Recession Myths: De-Constructing the Webs of Historical Falsification


This post highlights the most important issue a voter should have in mind when deciding who to vote for in the middle of a bad economy. The Great Recession of our time resembles the Great Depression of our grandparents' time in ways that are more eerie than you may realize. This post includes the statements of historical actors and present ones. I intend all quotes to be paraphrases more than direct quotes because I'm quoting them from my own memory, which is an imperfect faculty.

For starters, there is no difference between a recession and a depression. Until the Great Depression of the 1930's, the term depression was applied to every instance when there was a decline in economic growth. Depressions as such happened every ten or twelve years. Usually, they ended after 18 months and the recovery was often a booming one.

But something strange happened in the 1930's that made the term depression apply only to that crisis. There was no bounce back. Instead the economy limped, ever so sluggishly, with low growth, for eleven years! The scars ran so deep that the term depression came to be associated with an entire generation. Depression became not just a word associated with economic indicators, but rather, it defined the mood and psyche of the people old enough to remember suffering through that terrible decade! 

Subsequently, a new term was needed to describe usual periods of economic reversal, and so recession provided that need. The American economy boomed following the Second World War. Recessions still happened, sometimes more than once in a decade. But they were brief, and the damage temporary. Sometimes the stock market crashed (in 1987, and again in 2000) with mild consequences except for the people who had a vested interest in the industries that took the plunge.

But suddenly in 2007 and 2008, another recession broke out, and the aftermath has been more depression-esque than anything experienced since the Great Depression. What happened that made both the Great Depression and the Great Recession stand out among the cycles of boom and bust throughout history?

There are many striking parallels shared by both crises. Among them are

• In both cases a calamity was brought-on by choices made the government and the Federal Reserve. 
• In both cases the blame was shifted from these culprits to more convenient ones like "Wall Street", "greedy banks", and the "elite." 
• In both cases the solutions applied by the government made the calamity worse and longer-lasting. 
• In both cases few Americans understood the truth about what caused the crisis and what solved it. This misunderstanding stemmed from layers of mythology perpetrated by public officials, the media, and educators who have affinity for an activist government.
• In both cases the crisis broke-out under a Republican president thought to operate under a "hands-off" approach to governance, but in fact was a believer and practitioner of activist governance. 
• In both cases the Republican president was succeeded by a Democratic president who did more (not less) of them same.
• In both cases the damage and suffering was spread over a wider swathe of the public than needed to be the case.
• In both cases the recovery (if that's what it can be called) was slow, grinding, fitful, sporadic, and unpredictable. This reality kept people (with money) from having the confidence to invest.

Let us tackle the parallels...

Myth:
Teachers and textbooks tell of a decade when credit was cheap and people were living high on the hog. This decade was the 1920's. More commodities were purchased with credit than ever before (radios, cars, household appliances, etc.) People became rich trading stocks in these booming industries. Their greed fed a frantic boom which was followed by an equally intense bust when the stock market collapsed at the end of that decade. Retribution followed the greed when Wall Street bankers jumped out of windows or shot themselves. This was the cause of the Great Depression, or so we've been taught.

Fast Forward:
Following the Great Recession of 2008, similar mythology has put the blame for the crisis on "Wall Street" and the greedy "one percent". But As the deconstruction (below) shows, the real culprits were the same as in the Great Depression: the government and the Federal Reserve.

Deconstruction:
Anyone who understands how credit works knows that the people spending the credit are at the end (not the beginning) of the decision-making circuit. The decision-making begins with the Federal Reserve and the leeway given it by elected officials. In the 1920's, Benjamin Strong (Governor of Federal Reserve Bank of New York) inflated the U.S. and the world economy with massive and continuous injections of money available for credit. 

Strong and his counterparts in Britain (Montagu Norman) and in Germany (Hjalmar Schacht) sought to play God with credit. They wanted to see if they could engineer a formula to keep the world on a permanent economic boom. Elected officials in Washington did nothing to restrain the Fed. This money fed the speculative boom on the stock market which in the end caused the great crash. At some point, prices got too high for the people paying.  It was Washington and the Federal Reserve in an experiment in social engineering, not "greed", which caused the Great Depression. Even so, the Great Depression may not have been anything more than a normal downturn had it not been for the massive efforts of Washington to reverse it.

Fast Forward: 
Similar acts of social engineering by the government and the Federal Reserve caused of the Great Recession of 2008. This time, the motive was to level the opportunity of the masses to become homeowners. Was this a noble goal? Perhaps so, but idealism is often a poor substitute for practicality. Beginning in the 1990's and continuing for a decade, leaders in the White House (Presidents Bill Clinton and George W. Bush), Capitol Hill (Barney Frank, among others), and in the Federal Reserve (Alan Greenspan), browbeat lenders to lower mortgage application requirements for lower and middle income people to qualify for a loan. This would never have been a problem so long as most of these borrowers could pay on their loans.

The chickens came home to roost when waves of foreclosures pulled down the entire economy in a systemic free-fall. Since then President Obama, congressional Democrats, liberal media commentators, and thousands of "occupy" protesters have demonized the financial and business communities across the nation. They should have aimed their fingers at the White House and Capitol Hill instead.

Myth: 
For quite some time, it was accepted wisdom that the stingy Republican president, Herbert Hoover (31st U.S. President 1929-1933), made the Great Depression worse by taking a "hands-off" approach to solving the crisis when a rescue of the workforce could have reversed the downward spiral of deflation which ground the economy to a standstill.

Deconstruction:
It is true that Hoover preferred keeping banks solvent as opposed to providing shovel-ready jobs. Direct government relief was not in fashion in those days. Nonetheless, he made great strides to protect workers and, ironically, worsened the crisis. He backed labor unions in keeping wages artificially high. With prices plummeting, employers had no choice but to lay-off workers in masses. By 1932, 25 percent of the workforce was unemployed. Hoover stood no chance of re-election.

