U.S. economy may not be tough enough to survive incompetent government

It is time to wrap-up my postings on The Forgotten Man, a history of the depression. Newspaper reviews have concentrated on whether or not the author was too harsh on FDR. The more interesting subject of the book is to what extent the U.S. economy is robust to government incompetence. Calvin Coolidge is the author’s hero. He interfered with the economy as little as possible, discouraged Congress from making new laws that would confuse or disrupt business investment, and hid from the spotlight. As incredible as it may seem to a modern voter, Coolidge would stay at his desk working and send clerks to read speeches in public, even his State of the Union address to Congress. Coolidge understood that his six years of being president might be a reasonable maximum, writing “It is difficult for men in high office to avoid the malady of self-delusion. They are always surrounded by worshipers. They are constantly and for the most part sincerely assured of their greatness.” The growth of the 1920s was, according to author Amity Shlaes, a period in which workers at all levels of the economy benefited from increased employment, higher wages, lower prices, and, by modern standards, ridiculously low taxes.

Virtually every action by Hoover, Roosevelt (FDR), and Congress hindered the U.S. economy. The Economist magazine looked back and noted “In 1930, the per capita national income of the United States had been one-third larger than that of Britain. … At the end of the 1930s, it was about the same.” The problem, the magazine would conclude several years later, was “institutional obstructions to a free flow of capital.” During the 1930s, the U.S. actually fell behind Britain, a country without any of the natural resource advantages of the U.S. or the room to grow!

How was this possible? Unfortunately the Forgotten Man is rather weak on explaining macroeconomics. A major part of the problem seems to have been monetary policy and a devotion to the gold standard. If the economy grew but our supply of gold did not grow, we would literally run out of money. Prices and wages would have to fall in nominal dollar terms if only because there weren’t enough dollars to go around. Although the U.S. economy remained depressed into 1937, with terrible unemployment and hunger even 8 years after the stock market crash of 1929, things began to turn around as soon as Hitler was elected by the German people. The prospect of war in Europe unsettled investors and they began to ship gold to the U.S.

With prices and wages falling, debts became harder to repay and foreclosures were growing. The government’s main goal became maintaining high prices and wages, which it did with a series of ever-more-coercive laws and bureaucracies. Companies that couldn’t pay the minimum wage went out of business. Farmland owners got paid not to grow food, which caused them to fire all of their workers and break contracts with tenant farmers. The Depression wasn’t bad if you had a job, because so much government pressure was being applied to keep wages high, but a third of American workers did not have jobs.

The federal government expanded so much that they needed a lot more tax revenues. Politicians kept coming up with soak-the-rich schemes that never produced as much revenue as hoped. Corporate profit taxes were raised and the result was a massive reduction in business investment (no surprise to modern economists). High tariffs were established on imported goods, which resulted in greatly reduced trade.

The Depression finally ended, according to Shlaes, in 1940 when Roosevelt abandoned his anti-business policies in preparation for war: “A war on business and a war against Europe could not happen at the same time. In World War II, as in any war, bigger businesses tended to do well, for they were the ones who became government partners.”

What lessons can be drawn from this book? Mine is that the U.S. economy is not infinitely robust. We can survive a lot of government policies that benefit one constituency or another at the expense of the general public and that defy common sense, but there is a limit and it is not always obvious to politicians when the limit of what can be milked out of the U.S. economy has been reached.

Disturbingly for those of us who have predicted a Barack Obama victory, his campaign promises are very similar to what Hoover and Roosevelt were doing in the 1930s. Obama promises to prop up house prices with taxpayer money. Obama promises to restrict trade with higher tariffs in hopes of preserving American jobs. Obama wants to help unionized workers, partly with new regulations and partly by reducing competition from non-union labor via an increased minimum wage. Obama wants to give bankruptcy courts the authority to alter mortgage contracts, an issue that was litigated to the Supreme Court during the 1930s. Now that we are managing our money supply more competently, perhaps American business can survive these new regulations and the diversion of money into unproductive parts of the economy such as housing or paying people not to work. But perhaps not…

[Book review of the Forgotten Man as a book: Mostly I’ve been writing about ideas from the book, not about the book itself. The prose is highly readable and the narrative sustains reader interest, as you’d expect for something written by a full-time journalist. The author is relentless in her assassination of FDR’s reputation, forgetting that it is better to show rather than tell. FDR’s record in the 1930s speaks for itself. The U.S. fell behind one of the world’s most constrained and inefficient economies, i.e., Britain’s. That is all that needs to be said.

The copy editing on the book is so sloppy that it calls into question what function publishers serve. HarperCollins will pay Shlaes about 10 percent of the retail price of each book sold. In theory the book distribution chain is supposed to result in higher quality than authors putting up stuff on their Web sites, yet the book contains such phrases as “[business owners] were charged with conspiracy to flaunt the code” (rather than flout) and “dividing students’ days into blocs of study” (rather than blocks).]

Related:

• The Forgotten Man, Ted Kennedy, and Warren Buffett
• Black Unemployment: the effect of 80 years of government intervention
• Parallels between our current economic times and the Great Depression (July 2008; wish I’d shorted the market just then!)