Conclusion: “Do-Nothing” Politicians Deserve a Special Place in Heaven
I’m telling you that the cure is the disease. The main source of illness in this world is the doctor’s own illness: his compulsion to try to cure and his fraudulent belief that he can. It ain’t easy to do nothing, now that society is telling everyone that the body is fundamentally flawed and about to self-destruct.
—The Fat Man, House of God
If you see ten troubles coming down the road, you can be sure that nine will run into the ditch before they reach you.
—Calvin Coolidge
From 1920 to 1921, the U.S. economy endured a recession far more brutal than the one that set in from 1929 to 1930.1 There is a reason that history books do not spend much time on the 1920–1921 recession, however—it was very short.
It was so brief because the federal government got out of the way. Good doctors often allow the body to heal itself, and smart politicians allowed the economy to do the same. Today’s conventional wisdom is that governments must spend with abandon during times of economic hardship, but in 1920–1921 federal spending was slashed. While the government had consumed $6.4 billion of precious capital in 1920, by 1923 the government’s burden on the economy had been reduced to just under $3.3 billion.2 This was textbook growth economics. Governments have no resources, so during times of weakness, it is essential for them to reduce what they consume to free up always limited capital for the private sector.
Today’s conventional wisdom also says to devalue the currency during trying economic times, but “the gold standard was unshaken” in the early 1920s, notes Benjamin Anderson in his essential book, Economics and the Public Welfare.3 Since investors are buying future dollar income streams when they commit capital, devaluing money during downturns runs off investors when you need them most.
Recessions are the cure for what’s wrong with an economy. They cleanse it of the bad businesses, bad investments, and labor mismatches that got it in trouble in the first place. When the 1920–1921 recession hit, a wise political class sat back and did nothing other than lower taxes slightly and slash spending. Unemployment dropped from 11.2 percent in 1921 to 1.7 percent by 1923, and the Roaring ’20s took off.
In 1929 and 1930, the U.S. economy dipped again. Eager to shield Americans from the near-term pain of recession, Presidents Herbert Hoover and Franklin D. Roosevelt decided to intervene. Their interventions gave us the sixteen-year debacle known as the Great Depression. That disaster was not a creature of capitalism but the result of running away from it. Indeed, Hoover and Roosevelt violated the principles of growth in all four areas of economic policy—taxes, trade, regulation, and money.
First, they told entrepreneurs and investors—the people most essential for an economic recovery—that there was no point in taking risks because the government would confiscate most of the rewards. Hoover raised the top income tax rate from 25 percent to 62 percent, and then Roosevelt took it all the way up to 83 percent.4
Perhaps the most disastrous component of Roosevelt’s Depression-extending program was the Undistributed Profits Tax of 1936, which imposed a tax of up to 74 percent on earnings that businesses saved, whether for plant expansion, research on new products, or a rainy day.5 You’ll recall that Henry Ford, who incorporated the Ford Motor Company in 1903, perfected his manufacturing process through the constant reinvestment of profits. If the Undistributed Profits Tax had been in place then, the profits that he plowed back into his revolutionary enterprise would have been confiscated. There might have been no mass-produced Model T and a very different American auto industry.
Hoover and Roosevelt also increased government spending, which is a tax like any other. Rather than leaving credit and capital in the private sector, where they could fund real growth, government devoured them itself. Federal spending doubled on Hoover’s watch, and Roosevelt took it from there, saddling the economy with a seven-billion-dollar budget deficit in 1934.
Second, they imposed job-killing regulations. Hoover called on businesses not to reduce wages despite market signals telling them to do just that. If Walmart is struggling to sell televisions, it needs to reduce its prices to attract buyers. But Hoover kept the price of labor at an artificially high rate, so businesses were unable to add workers.
Roosevelt in turn passed the Fair Labor Standards Act, which introduced a minimum wage, maximum work week, and guaranteed overtime, imposing a cost of labor that should be set by markets and pricing workers out of the labor force altogether. Private employment was hurt even more by Roosevelt’s various make-work programs, in which the federal government paid artificially high wages for work that often had no discernible economic value. Every dollar the government pays an individual is an extra dollar businesses must pay to lure him into private-sector work. With government forcing wages above what the market would bear, unemployment was abnormally high throughout the 1930s.