Myth:
The same myth followed that recovery began with the massive government relief programs of Hoover's successor, a Democrat, Franklin Delano Roosevelt (32nd U.S president 1933-1945). 

Deconstruction:
It is true that Roosevelt and his helper, Harry Hopkins, created 4 million jobs in a six month period between late 1934 and early 1935 (as many as President Obama claims to have created in four years). Yet, unemployment did not break single-digits for the remainder of the 1930's. Many people had to compensate by working two or three part-time jobs. Consumer spending was low. The stock market was a tomb. All this, despite unprecedented deficit-spending by the Roosevelt administration and millions of acres of land opened by the federal government for the development of hydroelectric power, roads, parks, you name it.

Myth and History Repeat
More recently, another president believed in the myth of the do-nothing Herbert Hoover and the do-everything Franklin D. Roosevelt. This president was George W. Bush (43rd U.S. president 2001-2009). In his memoir Decision Points Bush repeats myth and history by boldly declaring to an aid, "I'm gonna be FDR not Herbert Hoover", upon learning of the collapse of Lehman Brothers and the onset of the Great Recession in September 2008.

Bush and Congress responded with the Emergency Economic Stabilization Act of 2008 which enabled the U.S. Treasury to spend $700 billion dollars to buy up the risky assets held by the nation's lenders. This influx of cash would save the financial system from collapse. In the coming months, Bush's successor would follow-up this bailout with additional bailouts of the auto industry. The assumption behind the approach was to save the entire economy by preventing the fall of public and private institutions deemed "too big to fail." 

Bush misunderstood history, worsened the crisis by delaying a genuine recovery, and in an Oedipus-like way, became Herbert Hoover, another victim of the myth of the stingy, do-nothing Republican. His Democrat successor, Barack Obama (44th U.S. president 2009 - present) was even more convinced he was FDR than was Bush. 

Looking at the Obama presidency from the hindsight of four years, it is hard to place Barack Obama and Franklin Delano Roosevelt in the same paragraph. When Roosevelt wanted shovel-ready jobs, he called up people (like Hopkins) who had a proven record of despensing relief in a responsible way. The result was genuine work-relief for millions Americans and the families that needed that paycheck to avoid hunger. The same accomplishment hardly applies to President Obama.

Yet, a relief economy funded and run by the government is not a permanent recipe for economic growth. It is vastly expensive and it involves the government in management practices its officials are not trained for. FDR understood this and wracked his brain to find ways to get the private sector to take over. But in this, he became a victim of his own rhetoric. In his 1936 re-election campaign, FDR had vilified the "forces of selfishness" who were supposedly to blame for the Depression. He boldly puffed, "Let it be said that in my first term, the forces of selfishness met their match. Let it be said that in my second term, they met their master!"

Consequently, "the forces of selfishness" sat on their money and decided to wait out the Roosevelt tide. Genuine recovery did not come until after the Second World War. By then Roosevelt was dead and the great crash was sixteen years in the past!

President Obama has shown himself to have all of FDR's shortcomings and absolutely none of his strengths. A poor delegater, Obama has relied on Congressional Democrats to craft his relief programs in the form of legislation, instead of assigning that task to people with a proven record of positive results in planning and implementing relief work. Having failed in this, the president jokingly mused, "shovel-ready was not as shovel-ready as we thought."

In the full blaze of his re-election campaign, the president touts a 7.8 percent unemployment rate (down from 8.1 percent, a few weeks ago) as evidence that his policies are working. Let us assume the unemployment rate is accurate (and I am not at all convinced it is). Obama's stimulus spending was spent years ago and 7.8 is about what unemployment was when he took office. After four years and 5 trillion dollars in new debt having been pumped through the economy, what Obama is telling us is that things are exactly the same as when he took over! With a 16 trillion-dollar national debt, and nothing to show for it, we are worse-off than four years ago.

Why does activist governance not work?
The short answer is that it delays recovery by keeping bad capital locked-up in the system. By this I mean the people who make poor investments are allowed to stay in the system, at precisely the moment when the system can not bear them anymore and is trying to flush the bad capital out. Billions of taxpayer dollars are then pumped into the veins of companies with poor financial sense. The continued presence of bad capital keeps good capital from getting a footing in the economy. The power of labor unions is a particular hindrance to recovery. They will not allow wages to fall, therefore they have to tell their members, "oops" when they receive a pink slip instead of a wage increase.

The auto bailouts illustrate what I mean by "bad capital" staying in the system. GM claimed it needed a bailout to avoid bankruptcy. GM ended up in bankruptcy after having been bailed out. Nobody remembers the Depression of 1919 - 1920. Republican president Warren Harding inherited that crisis. All he did was slash expenditures, slash taxes, and allow wages to fall to their natural level. Nobody got a bailout. Yet, within a year, the depression was over and the Roaring 20's followed. Yes, the recovery was a "roaring" one! We can have that tomorrow. We just need to elect leaders who will do what it takes and let the private sector take over.

What is interesting is that the public does not seem to be buying Obama's spin anymore. We are only two weeks into the presidential debate series. Fourteen days ago, Obama was ahead of his challenger, Mitt Romney, in all the leading national and swing-state polls. Now, the challenger is ahead of him in many of the swing states and has broken a six-point lead over him in the latest Gallup national poll. Could it be that the American people have figured out something that has eluded presidents Hoover, Roosevelt, Bush, and Obama, for the last 80-plus years? Could it be that activist governance has finally fallen out of fashion. We will find out November 6.

Jason A.