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2008 October 19 Sunday
FDR Lengthened Economic Depression By Years

The most sainted figure in the Democratic Party implemented policies that lengthened the US Great Depression by several years.

Two UCLA economists say they have figured out why the Great Depression dragged on for almost 15 years, and they blame a suspect previously thought to be beyond reproach: President Franklin D. Roosevelt.

The saintliness of Franklin Delano Roosevelt makes me flash on a Prior saying "Hallowed are the Ori". In spite of the reverence that we are supposed to feel for FDR the guy caused huge amounts of human suffering. Heck, by lengthening the Depression he helped cause World War II. How did he do this? Interference with market pricing mechanisms.

After scrutinizing Roosevelt's record for four years, Harold L. Cole and Lee E. Ohanian conclude in a new study that New Deal policies signed into law 71 years ago thwarted economic recovery for seven long years.

We are suffering from a financial crisis because US government policies to encourage home ownership caused lending standards to get lowered so far that a real estate bubble and massive defaults became inevitable. But partisan promoters of the wrong policies that created this mess (e.g. Barney Frank, Chuck Schumer, Chris Dodd) still try to shift the blame. If they succeed in shifting the blame then the Obama Administration and a supermajority of Democrats in the US Congress will enact policies that will make the financial crisis even worse.

Roosevelt's policies artificially inflated wages and prices and this choked off demand and deflated the economy.

In an article in the August issue of the Journal of Political Economy, Ohanian and Cole blame specific anti-competition and pro-labor measures that Roosevelt promoted and signed into law June 16, 1933.

"President Roosevelt believed that excessive competition was responsible for the Depression by reducing prices and wages, and by extension reducing employment and demand for goods and services," said Cole, also a UCLA professor of economics. "So he came up with a recovery package that would be unimaginable today, allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies."

Start with a wrong-headed Federal Reserve policy that reduces demand by reducing monetary supply. Add in policies aimed at keeping up prices in the face of this lowered demand. Result? Prices can't fall to clearing levels that would make the economy once more grow even with a smaller money supply.

Using data collected in 1929 by the Conference Board and the Bureau of Labor Statistics, Cole and Ohanian were able to establish average wages and prices across a range of industries just prior to the Depression. By adjusting for annual increases in productivity, they were able to use the 1929 benchmark to figure out what prices and wages would have been during every year of the Depression had Roosevelt's policies not gone into effect. They then compared those figures with actual prices and wages as reflected in the Conference Board data.

In the three years following the implementation of Roosevelt's policies, wages in 11 key industries averaged 25 percent higher than they otherwise would have done, the economists calculate. But unemployment was also 25 percent higher than it should have been, given gains in productivity.

Meanwhile, prices across 19 industries averaged 23 percent above where they should have been, given the state of the economy. With goods and services that much harder for consumers to afford, demand stalled and the gross national product floundered at 27 percent below where it otherwise might have been.

In the name of compassion and social justice many in Congress want to keep up housing prices and keep people in houses they can't afford. If Congress succeeds in preventing the housing correction from working its way out then the US recovery will be delayed. Unfortunately, a left-leaning press does not want to handle the truth.

Update: Let me clarify one point: I think the financial crisis had a few causes. Regulatory pressures on financial institutions to lend to poor non-Asian minorities (NAMs) was just one of the causes. The SEC's rules change that allowed investment banks to become more leveraged was another cause. Chinese and other Asian buying of US debt kept consumer prices down while driving up asset prices. I'm one of a handful of people who even mention this cause. But I suspect it might be the most important of all. The asset bubble seems linked in my mind to the huge US trade deficit.

Share |      By Randall Parker at 2008 October 19 10:37 AM  Economics Political


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Comments
James Bowery said at October 19, 2008 1:11 PM:

Teasing apart cause and effect via controlled experiment is the triumph of science yet so-called "soft scientists" such as economists refuse to face the fact that they have almost no basis in controlled experimentation.

The soft sciences have an ethical obligation to stand against the kind of systems that routinely subject humans to experimental treatment without their consent. Yes, this does mean that the international regime based on the idea of "liberal democracies", where populations within fixed territorial boundaries are subjected to a experimental treatments (aka "tyranny of the majority" limited only by a laundry list of selectively enforced "human rights") is ethically bankrupt from a scientific point of view.

The economists, sociologists, political scientists, anthropologists, etc., have an ethical obligation to demand that their theories not be tested except on individuals that have consented to adopt them as working hypotheses (as quasi religious beliefs). This does mean that soft scientists have an ethical obligation to the rest of society to advocate the formation of experimental controls via assortative migration -- migration supported with all the moral and material force supporting human rights -- so that ideological purity is maintained within respective human ecologies.

Thomas Jefferson at least had the excuse that to the west lay a huge territory largely occupied by people with relatively low carrying capacity technologies -- so he could more or less presume the assortative migration required for crafting an ethical State by scientists, as Jefferson saw himself, and as many other founders saw themselves.

What scientists as citizens need to do is recognize that they do have a responsibility that falls to them as heirs of the tradition of Jefferson and other founders of the "laboratory of the states" to speak out and, if necessary, act, to prevent the further abuse of human rights entailed by the closing of the frontier -- now generations old.

Emma said at October 19, 2008 7:37 PM:

You may like this article written about the perspective of Anna Schwartz, who co-authored with Milton Friedman "A Monetary History of the United States":

In the 1930s, as Ms. Schwartz and Mr. Friedman argued in "A Monetary History," the country and the Federal Reserve were faced with a liquidity crisis in the banking sector. As banks failed, depositors became alarmed that they'd lose their money if their bank, too, failed. So bank runs began, and these became self-reinforcing: "If the borrowers hadn't withdrawn cash, they [the banks] would have been in good shape. But the Fed just sat by and did nothing, so bank after bank failed. And that only motivated depositors to withdraw funds from banks that were not in distress," deepening the crisis and causing still more failures.