Third, Hoover signed the Smoot-Hawley Tariff, raising taxes on imports and provoking other countries to raise taxes on U.S. exports. “I almost went down on my knees to beg Herbert Hoover to veto the asinine Smoot-Hawley tariff,” recalled Thomas W. Lamont, the head of J. P. Morgan. Graeme Howard, the European head of General Motors, sent a telegram to Washington warning that Smoot-Hawley would lead to the “MOST SEVERE DEPRESSION EVER EXPERIENCED.”6 The tariff shrank the foreign markets of the best U.S. companies while subsidizing America’s weakest producers. While free trade allows people to exploit their comparative advantage, taxes on trade encourage the opposite.
Fourth, Roosevelt set about devaluing the dollar. It bought one-twentieth of an ounce of gold when he reached the White House, but he soon devalued it to one-thirty-fifth of an ounce. Investors, who seek future dollar income streams when they commit their capital to businesses, were promised that the reward for their job-creating investments would be devalued dollars.
It is instructive to compare the economic policies of the Depression era with those of today. The parallels are striking. The doldrums in which our economy has been stuck since the panic of 2008 are the result of government intervention, not capitalism itself. Presidents George W. Bush and Barack Obama have replayed the Hoover-Roosevelt follies.
On September 25, 2008, Bush told the nation:
I’m a strong believer in free enterprise, so my natural instinct is to oppose government intervention. I believe companies that make bad decisions should be allowed to go out of business. Under normal circumstances, I would have followed this course. But these are not normal circumstances. The market is not functioning properly. There has been a widespread loss of confidence, and major sectors of America’s financial system are at risk of shutting down.7
There is something odd here. Markets are not a living, breathing organism any more than an economy is. Markets are simply people with differing views on the price of just about everything. For that reason, markets cannot be said to function properly or improperly; they just function. Markets are a constantly changing source of information.
In 2008, the individuals who constitute the markets concluded that consumption of housing was overdone. The market result was failure of financial institutions too exposed to the housing market, along with defaults by individual consumers who had bought more house than they could afford. The market was correcting investments that were bad for the economy and were themselves the results of government error. The markets that Bush claimed were “not functioning properly” were in fact correcting Bush’s mistakes.
President Bush, Fed Chairman Bernanke, Treasury Secretary Paulson, and Congress led the charge of government intervention, blocking the natural way in which markets correct for errors. In doing so, they created a crisis.
Before plunging into his destructive program of intervention, Bush would have been smart to consult the thinking of the early-twentieth-century social critic Albert Jay Nock, who cautioned, “Any contravention of natural law, any tampering with the natural order of things, must have its consequences, and the only recourse for escaping them is such as entails worse consequences.”8 The short-term consequence of Bush’s tampering with the markets’ natural order was a financial crisis that was by definition a creation of the political class. The long-term consequence was an anemic recovery.
Learning nothing from Bush’s errors, Barack Obama promptly revealed that his own misunderstanding of how economies grow rivaled that of Bush. In his first State of the Union address he said:
I can assure you that the cost of inaction will be far greater, for it could result in an economy that sputters along not for months or years, but perhaps a decade. That would be worse for our deficit, worse for business, worse for you, and worse for the next generation. And I refuse to let that happen.9
Full of the hubris all too common in politicians, Obama continued the intervention in an economy which should have been allowed to correct itself. Although Obama signed an extension of the 2003 Bush tax cuts in 2010, he initially passed a suffocating $787 billion federal spending bill, an economic chokehold on a nation that was trying to recover from its errors. And at the end of 2012, Obama finally got his tax hikes, increasing the penalties on work and investment.
Obama introduced a regulatory reign of terror in the energy, finance, and healthcare industries. His preposterously named Affordable Care Act, requiring businesses with fifty employees or more to offer expensive health insurance plans that have nothing to do with insurance, is dying of its myriad contradictions, but it has substantially raised the cost of hiring workers.
The Bush and Obama administrations both made our trading partner China an enemy even though the growth of its economy has done wonders for every American. Each day the Chinese get up to go to work, Americans get a raise. Nevertheless, the Obama administration levied a tariff on Chinese tires, while the Bush administration imposed tariffs on steel, softwood lumber, and shrimp from any country. The only winners were businesses with close Washington ties. The losers were the American people, who saw their paychecks diminished by government edict.
