 crash was popular in Washington in the early 1930s. Lawmakers attacked the practice of short selling; Senate Banking Committee counsel Ferdinand Pecora hauled J.P. Morgan and other Wall Streeters in for hearings. By 1934, Congress was creating the Securities and Exchange Commission. The Roosevelt administration also prosecuted business leaders, including former Treasury secretary Andrew Mellon and utilities magnate Samuel Insull. The new regulatory culture cut crime and protected investors. But the arbitrary nature of the assault petrified Wall Streeters.

Increasing taxes in a downturn - Hoover more than doubled income tax rates, taking the top marginal rate to 63 percent from 25 percent. FDR hiked the top rate to 90 percent. Perhaps worse, Roosevelt's Treasury crafted taxes to punish business, including an undistributed profits tax and an excess profits tax, that ultimately sucked cash from a capital-starved economy.

Assuming bigger government will bring back growth. There's a sense today that Washington has retreated too much from daily lives. Wall Streeters mutter that "the system" (the financial markets) doesn't work anymore. In the 1930s, people didn't just mutter that -- they believed it. Public-sector expansion seemed the only way to sustain America's promise. New Deal programs did much to alleviate the pain month to month -- many found dignity in six months of work at the Works Progress Administration, the Public Works Administration or the Civilian Conservation Corps. But economics is a competition for scarce capital. Such state solutions tended to suppress the creation of long-term private-sector jobs, as did the aggressive Wagner Act for organized labor.

Ignoring the cost of inconsistency. FDR spoke of "bold persistent experimentation." Obama speaks of "change." Both can do damage. What's more, the list of experiments is always finite. Our bailouts look reassuring, but even Washington cannot rescue the entire economy. And foreign investors wonder where Washington will stop. Already concerned about the inconsistent dollar policy, China is now troubled by the inconsistent rescues.

My greatest fear about the economy is the fiscal response out of Washington after the election. I have previously written about the Great Recession of 2010 and if we follow this path, I may have to change the title.

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