In reading the Forgotten Man, one is struck by some parallels between our current economic times and the Great Depression of the 1930s.
Then: The Great Depression was preceded by the stock market crash of 1929. Prior to the crash people were borrowing money to buy stocks sure that stocks could only go up in value. Margin requirements were relaxed so that a buyer need only put 10% down.
Now: Prior to the housing crash Americans were borrowing money to buy houses sure that houses could only go up in value. Margin requirements were relaxed so that a buyer need not put anything down (the 100% mortage).
Then: “the New Deal had created thirty agencies, nearly all close to the executive, leaving ‘the average citizen bewildered’ … In the period of [one year under FDR], 10,000 pages of law had been created, a figure that one had to compare to 2,735 pages that constituted federal statute law. In twelve months, the NRA had generated more paper than the entire legislative output of the federal government since 1789.” Shlaes points out that a lot of business investment was deferred because nobody knew what the legal or tax environment was going to be.
Now: Federal and state legislatures constantly change and add new laws and regulations.
Then: “[in November 1929] Hoover pushed to expand an existing public buildings program by the healthy sum of $423 million on the theory that the spending would boost the economy”
Now: Government payrolls nationwide are expanding, with an ever greater percentage of Americans employed by federal, state, or local government. This comes on top of a huge expansion after September 11, 2001, when we began devoting a larger fraction of our labor force to security and many of those folks are government employees. Governments at all levels continue with massive building programs.
Then: “Roosevelt himself saw that while [Social Security’s] revenues might cover its costs now, the numbers from the actuaries suggested that there would not be enough money for old-age pensions for future generations.” Social Security was explained thusly: “You and your employer will each pay three cents on each dollar you earn, up to $3,000 a year. [That amount] is the most you will ever have to pay.”
Now: The impending bankruptcy of Social Security is a feature in newspapers every few months. Taxes are up to 14 percent of wages.
Then: Both Hoover and Roosevelt devoted a lot of attention to keeping food prices high. At a time when Americans were genuinely hungry, and some starving, Roosevelt introduced the new idea of paying farmers not to grow food. This was a boon to owners of farm land. It impoverished tenant farmers and other laborers who could not earn a living unless the land was actually farmed.
Now: Congress recently passed the most expensive agriculture bill in American history. At a time when people worldwide are struggling to pay for food, we pay farmers not to grow food and/or encourage them to turn food into SUV fuel. The government strives to keep food prices high.
Then: “Hoover’s humanitarian policy sent a signal nationwide: do not lower wages. In the end, businesses had to choose between lowering wages and shutting down. Often, they shut down.” Albert Wiggin of the Chase bank said “It is not true that high wages make for prosperity. Instead, prosperity makes high wages.”
Now: Congress has recently passed several minimum wage increases, one of which goes into effect on July 24, 2008. http://en.wikipedia.org/wiki/Minimum_wage notes that “minimum wage laws have been shown to cause large amounts of unemployment, especially among low-income, unskilled, black, and teenaged populations”. Barack Obama promises to “raise the minimum wage and index it to inflation to make sure that full-time workers can earn a living wage that allows them to raise their families and pay for basic needs such as food, transportation, and housing.”
Yeah, but the principle difference was that during the depression, the Federal Reserve reduced the supply of cash. In a deflationary environment the value of existing debts skyrocketed, to the point where people couldn’t pay them. This effectively bankrupted every business in the country. It took the inflation that came with WWII to reverse that error and right the economy again.
In this recession, the Fed seems intent to INFLATE the currency. This will better enable people and businesses to pay off their debts, and help the banks avoid book write-offs on their bad loans. The risk, of course, is that it turns into stagflation, which is what happened in the 1970’s which is where I think we’re heading again.
Then again, in the 1970’s the dollar was the only game in town. It remains to be seen if the global repercussions of the Fed’s policies will be as large this time around, in the age of the Euro.
Philip, on that wikipedia page that you have a link to there is section titled Minimum Wage Alternatives. Would you then support one of the policies mentioned there – the negtive income tax and the EITC?
Rob: I’m going to talk about this in a later posting. It is certainly the case that both the Hoover and Roosevelt Administrations did some insane stuff (by modern standards) with monetary policy, not the least of which was their devotion to the gold standard.
Luke: I wrote about this a bit back in 1996 in http://philip.greenspun.com/politics/welfare-reform ; our current welfare system is so expensive that if we stopped trying to figure out who is worthy we could probably feed and house any American who wanted basic food and housing. Anyway, it isn’t clear that a minimum wage keeps people off welfare. We already have the EITC as you note. The minimum wage does seem like a bad idea. If a person’s labor isn’t worth the statutory minimum wage then the person’s labor has essentially become worthless in the U.S. legitimate economy. Companies aren’t so stupid that they will overpay for labor. They can relocate jobs to cheaper countries. They can substitute more automated equipment for additional labor. They can restrict themselves to hiring only the best educated and most qualified workers.
Not to argue with with the overall gist of your post, but to pick one point out:The impending bankruptcy of Social Security may sometimes be featured in newspapers, but are the newspapers right?
