Boom & Bust cycles, the New Deal, and the financial crisis of 2008
A depression is the low part of the business cycle, or the opposite of prosperity.
The roaring 1920's
During World War I, US federal spending grew three times larger than tax collections. When the government cut back spending to balance the budget in 1920, a severe recession resulted. However, the war economy had invested heavily in the manufacturing sector, and the next decade did see an explosion of productivity. The 1920's saw a return to a laissez-faire market economy; the top tax rate was lowered to 25 percent and the stock market began its spectacular rise.
laissez-faire is a term used to describe a policy of allowing events to take theirDeregulation in the 1920's allowed for heavy concentration of large corporations. About 1,200 mergers swallowed up more than 6,000 previously independent companies; by 1929, only
200 corporations controlled over half of all American industry.
The Depression of the 1930's
The booming economy led in 1929 to a backlog of business inventories which was three times larger than the year before. As a result a recession began in August 1929, two months before the stock market crash. During this two month period, production declined at an annual rate of
1932 and 1933 were the worst years of the Great Depression. Industrial stocks lost 80 percent of their value since 1930. 10,000 banks failed , or 40 percent of the 1929 total. GNP fell 31 percent since 1929 and over 13 million Americans lost their jobs between 1929 and 1932. In 1933 unemployment did rise to 24.9 percent.
The New Deal 1933 - 1945
The Roosevelt administration acted on this idea in an attempt to lift the United States out of the Great Depression of the 1930's. Roosevelt's 'New Deal' introduced certain features which automatically produced government deficits during a depression. The social security system, including unemployment insurance, and the income-tax system both are set up so that government revenues fall off while government expenditures increase as a depression gets under way. These features were called built-in stabilizers.
Roosevelt began relatively modest deficit spending that arrested the slide of the economy and resulted in some astonishing growth numbers. (Roosevelt's average growth of 5.2 percent during the Great Depression is even higher than Reagan's 3.7 percent growth during his so-called 'Seven Fat Years!') When 1936 saw a phenomenal record of 14 percent growth, Roosevelt rejected Keynes' advice for heavy deficit spending, instead he eased back on the deficit spending, worried about balancing the budget. But this only caused the economy to slip back into a recession in 1938.
( Note: In 1934 Sweden followed a policy of Keynesian deficit spending and became the first nation to recover fully from the Great Depression )The United States began emerging from the Depression as it borrows and spends 1 billion dollars to build its armed forces. From 1939 to 1941, when the Japanese attack Pearl Harbor,
U.S. manufacturing will have shot up a phenomenal 50 percent ! The Depression is ending worldwide as nations prepare for the coming hostilities.
In 1944 Roosevelt signed the
GI Bill of Rigths which would provide significant benefits to returning soldiers. This bill
was credited with forestalling a widely feared post-war economic depression and led to an unprecedented period of
prosperity following World War II. The G.I. Bill is sometimes considered to be the last piece of New Deal legislation.
In order to pay for the New Deal programs Roosevelt raised the top tax rate, and to finance the war economy the top tax rate was raised even more. It remained at 88 percent until 1963, by which time the entire war debt was payed down.
Internationally, delegates from 44 countries met in Bretton Woods in 1944 to reshape the world's international financial system through the International Monetary Fund which established a stable system of exchange rates. The Keynesian economic model helped to level valleys and peaks of business cycles for more than fifty years. During those years cyclical depressions were much less extreme and were therefore called recessions.
1980's - Reaganomics
In the 1980's a renewed scepticism of large-scale government intervention led once more to far reaching deregulations. Keynesian concepts got rejected and his warning about runaway money supply got dismissed.
In a repeat of the 1920's the top tax rate was lowered and the slogan became once again : 'Government is dumb, markets are smart'. The stock market saw again a spectacular rise and for a time the less regulated market forces led to considerable economic successes. (example: the hightech bubble in the 1990's). Blinded by success the money supply got even more increased by so-called derivatives - a development which alarmed some economists. But such warnings got curtly dismissed by most experts of the time as old-fashioned Keynesian politics.
Towards the crisis of 2008
In contrast to Roosevelt's tax increases during World War II, the Bush administration tried to
Eventually, the hightech bubble burst, and then the housing market collapsed. Unregulated credit availabilties had induced more and more people to get into unsustainable debts. The journalist Fareed Zakaria wrote that "Household debt had ballooned from $ 680 billion in 1974 to $14 trillion today." He described every city, county and state wanting to preserve its proliferating operations without raising taxes, and doing so by borrowing. He described Federal Reserve chairman Alan Greenspan as having "refused to inflict pain" with higher interest rates.