But "that's not what's going on in the market now," Ms. Schwartz says. Today, the banks have a problem on the asset side of their ledgers -- "all these exotic securities that the market does not know how to value."

"Why are they 'toxic'?" Ms. Schwartz asks. "They're toxic because you cannot sell them, you don't know what they're worth, your balance sheet is not credible and the whole market freezes up.

MORE

In 2002, Mr. Bernanke, then a Federal Reserve Board governor, said in a speech in honor of Mr. Friedman's 90th birthday, "I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

"This was [his] claim to be worthy of running the Fed," she says. He was "familiar with history. He knew what had been done." But perhaps this is actually Mr. Bernanke's biggest problem. Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job."

http://online.wsj.com/article/SB122428279231046053.html

JBS said at October 19, 2008 8:12 PM:

The Messiah is also going to make the recession worse by crippling our energy suppliers with carbon regulations:

Obama's Carbon Ultimatum

http://online.wsj.com/article/SB122445812003548473.html

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Well, well. For years, Democrats -- including Senator Obama -- have been howling about the "politicization" of the EPA, which has nominally been part of the Bush Administration. The complaint has been that the White House blocked EPA bureaucrats from making the so-called "endangerment finding" on carbon. Now it turns out that a President Obama would himself wield such a finding as a political bludgeon. He plans to issue an ultimatum to Congress: Either impose new taxes and limits on carbon that he finds amenable, or the EPA carbon police will be let loose to ravage the countryside.

The EPA hasn't made a secret of how it would like to centrally plan the U.S. economy under the 1970 Clean Air Act. In a blueprint released in July, the agency didn't exactly say it'd collectivize the farms -- but pretty close, down to the "grass clippings." The EPA would monitor and regulate the carbon emissions of "lawn and garden equipment" as well as everything with an engine, like cars, planes and boats. Eco-bureaucrats envision thousands of other emissions limits on all types of energy. Coal-fired power and other fossil fuels would be ruled out of existence, while all other prices would rise as the huge economic costs of the new regime were passed down the energy chain to consumers.

These costs would far exceed the burden of a straight carbon tax or cap-and-trade system enacted by Congress, because the Clean Air Act was never written to apply to carbon and other greenhouse gases. It's like trying to do brain surgery with a butter knife. Mr. Obama wants to move ahead anyway because he knows that the costs of any carbon program will be high. He knows, too, that Congress -- even with strongly Democratic majorities -- might still balk at supporting tax increases on their constituents, even if it is done in the name of global warming.

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Stephen said at October 20, 2008 2:34 PM:

I thought that during the election campaign between Hoover and Roosevelt both promised pretty much the same type of market interventions - its just that Roosevelt won. Understandable really as there was the scent of revolution in the air during the 30s.

realist gun nut said at October 20, 2008 8:34 PM:

"I thought that during the election campaign between Hoover and Roosevelt both promised pretty much the same type of market interventions - its just that Roosevelt won. Understandable really as there was the scent of revolution in the air during the 30s."

Sounds a bit like today, except there is the scent of a Maunder-like minimum in the air ...

Luke Lea said at October 21, 2008 9:17 PM:

Was there much inflation during the Depression?

If not, that might explain the delay in recovery. In a deflationary situation, general inflation is the only way to get real wages down to a full-employment level without requiring employers to reduce nominal wage-rates, which they are reluctant to do. Workers historically do not willingly accept such cuts lying down. This is what economists call "the downward stickiness of wages." It follows that the only way to restore full employment in a deflationary environment is to bring about a gradual inflation, via monetary and fiscal policies. This was Keynes's key insight, which lies concealed at the heart of his General Theory. It was true then, and it remains true today, as I assume you, Randall, are aware. But back in the 1930's neither Roosevelt nor most economists knew it.

It becomes a problem, however, when we have strong labor unions that get cost-of-living adjustments in their wage contracts, as happened in the 1970's. Then you get stagflation.

Brent said at October 21, 2008 9:45 PM:

Come on people. FDR's new deal caused high prices( because it allowed companies to fix prices and it also allowed labor to seek wages higher then the market allowed. some 24% higher then normal.) and high wages. This caused 25% unemployment.

25 % of the work force sitting around not producing anything.

Randall Parker said at October 21, 2008 9:49 PM:

Luke,

The Depression was deflationary. Less cash available to chase goods. Some prices fell. Either all prices needed to fall or the money supply needed to be drastically expanded. FDR delayed the needed price decline. He probably had no idea that his policies were counter-productive.

Luke Lea said at October 22, 2008 5:58 PM:

Randall,

I am not disagreeing. Just pointing out that Keynes found a way around the problem that wages were "sticky," whatever the reason for that. It was an historical observation on his part. I think Friedman agreed with him on this point, which is why he (and a lot of others) ended up advocating a slow, steady rate of inflation. It was an easy way to get wages to adjust downwards in time of slack labor markets. I am guessing that you know about all this, though maybe some of your readers don't. It is standard macro-economics, at least I think it is. Was certainly what Keynes and Friedman had in mind.

Randall Parker said at October 22, 2008 6:39 PM:

Luke,

FDR took already sticky wages and made them even more sticky. That's dumb.

If FDR had run a huge budget deficit and the Fed had bought up all of the Treasury bonds then that would have pulled us out of the Depression even with sticky wages. But it was not politically possible for FDR to do that.

Alternatively, if FDR had let wages and prices fall while the Fed bought up all US government debt and even state government debt that would have shortened the length of the recession as well.


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