Wednesday, July 27, 2011

The Politically Incorrect Guide to the Great Depression and the New Deal

The Politically Incorrect Guide to the Great Depression and the New Deal is the most accessible book I have read on the Great Depression to date. Having read The Forgotten Man by Amity Shales (which I believe to be the definitive history of the Depression) and New Deal or Raw Deal by Burt Folsom, I think I can safely say that this book is the easiest to read and the easiest to digest.

He begins by stating, "Everything You Learned about the Great Depression and New Deal is Wrong," then proceeds to debunk myth after myth. As to the actual cause of the Great Depression, he offers this: The Federal Reserve fueled the stock market boom of the 1920s with its easy-money policies. After the crash, the Fed did the wrong thing by cutting rates and propping up unsound institutions. Hoover and FDR's interventions in the economy only made things worse.

He compares Hoovers reaction to the crash to that of Calvin Coolidge when the market crashed in 1920. Coolidge relied on the wisdom of all the presidents who had gone before and "did nothing." He knew a market had to find its own way out of a financial hit. Although this incurred short-term pain as jobs were lost and industries thrown into turmoil, the market emerged stronger than ever. From this we get "The Roaring 20s." Coolidge did exactly the right thing, but is given no credit. FDR, following Hoover's lead, meddled in every aspect of the economy and led us into the Great Depression. Yet FDR has somehow managed to earn the reputation for pulling us OUT of the Depression.

Contrary to the popular narrative, Hoover was not a laissez faire president who cared nothing for the poor and hurting and therefore did nothing to help the economy. In fact, he actively rejected the advice of the "leave it alone liquidationists" like Treasury Secretary, Andrew Mellon, who urged Hoover to let the economy collapse all the way to the bottom. He stated, "It will purge the rottenness out of the system." Mellon knew that if the government intervened, it would only prolong the pain and prop up businesses and industries that needed to fail.

Hoover was the first to put the "Great" in the Great Depression. The first thing Hoover did was to prop up wages, which was fine, if you had a job. But millions were thrown out of work and with wages forced up artificially, work became that much harder to find. Then he crippled international trade with the Smoot-Hawley tariff. This monstrosity slapped tariffs on imports and was predictably retaliated against by our trading partners, shattering our already limping economy. In addition, Hoover engaged in reckless borrowing and spending, leading to massive tax hikes (the highest rate was 63%) and a 20% unemployment rate at the end of his presidency. Finally, Hoover gave FDR a firm foundation on which to build his New Deal. It was Hoover, not FDR that began the alphabet soup agencies that ultimately hindered any kind of economic recovery.

Murphy then goes on to examine the roll of the Federal Reserve in the Great Depression. Prior to the crash, the Fed had an "easy money" policy, similar to the policies in place in the early 2000s. Conservative polices, like Andrew Mellon's tax cuts in the early 20s, fueled the roaring economy of the 1920s. But a cut in the interest rate after 1927 led a strong economy into an artificial boom. Two years later, the bubble burst. After the crash, the Fed lowered rates even further. Had they in fact raised the rates, the weakest institutions would not have been able to borrow at the higher rate and would have been forced out of business. The stronger businesses, confident of future success, would have taken the bet and paid the higher rates. This would have provided the economy with some "tough love," leading to quicker recovery. Instead, with its easy money, the Fed prolonged the day of reckoning and therefore the Depression.

The biggest myth surrounding the Great Depression is that FDR and the New Deal pulled us out of it. However, by any measure, the New Deal failed in its most basic mission - to improve the economy. Unemployment was 8.9% in 1930, and it didn't hit single digits again until the war "employed" millions as soldiers. Compared to Canada, which experienced its own "Great Depression" yet did not implement a "New Deal," the U.S. unemployment rate consistently remained 5 - 7 points above theirs. A very destructive policy of the New Deal was the National Industrial Recovery Act. This led to the artificial propping up of wages and prices. This worked if you had a job, but overpriced labor led to fewer jobs. Overpriced goods led to real poverty. Americans literally starved to death as crops were destroyed to maintain the higher prices. The "Codes of Fair Competition" likewise benefited specific jobs and industries, but imposed huge harms through severe economic inefficiencies on those not in favored classes. Finally, Roosevelt was no businessman and barely understood what he believed he could manage as a benevolent ruler. His policies led to a "capital strike" as those with money basically sat out the economy during the 30s. In an era that produced Stalin, Mussolini, and Hitler, businessmen were understandably afraid that FDR was on a path to a similarly socialist economy. In fact, FDR intentionally introduced uncertainty into the market so the common man would look to him as a savior. His political ambitions and lust for power led 93% of business executives polled by Fortune magazine in 1941 to conclude that after the war, FDR would socialize much if not all of the economy. The fact that he had sought and won a third term did nothing to alleviate their fears of a budding dictatorship.