A typical instrument for enticing credit in the 1990's was the subprime mortgage, ostensibly to make credit available to people who could not get a mortgage otherwise. Many banks, freed from the strict regulations of earlier times, offered loans and mortgages to people who could not afford repayments during an economic downturn.
Unpayable loans became bad assets for banks and when such bad assets accumulated rapidily many banks were unable to offer any credit which led to aSince most of the world had adopted the American economic model the financial melt-down of assets-poor banks led in October 2008 to a repeat of a depression-type financial panic. The sudden intrusion of reality led economists of all stripes to reputiate the economic philosophy of the last 25 years calling for a return to large government intervention and much tougher regulations.
The libertarian philosophy, that is, an aversion to any infringement of the right to buy and sell (also called 'market fundamentalism') best explains how permissive lending standards during a boom period led to a global calamity that spread so far and so fast.
2008 - Reaction of the Bush administration
In 1929, during a similar panic, the US government had not reacted for three years resulting in the Great Depression of the 1930's.
Critics argued that more of the money should have been used to help struggling homeowners avoid losing their homes. To many people it seemed strange toUnsurprisingly it was soon revealed that some of the bail-out money was used to finance dividend payouts and bank mergers instead of easing credit availability. (The most obnoxious cashgrabs were the so-called 'performance bonuses' to many CEO's responsible for the crisis, bonuses in the amount of over 18 billion dollars.)
2009 - Obama's stimulus proposal
The new President Obama proposed to stimulate the economy by spending large amounts of capital for infrastructure building (badly neglected since the 1980's) and to initiate a Green Revolution by financing alternative energy sources to reduce dependency from foreign oil supplies and to mitigate CO2 emissions which threatens a looming global climate crises.
Critics charge that spending for large public projects will take too much time and that tax relief would be effective more quickly. However, it's also possible that people - instead of spending their tax savings - would use the money to pay down their enormous credit debts. And it's not clear why enterpreneurs would spend their tax relief money to expand their businesses if there is no market for their goods. Why would automakers expand their capapilities at a time when the car market is shrinking?
The ideological split widens
As the U.S. Senate designed a bill to stimulate the economy it was revealed that most Democrats accept the Keynesian position that stimulus takes place by government spending replacing temporarely the spending that the private sector is not providing. But Republicans dislike Keynesian economics and think of stimulus more as tax cuts. Senator Mitch McConnell, Republican leader, says "we know for sure that the big spending programs of the New Deal did not work." What got the U.S. out of the Great Depression, he adds, "was the beginning of World War II."
Conveniently left out is the fact that the biggest stimulus ever was the U.S. government spending for the war economy. It was the war wich finally made the opponents of the New Deal accept large deficit spending - the resulting debt was completely payed down in 1963 on account of higher tax rates. (During this period, America did experience the greatest economic boom it had ever known until the oil shock of 1974)In an attempt to receive Republican support Obama included several hundred billion dollars for tax cuts in his package. (See: BBC - The Stimulus Plan) Critics charge that the Obama plan was at best a half measure and that stimulus funding should have been twice as much. (China for example injected enormous stimulus money into its economy as an attempt to minimize the impact of the global financial crises. The result was an astonishing growth of 7.2 % in 2009)
In relation to the debate about taxes and spending it is interesting to note that the US economy grew fastest in the 1950s and 1960s when there was plenty of money for infrastructure and other public investments. In the 1950s America's top tax rates varied between 91 per cent and 92 per cent on incomes over $400,000 per year. In the early 1960s, Kennedy dropped the top rate to 70 per cent. Reagan reduced the top rates to 50% and the Bush tax cuts lowered it to 35 %. ( Opinion: John McCain ).
Successive tax cuts, expenditures for several wars, reduced revenues on account of the recession and stimulus financing resulted in a crushing debt of over 14 trillion dollars by 2011. ( see Milton Friedman's view about deficits). The enormous debt led to a demand for severe spending cuts, but the choice to increase taxes (which are the lowest since 1925) is off the table under the mistaken slogan that tax increases caused the great depression - which is a myth as shown in the diagram Myth and realty.
Even the business magazine 'The Economist' (July 9th 2011) criticised the American reluctance for higher taxes thus: "The vast majority of Republicans, driven on by the cacaphony of conservative media, cling to the position that not a single cent of deficit reduction must come from a higher tax rate. This is economically illiterate and disgracefully cynical"
Finally a commentary from Fareed Zakaria about the issue of the debt crisis in the US :
List of countries by tax revenue as percentage of GDP from Wikipedia.
|Back to Index|