Note: only the first part of the book (Contents, Preface, Foreword and Introduction) is currently available to download.
The economic policies of the Obama administration are repeating many of the mistakes made during the Great Depression, according to a study* released today by the Institute of Economic Affairs, and endorsed by Nobel-Prize-winning economist James M. Buchanan.
The authors** argue that there are "troubling similarities" between the approach of the current US government and the disastrous economic policies of President Roosevelt during the 1930s.
By trying to revive the economy with profligate deficit-spending and increased state intervention, Obama is undermining the long-term growth potential of the US economy and risks delaying full economic recovery by several years.
Examining the economic evidence, the study challenges the widely held view that conservative fiscal policies caused the Great Depression and Keynesian fiscal policies brought recovery. Rather, excessively loose monetary policy was the cause of the stock market bubble that burst in 1929, while excessively tight monetary policy was the principal reason that a normal recession turned into a deep depression.
Relaxation of monetary policy was the main reason for a brief and limited recovery after 1933. But, argue the authors,
"FDRs interventionist policies and draconian tax increases delayed full economic recovery by several years by exacerbating a climate of pessimistic expectations that drove down private capital formation and household consumption to unprecedented lows."
As a result, the US had arguably the deepest and longest-lasting depression of all the major industrial countries in the 1930s.
While this recession appears to be far less severe, current US policies are likely to hamper recovery by crowding out investment and leading to much higher taxes and interest rates in the medium term.
In a damning indictment of Obamas economic programme, the authors conclude that:
"Now is a particularly bad time to enact socialistic reforms to the market for healthcare, pursue wealth-destructive cap and trade environmental programs, or force additional federal tax dollars into state and local education markets. Such policies imply higher government spending and, eventually, either higher taxes or runaway inflation, thus depleting taxpayer and business confidence in the economy "
In their recipe for recovery, the authors suggest, that whilst expansionary monetary policy is appropriate to avoid the main mistake in the US in the 1930s, on the micro-economic side there should be a return to the policies of laissez-faire capitalism from which George W. Bush departed in the early years of the twenty-first century: tariffs and other trade barriers should be repealed unilaterally; a Right-to-Work Act should reduce the minimum wage and curtail the powers of unions; there should be a return to fiscal conservatism; and business regulation should be reduced. Furthermore, there should be a reform of the approach taken to insolvent banks. Individual banks and their counterparties should not be bailed out, although the system should be protected by ensuring that failing banks are wound up in an orderly fashion this is the only way to restore market discipline.
Economic Contractions in the United States: A Failure of Government by Charles K. Rowley and Nathanael Smith, Institute of Economic Affairs and The Locke Institute, 2009.
** Charles K. Rowley is General Director of
The Locke Institute and Duncan Black Professor of Economics at George Mason University; Nathanael Smith is Senior Research Fellow at The Locke Institute.
The Great Depression
The rate of unemployment increased each year throughout the great contraction, from 3.2 per cent in 1929 to a peak of 24.9 per cent in 1933. It remained stubbornly high, and was still 17.2 per cent in 1939.
The money supply (M2) began to level off in 1929, following a period of rapid expansion underwritten by the Federal Reserve. In 1929, M2 increased by just 0.39 per cent. It then fell by 1.8 per cent in 1930, 6.65 per cent in 1931, a momentous 15.55 per cent in 1932, and 10.62 per cent in 1933, before it began to increase again in 1934.
The first Roosevelt administration ran a budget deficit of 7.98 per cent of GDP in 1931, rising to 8.94 per cent in 1934, before it fell back to 5.46 per cent in 1935.
In 1932, Hoover doubled all tax rates and hiked the maximum rate of income tax to 63 per cent. Expected tax revenues did not materialise and continued to decline, and the budget failed to balance.
In 1936, Roosevelt increased the top rate of income tax even further, to 79 per cent, and then, in 1940, to a punitive 90 per cent.
'George W Keynes'
Fiscal policy became expansionary after 2000. Real federal expenditure per capita rose at an annual growth rate of 2.45 per cent between 2001 and 2008
Under Alan Greenspan, the growth in M2 exceeded 8 per cent per annum throughout the period 2001-2003. This expansion was accompanied by the lowering of the Fed Fund Rate from 6.25 per cent in early 2001 to 1.75 per cent by the end of the year, and lower still in 2002 and 2003.The real Federal Funds Rate was negative for an unprecedented two and a half years.
Household debt levels rose exponentially between 2001 and 2007. In October 2008, consumer debt stood at $2.58 trillion. Home mortgage debt stood at $11.2 trillion.
'Franklin Delano Obama'
The American Recovery and Reinvestment Act was signed into law in February 2009. At a cost of $787 billion, it is the largest single government stimulation legislation in the history of the Republic. Of the total, 45 per cent ($357 billion) is devoted to federal social and spending programmes.
Congress has passed and Obama has signed into law a 2009 budget with a $1.75 trillion deficit.
Since 2007, the equity ratio of the Federal Reserves balance sheet has fallen from 4.5 per cent to 2 percent, so its leverage has increased dangerously, from 22 to 50.
Charles Rowley Tel: 001 703 934 6934 (-6 hrs)
Philip Booth (IEA) Tel: 020 7799 8912
Richard Wellings (IEA) Tel: 020 7799 8919