Finally, Murphy demolishes the myth that WWII pulled us out of the Great Depression. Just as the National Recovery Administration allocated scarce economic resources inefficiently and prolonged the Depression, the war allocated resources according to war aims (i.e. labor was redirected from private industry to war efforts and goods reallocated from consumer, free market, priorities to wartime priorities). Inefficient use of resources is inefficient whether dictated by socialist policies or wartime policies. The case can be made that it was MORAL to reallocate labor and capital towards victory against Hitler, but it cannot be argued that it was economically efficient. It's the "broken window" fallacy. The broken window fallacy states that a window, broken by something like vandalism, benefits a community because of the economic activity created when the window is replaced. The fallacy lies in the fact that the money used to replace the window is money NOT used for more efficient uses. The owner of the window had many other uses for the money available to him other than replacing a window, but those uses are now precluded. It's simply common sense that killing workers and blowing up capital cannot be helpful to an economy. In addition, wartime economic statics are misleading. Millions of laborers were shipped overseas, and hence removed from the unemployment rolls, government spending increased astronomically on war equipment, causing a corresponding rise in GDP, price controls and rationing distorted consumer price index measurements, and civilian sacrifices further distort the economic picture. Most problematically, the wartime era operated as a centrally planned economy rather than as a free-market, which has proven time and again to be the most efficient way to allocate scarce resources. Ludwig von Mises states, "Capitalism is essentially a scheme for peaceful nations. But this does not mean that a nation which is forced to repel foreign aggressors must substitute government control for private enterprise. If it were to do this, it would deprive itself of the most efficient means of defense. There is no record of a socialist nation which defeated a capitalist nation. In spite of their much glorified war socialism, the Germans were defeated in both World Wars."

Murphy ends the book with lessons for today. Yes, we are doing it again. Yes, with Obama, we are heading in the same direction.

Books to read to follow up:
Great Myths of the Great Depression, by Reed
The Causes of the Economic Crisis and Other Essays Before and After the Great Depression, by Mises
The Great Depression, by Robbins
The Politically Incorrect Guide to American History, by Woods
The Politically Incorrect Guide to Capitalism, by Murphy
Free to Choose, by Friedman
America's Great Depression, by Rothbard
Out of Work: by Vedder and Gallaway
The Memoirs of Herbert Hoover, by the Macmillan Company
The Ethics of Money Production, by Hulsmann
A Monetary History of the United States, by Friedman and Schwartz
Less than Zero, by Selgin
The Case Against the Fed, by Rothbard
What Has Government Done to Our Money? by Rothbard
The Creature from Jekyll Island, by Griffin
Salvos Against the Neal Deal, by Garrett
The Roosevelt Myth, by Flynn
Rethinking the Great Depression, by Smiley
FDR's Folly, by Powell
Economics in One Lesson, by Hazlitt
Depression, War, and Cold War, by Higgs
Against Leviathan, by Higgs
The Costs of War, by Denson

Wednesday, July 13, 2011

Basic Economics by Thomas Sowell

Well this took forever to read! At 634 pages, it's not a quick, light read for the faint of heart.

But it is an essential book for all Americans. Everyone needs to know the common sense principles contained in this book so that we can make sense of economic policies and not be taken advantage of by power-hungry politicians counting on our economic ignorance to keep voting for them.

First the most basic of all things: a definition. Economics - the allocation of scarce resources that have alternative uses. I wrote that from memory because Sowell repeats it so frequently. (It probably takes up about 200 of the 634 pages!) But that's because he wants this ingrained in our minds! Scarce resources, whether gold, beach-front property, oil, time, talent, money, all must be allocated one way or another and all have alternative uses.