Impending bankruptcy seems unlikely:
http://www.ssa.gov/OACT/TR/TR08/II_project.html#105057
I went and checked out what you wrote about welfare back in ’96. You stated that “Congressional Budget Office figures show that our current welfare system cost about $324 billion in 1993.” That number didn’t sound reasonable to me, so I visited the page http://cbo.gov/budget/data/historical.shtml. If you go down to the table called “Outlays for Mandatory Spending, 1968 to 2007, in Billions of Dollars” It shows that $116.1 billion was spent in 1993 for “Income Security” which is defined as “unemployment compensation, Supplemental Security Income, the refundable portion of the earned income and child tax credits, Food Stamps, family support, child nutrition, and foster care.”
Where did you get $324 billion amount? Do you include other expenditures, such as Medicaid?
The understanding of “money supply” was bleeding edge stuff as the Great Depression began to take hold. The banks did what banks do… they pulled in their loans. The Fed, not understanding the mechanics of money supply simply sat back & allowed the banks to pull back.
One of the earliest “pre-Keynsians” (that’s a formal label amongst economists) to examine the issues in detail was a Harvard PhD, Lauchlin B. Currie, Harvard (approx) ’28
http://en.wikipedia.org/wiki/Lauchlin_Currie
If you’re a glutton for punishment, you can read Currie’s catchy “Supply & Control of Money in the United States.” It’s a tad dense.
Do note that this book was researched for his 1928 PhD & published in 1934, two years before John Maynard Keynes’s famous work, “General Theory of Employment, Interest and Money”.
Luke: I wrote the referenced article back in 1996 so I can’t remember where I got that $324 billion number. It certainly would have included spending by state and local governments as well as federal.
OK, then, even if your number is valid, there are a number of problems with your proposal. People have needs beyond food and shelter. Most of the poor are not actually homeless. I could go on.
However, the more important practical point is that just giving things or money to able-bodied people is unpopular. Talk to a regular working guy making $30k or $40k and you’ll find a lot of hostility to welfare programs. Welfare programs are always somewhat vulnerable politically for that reason. On the other hand, minimum wage is quite popular among the American people. The idea of people getting money in exchange for work is what the American people approve of. I read Milton Friedman’s negative income tax proposal many years ago and it sounded like a great idea to me. However, I think that, in the real world, we are going to have suffer a little bit of deadweight loss. Besides that, the able-bodied poor themselves get some benefit by getting out and doing useful work that needs to be done.
Luke: Philip’s proposal might prove more popular than you think based on the fact that the services would be available to everyone. This might strike American voters as more of a true “safety net” than the current welfare system, especially since they can take advantage of it easily when their time of need comes.
I’m not sure if it would work or not. I think there’s the potential for the system to be abused to the point of collapse. But if I were in charge of designing a new welfare system for America, I would certainly give that plan some thought.
As to the original post, the parallels are frightening. Though Rob makes a key point. I think we’re more likely to see stagflation than a second great depression.
While we may be heading for a depression, as you point out, and your reasons seem logical and
familiar, I would look to a completely different set of causes to explain our current economic plight, and will not delve into the 1930’s. Under the Bush administration, “A budget surplus of 2.4 percent of gross domestic product (G.D.P.), which greeted Bush as he took office, turned into a deficit of 3.6 percent in the space of four years….”http://www.vanityfair.com/politics/features/2007/12/bush200712?currentPage=2 — more quotes below)
Why? Let’s talk Iraq war, which you didn’t explicitly mention. The National Priorities Project (www.nationalpriorities.org) runs a database that breaks out government spending (federal and state) and calculates that the median family spends $2,628 federal taxes. Here are the top three recipients of that $2628:
Military $1,109 (40%) (not necessarily the “war on terror”***)
Health 581
Non-Military Interest 269
In addition to the ag subsidies you mentioned, “a vast system of subsidies and preferences hidden in the tax code—increased more than a quarter. Tax breaks for the president’s friends in the oil-and-gas industry increased by billions and billions of dollars. Yes, in the five years after 9/11, defense expenditures did increase (by some 70 percent), though ***much of the growth wasn’t helping to fight the War on Terror at all, but was being lost or outsourced in failed missions in Iraq.”(quote from VF)
While it’s popular to say the the economy is in peril because consumers have made bad finance choices (and need to be educated), or are confused about excess regulation, it was arguably the deregulation of the finance that got us into this pickle, as described in this NYT article today: (http://www.nytimes.com/2008/07/20/business/20debt.html). Here’s an interesting timeline of deregulation (http://www.motherjones.com/news/feature/2008/07/where-credit-is-due-timeline.html). So IMO this is not like “business investment was deferred because nobody knew what the legal or tax environment was going to be”. Instead, deregulation enabled risky deals and huge gains by various financial companies. When some bets go south (Fan. M, Fred, M.) tax-payers are asked to bail them out.