And then there is the dollar. It bought 1/266 of an ounce of gold when Bush entered office. By the time he departed, the greenback had shrunk to 1/880 of an ounce. Under Obama, the dollar’s slide continued to an all-time low of 1/1900 of an ounce. The message to investors: Intrepid capital commitments intended to create the wealth of the future will endure erosion by dollar devaluation.
The economy has been weak for much of the last thirteen years, and the weakness is reflected in stock indices that basically sit where they did in 2000, when the dollar was much stronger. The sources of the weakness are obvious for all to see: taxes on work and investment are up, the tax that is government spending has reached new records, regulation has run wild, trade has been choked, and the dollar has been in free-fall.
All of which brings us to Ben Bernanke, the mercifully departed former Fed chairman who drove the short rate for credit to zero, the last thing a central banker should have done. Interest rates are a price like any other, and in free markets, interest rates are simply the way that markets match the needs of savers and borrowers. But just as apartments in Manhattan would be scarce if Mayor Bill de Blasio capped rents at one hundred dollars per month, credit is scarce for all but the biggest governments and businesses because Bernanke told savers that they would get nothing in return for their savings.
Bernanke’s policy of buying up Treasuries and mortgage bonds—“quantitative easing”—simply propped up government consumption and delayed a necessary housing correction. Wouldn’t life be simple if the Fed’s purchases of Treasuries and mortgages could hatch the Googles and Apples of the future? Back in the real world, the way to foster the companies of the future is to get the four basics right, with the Fed doing as little as possible.
But Bernanke’s gravest economic sin was thinking that meddling with the economy could dull the pain of recession or avoid another one. He ignored the necessity of recessions for economic recovery. By blocking the natural direction of the economy, Bernanke prevented a powerful rebound. Those who should know better have called Bernanke the leading scholar of the Great Depression, yet his every action at the Fed revealed an economist who learned all the wrong lessons from that disaster.
Writing in the midst of the Great Depression, Nock observed, “The present paralysis of production, for example, is due solely to State intervention, and uncertainty concerning further intervention.”10 That diagnosis is as accurate for the U.S. economy since 2008 as it was for the economy of the 1930s, and that’s why we can be optimistic about our economic future.
Americans have not run out of ideas, work ethic, or entrepreneurial spirit. Our problem is the government, which continues to violate the four basic economic truths that I have discussed in this book. The reasons for the economy’s struggles are obvious, and that is why people should be giddy about the future.
It seems that once a generation Americans become careless in their voting. In the 1930s, we violated the basics of growth, only to rediscover them with the free trade and sound money that prevailed after World War II. In the 1970s the economy suffered from tax and monetary blunders. But the economic agonies of the Nixon, Ford, and Carter presidencies awakened the electorate, who turned to Ronald Reagan and eventually extended his economic policies with Bill Clinton.
Two decades of prosperity made Americans complacent. The result was Presidents Bush and Obama and their economic wreckage. Fortunately, Americans have woken up again. They are increasingly skeptical of government, and there is a good chance that such unhappiness will influence the outcome of the 2016 presidential election.
Until then, there is reason for hope. In February 2014, Facebook purchased a fifty-five-employee company called WhatsApp for nineteen billion dollars. However that acquisition works out, it is a reminder of Americans’ growing ability to create wealth in an interconnected global economy. The future wealth creation to which the WhatsApp purchase points will make today’s market look puny. And WhatsApp is a sign that Americans have not forgotten how to innovate.
The economy is set to grow in the years ahead because President Obama’s presidency ended for all practical purposes in 2012. Crippled by the spreading failure of Obamacare, he has lost the power to do more harm. He will leave office with the economy growing precisely because he will have passed no further substantial legislation before his departure.
Obama’s presidency, and Bush’s before it, has done wonders for the freedom movement. Americans are far more skeptical about government in 2014 than they were in 2000. This should lead to the election of a much less interventionist president in 2016, and boom times thereafter. What we don’t know is whether Americans will again forget why economies grow once this next economic boom takes place.
In the hope that Americans won’t forget, I have tried to make the basic ingredients for economic growth understandable. Our economy is ailing today because the state has grown too large and intrusive. But economics is easy, and its lessons are all around us. Once we citizens force the political class to get the basics right, everyone will soon see that economic growth is easy too.