A free-market, capitalist economy like ours uses prices to allocate these scarce resources with alternative uses. Some economies use lotteries, or personal connections, or the spoils system, but all economies allocate scarce resources one way or another. The beauty of the price system is that it is so efficient and much less bloody than other methods. It is a mechanism of instant feedback. Prices rise when a scarce resource is considered more valuable in a particular usage. For example, if I have a dairy, my milk could be bought by milk vendors or ice cream manufacturers. If the ice cream manufacturer believes he can bid up the price of my milk because he knows he can recoup the cost in his sales price for ice cream, my milk will most naturally flow to him. Consequently we will have no shortage of ice cream! Another reason to love the free market.

When the price mechanism is messed with and not allowed to work naturally, shortages and surpluses occur. This is why price controls never work. If prices are kept artificially low (as defined by the price which would have been set by the free market) we will experience shortages as people buy up and over use what appears to be cheap or free - think healthcare or gasoline in the 70's. If prices are kept artificially high, in order to prop up an industry for example, we will suffer sometimes crippling and cruel surpluses. During the Depression, food was destroyed by the ton in order to keep food prices artificially high and prop up farmers. Americans literally starved to death because they couldn't afford the food. The same thing is happening with ethanol subsidies which artificially inflate the price for ethanol and therefore the scarce resource of corn is diverted from food to fuel, resulting in mass starvation around the world. 

A most important point made by Sowell is about the role of profits and LOSSES in regulating our free market to most efficiently allocate scarce resources that have alternative uses. Business have every incentive to provide what the public wants at a price the public is willing to pay. The promise of profits keep businesses working hard to innovate and lower production costs to consistently deliver what their customers want. The threat of losses is just as important, as loses provide very powerful feedback as to what not to do - think Edsel or New Coke. Business can respond very quickly and very efficiently or risk losing it all. While they may do it out of pure greed or an altruistic heart to better provide for their fellow citizens, the result is the same: better products at cheaper costs and a higher standard of living for all.

When the profit and lose mechanism is taken out of the picture, the result is ALWAYS inefficiency and a lower standard of living - think DMV. This is not because those involved in organizations like government bureaucracies are always incompetent and inefficient, it's simply that there is no other result possible. They have no feedback to tell them if what they are doing is working or not. Even if an agency begins with the best possible intentions and product, like the East German car, Tabrant, which was cutting edge when first entering production, but remained the EXACT SAME CAR for 30 years, they will very quickly become inefficient and wasteful simply from a lack of feedback provided by a free market. Ask yourself, would you be excited to buy a 1981 Ford today? They had no reason whatsoever to modernize and update the only car in existence in a government-run economy.

Sowell shines when he takes on economic fallacies and myths. A particular enlightening passage destroys the myth of "trickle-down economics." He states this has never been an economic theory and never will be. Money does not "trickle-down" in a business. It trickles-up. The owner and investors are the last to get paid, not the first. He uses Amazon as an example. Amazon went several years without making a profit at all. But their investors were willing to wait many years for a payout while continuing to pay employees, vendors, and other costs associated with the business. The little guy was paid first! The big guy was paid last, and many never get the payout if they run out of capital before they have a chance to make a profit. Yet you will never hear this told in the media. It's always "Tax cuts for the rich in the hopes of trickle down prosperity."

He also discusses the fallacy of greed controlling the markets. The simple fact is that everyone is greedy. That's human nature. Would you willingly give up 20 - 30% of your salary because you personally are not greedy? Of course not. You are not paid according to your greed or according to your employers stinginess. You are paid because that's what you are worth. Of course, every business would love to pay their employees nothing and charge millions for their products. But they cannot. Why? The beauty of the self-regulating free market. No one would work for free and no one would pay millions for a toothbrush. So the ostensibly greedy business man MUST pay his workers to make toothbrushes and charge only a few dollars each so people will buy them. Too bad for him.

This leads to a discussion of the job-killing minimum wage. It's a simple fact that an employer CANNOT pay you more than you are worth. If the minimum wage is $7.25/hour and you do not produce more than $7.25/hour benefit to your employer, you are unemployable. Read that again. The minimum was has had the effect of making certain members of our society, fit, able-bodied, reasonably smart, people unemployable. This is a crime! It is particularly hard on minority youths, who through no fault of their own, do not yet have the skills to provide economic benefits to an employer. With a high level of entry pay, they may never be able to obtain the skills to make them employable.

Read this book. If you cannot stomach 634 pages, read the "Overviews" at end of every chapter. They provide an excellent summary. The book will change your life and expose you to how stupid politicians think you are.