President Franklin Roosevelt has been universally hailed both in his lifetime and since as one of America's greatest presidents. By serving for three presidential terms and the beginning of a fourth, and confronting two of the greatest crises in America's history, he became a hero to political historians both of his generation and since. Even in 2003, an allegedly conservative tycoon, Conrad Lord Black, has published a laudatory biography of Roosevelt that has been received with general critical acclaim. Whatever the criticisms of his economic policies, or indeed of his foreign policies, right and left can agree that he was a consummate politician, probably the best in U.S. history.
Economists, however, have been more critical of his policies since the 1960s, and Powell goes into considerable detail on their criticisms. Output in the early 1930s dropped about as much as in the previous two depressions, of 1893-94 and 1920, but the recovery was far more sluggish than in either case. Only politically was Roosevelt more successful than at least one of his predecessors -- Grover Cleveland, the president in 1893-97, was repudiated by his own party at the 1896 Democrat presidential convention that nominated William Jennings Bryan.
There's no question that there's an economic case for Roosevelt's supporters to answer. Britain, which after 1931 pursued conventional policies of tight control of government spending and sound money (and abandoned her quixotic experiment with unilateral free trade) recovered much more quickly than the United States, and by 1934 was already reaching new heights in output. The United States was still below its 1929 level of private sector output in 1941, when World War II was declared. Yet U.S. population increased throughout the 1930s, and technological progress did not go away, so why did the economy not recover properly?
There's plenty of blame to go round -- Hoover's policies were in many respects even more misguided and deflationary than Roosevelt's, while, as famously documented by Milton Friedman and Anna Schwartz in their 1963 classic "Monetary history of the United States" the Federal Reserve played a major though largely unwitting part both in the initial downturn and in the sharp relapse of 1937-38.
Some of Hoover's and Roosevelt's policies were conventional political wisdom, that flew in the face of economic theory; others were experimental both politically and economically. Almost none of the political and economic experiments worked properly, creating huge disillusion with the system.
Hoover believed in the free market, but he believed even more strongly in his own "Great Engineer" capacity to manage the market to correct its defects. In this respect he was quite close to the ideas that John Maynard Keynes was contemporaneously working out, and would publish in his 1936 "General Theory of Employment, Interest and Money." Roosevelt's economic mistakes were only tangentially Keynesian; even the dirigiste social democrat Keynes caviled on a number of occasions at some of his more eccentric inventions. It's fair to claim that Roosevelt and those who surrounded him had neither a clear understanding of how the free market works, nor any coherent plan for how to replace it.
As we sit in the aftermath of a stock market bubble even greater than that of 1929, it must be worth asking: what are the chances of the mistakes of the 1930s being repeated, and if we don't repeat them, are we fully secure from a repetition of that dreadful decade?
To take the most notorious policy first, there is very little chance, thank goodness, of a modern U.S. President signing a huge across-the-board tariff increase like Smoot-Hawley. The intellectual argument for free trade is much better understood in the United States than it was in 1930 (it was well understood even back then in the free-trading Britain) and the World Trade Organization mechanism, battered though it is, would make such a broad based tariff diplomatically extremely perilous. Of course, the real damage caused by Smoot-Hawley was exacerbated by the U.S. position as a major creditor nation, and Europe's continuing need for dollar recycling from Wall Street; Smoot-Hawley increased the imbalances in world trade that already existed, and triggered a further sharp recession in Central Europe, and the Creditanstalt bankruptcy.
Today the United States runs a huge trade deficit, not a surplus, so the potential destabilizing damage from U.S. protectionism is less. Protectionism from trade surplus countries such as Japan and China would be more of a threat, but a move to further protectionism from those countries is unlikely. Europe, in particular the euro zone, is the most likely protectionist danger -- if the euro reaches $1.50 by mid-2005, as many are forecasting, you can expect a huge move in that direction from the EU, as much of the U.S. recession is exported to Europe.
The other notorious blunder of the Hoover years, the Fed's tight money policy, is also unlikely; indeed, the continued buoyancy in the U.S. economy has been largely due to an exceptionally loose Fed monetary stance. Inflation is likely to resurge in the years ahead, but it is unlikely that the Fed will act strongly against it, instead attempting to slow it by tight money. Indeed, it is likely that the Fed will repeat the mistake of the early 1970s, being too accommodatory in face of a surge in inflation, thus cementing in place an inflationary trend that is in the long run as damaging as the much vaunted 1930s deflation. The long term damage to U.S. growth prospects from higher inflation, and the higher interest rates that will be necessary to cure it, may be very substantial indeed, but we are probably some years yet from facing this problem.
Hoover's third mistake, less celebrated than the first two, was in attempting to cure the depression by public spending and then, as the depression grew worse, panicking and instituting a massive tax rise in the depths of 1932. The increase in public spending was pure Keynesianism (interestingly, Keynes may well have evolved his "spend money in recessions" theory simply in order to increase the size of government, which he regarded as in any case desirable. He knew perfectly well that the converse advice, of cutting back public spending in booms, would never in practice be followed.) It thus produced a short term stimulus, in the event swamped by the deflationary effects of Smoot-Hawley and Fed policy. In the long term, the public spending increase would have been a drag on the economy, but not a very important one, since the Federal government was still so small. However, increasing taxes was entirely unnecessary; there was no evidence in the capital markets or elsewhere that the Federal deficit was becoming unfinanceable -- its 1931-32 peak was less than 1.5 percent of gross domestic product, a third of the level in 2004. Hence the tax increases both deepened the depression and, by their adoption of steeply progressive marginal rates on high incomes that had been seen only in wartime, severely damaged business confidence.
Tuesday I will consider in part 2 the economic blunders of the New Deal itself, and the extent to which their repetition remains a threat.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
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