Well known economists question the Laffer Curve but not the administration. Bush’s taxcuts favored the most wealthy, meanwhile, “[s]ome 5.3 million more Americans are living in poverty now than were living in poverty when Bush became president.”(VF))
Increasing the minimum wage from $5.85 to $6.55 (July, 2008) means that millions of people will now earn 70 more cents on the dollar, $5.60 more a day, minus taxes. This whopping five dollars a day, forty per week, will enable these people will be able to afford a couple more cans of soup, 10 gallons of gas, or a little more heating oil. Millions of people earning that extra .70 per hour will immediately kick that right back into the economy. But people want to argue businesses can’t afford that? I submit that it’s certainly not minimum wage increases threatening the US economy.
Nor is it Social Security. I second the comment about Social Security, I think it’s been persuasively debunked.
Jens: I won’t argue with the assertion that the minimum wage doesn’t buy a person a whole lot, or with the assertion that increases in the minimum wage will, in turn, be spent on essential goods.
However, I believe the practical matter which the book is addressing is whether the minimum wage is competitive or not. During the depression era, if a company was struggling in part because of payroll expenses, the company’s recourse would be to cut jobs or shut down completely. The minimum wage wouldn’t have helped this, obviously, but closing a company is an action of last resort so owners tend to avoid this as much as possible.
In our evolving world economy (and a point of difference between the 1930s and now), there is another option. The company’s management can cut payroll expenses without cutting jobs or shutting down: that is by moving the jobs to another country with lower wages. This is really good for the company’s owners (they don’t have to shut down), and really bad for the American employees for whom the minimum wages are supposed to protect.
Americans workers are in a tough spot. Their negotiating power is much less than it used to be. I assure you that the poor and hungry families of Bangalore are completely content with an increase in the American minimum wage.
Regarding social security: the fairest characterization is something like:
(1) assuming smooth-enough economic sailing for the next few decades, there will be little trouble paying out the funds the program is obligated to provide to retirees. If the fica cap is raised or eliminated, there will be even less trouble.
…but does that mean that social security is “fine”? Not really, b/c:
(2) a severe enough event (a real war that reached domestic shores, a second great depression, etc.) could throw that calculation off.
(3) the *important* one: social security payouts — if not increased dramatically — are going to be too small to accomplish their original policy goal, even if paid-out as obligated.
The original point of social security was retirement insurance, not a retirement plan: a guarantee that at the end of your working life you could count on getting a regular stipend that’d be enough to support your basic needs, if only in a very meager fashion; if you want to retire, social security is there no matter what, but if you want to retire comfortably, the onus is on you to plan for that.
We’re reaching the point in time at which social security no longer credibly accomplishes its design goal: ensuring a minimal retirement. The purchasing power of social security payouts has always been meager by design — and has never kept up with inflation — but it’s finally getting to the point that the amounts involved are no longer going to be adequate to actually enable real hard-luck cases to retire.
When that becomes apparent, the program will seem bankrupt, even if it’s meeting its nominal obligations. It’s any guess what happens then, though it’ll certainly be interesting.
Summary: literally bankrupt? unlikely. meetings its nominal obligations, but not accomplishing its chartered purpose in so doing? right around the corner.
One big difference: in 1929 the US was the largest lender nation in the world and it had a gold standard. Germany was the largest debtor nation and had no gold standard or statutory minting limits. The obvious result was hyperinflation of the Mark.
I could go on, but I shouldn’t have to.
In other news, in stark contrast to the 2.2 million percent inflation described by economists, Zimbabwe claims that their inflation rate is 29% (1). This was the result of the government printing just enough money to cover a 10% deficit from foreign debt(2).
The moral of the story is that inflationary policy, hallmark of Bernanke’s career, has historically proven disastrous for a central bank with domestic reserves and foreign debt.
It’s too bad, I really wanted to like him as an MIT person.
(1) http://www.mofed.gov.zw/CPIApril2005.pdf
(2) http://www.mofed.gov.zw/docs/First_Quarter_Treasury_Bulletin_2007.pdf
If I got any terminology wrong, I apologize as I am an engineer and not a banker, lawyer or economist.
Tim,
I have not read the book yet, but thanks to the review I will, it’s on the list. My comment about minimum wage was not to compare labor markets between the two eras, but to contend and provide links arguing that raising minimum wage is not the reason the economy is in trouble. Similarly California solve its fiscal problem by cutting minimum wage. Why cut a quarter off of millions of peoples income (CA income) when you could save more money shaving some off those at the top of the payscale? Those are simply the people who are least likely to put up a fight. I tend not to agree the fallacy that workers either take lower wages or jobs go overseas, anymore than hey if the kids weren’t working 10 hours a day in a sneaker factory they’d be playing in puddles. The global labor market (not my original point) is complicated, with transactions not only between workers and corporations (doing what they need to do) but importantly cities and states and countries all vying for the same business. Boeing moves Seattle to Chicago, it’s not a last resort, but a better deal with multiple cities always, as in that case vying with huge incentives and tax breaks. Every mayor is a businessman. There’s lots more…the American worker is not just a worker he’s a consumer demanding lower prices….etc.