A Chequer-Board of Nights and Days

Now that we are heading into the Age of Obama and associated Keynesian stimulus packages that are designed to fulfill the policy wishes of big-government Democrats give our economy a jump start, it is, more than ever, worth paying attention to Amity Shlaes's The Forgotten Man, which has become even more relevant than when it was first published.

I suppose that I could go ahead and tell you what the thesis of The Forgotten Man is, but I see that George Will has covered the matter succinctly:

In "The Forgotten Man: A New History of the Great Depression," Amity Shlaes of the Council on Foreign Relations and Bloomberg News argues that government policies, beyond the Federal Reserve's tight money, deepened and prolonged the Depression. The policies included encouraging strong unions and higher wages than lagging productivity justified, on the theory that workers' spending would be stimulative. Instead, corporate profits -- prerequisites for job-creating investments -- were excessively drained into labor expenses that left many workers priced out of the market.

In a 2004 paper, Harold L. Cole of the University of California at Los Angeles and Lee E. Ohanian of UCLA and the Federal Reserve Bank of Minneapolis argued that the Depression would have ended in 1936, rather than in 1943, were it not for policies that magnified the power of labor and encouraged the cartelization of industries. These policies expressed the New Deal premise that the Depression was caused by excessive competition that first reduced prices and wages and then reduced employment and consumer demand. In a forthcoming paper, Ohanian argues that "much of the depth of the Depression" is explained by Hoover's policy -- a precursor of the New Deal mentality -- of pressuring businesses to keep nominal wages fixed.

Furthermore, Hoover's 1932 increase in the top income tax rate, from 25 percent to 63 percent, was unhelpful. And FDR's hyperkinetic New Deal created uncertainties that paralyzed private-sector decision making. Which sounds familiar.

Bear Stearns? Broker a merger. Lehman Brothers? Death sentence. The $700 billion is for cleaning up toxic assets? Maybe not. Writes Russell Roberts of George Mason University:

"By acting without rhyme or reason, politicians have destroyed the rules of the game. There is no reason to invest, no reason to take risk, no reason to be prudent, no reason to look for buyers if your firm is failing. Everything is up in the air and as a result, the only prudent policy is to wait and see what the government will do next. The frenetic efforts of FDR had the same impact: Net investment was negative through much of the 1930s."

As Will demonstrates, Shlaes's arguments have been verified and validated by history (the Cole/Ohanian paper referenced by Will can be accessed via this post). Especially valuable from the standpoint of the reader is Shlaes's discussion of key moments in New Deal policymaking and the jurisprudence attendant to it, including the Schechter Poultry Case. And of course, Shlaes has been singularly effective in discussing the outlines of her thesis in various interviews and op-eds. In this piece for the Wall Street Journal, published this past September, Shlaes reminds us just how little new there is under the sun:

Police short sales and block them, says Securities and Exchange Commission Chairman Christopher Cox. Fire the SEC chairman, says John McCain. Investigate those short sellers, say state attorneys general. Hold hearings to grill Wall Streeters says Nancy Pelosi. "Fire the whole Trickle-Down, On-Your-Own, Look-the-Other-Way crowd" says Barack Obama, and "get rid of this whole do-nothing approach to our economic problems." The Democratic presidential candidate wants public affirmation of his argument that the whole free-market philosophy of economics has been wrong.

Some of this talk carries an implicit suggestion: Do what I say or we will have another Great Depression. And no wonder: This September feels a lot like autumn 1929.

But there's an important fallacy here. The stock market crash of October 1929 and the Great Depression were not the same thing. What made the depression great was not magnitude but duration -- the fact that unemployment was still 20% 10 years later. In the 1930s, policies like the ones described above did not speed recovery; they impeded it.

Not long after the market crashed to 199 from its 381 high at the end of the summer of 1929, President Herbert Hoover turned on short sellers. Like our SEC, he demanded a curb on short sales. "Bear raids" or "bear parties" were to be stopped; the blame for the crash all belonged to "certain gentlemen."

Then, as now, there was a lengthy discourse on the difference between "normal" short sales and "naked" ones. New York Stock Exchange President Richard Whitney argued that curtailing such sales postponed unavoidable pain -- or even made it greater.

It was wrong, he said, to vilify shorts. "Such a contract to deliver something in the future which a person does not own is common to many types of business," Whitney carefully spelled out in layman's language. "When a builder contracts to build a skyscraper he is literally short of every bit of material." Yet the anti-short and anti-Street mood grew. In a spirit every bit as zealous as Sen. McCain, lawmakers assigned attorney Ferdinand Pecora to lead a commission hunting for wrongdoing on Wall Street.

The ban on short-selling worked about as well back in the day of the Great Depression as it has worked in recent times, of course. And of course, the following is very familiar to us, isn't it?

In 1933 there was a moment when the U.S. really did seem poised for recovery -- the moment of Franklin Roosevelt's inauguration. Confronting the banking crisis, President Roosevelt did what President Bush, Congress and the Treasury are likely to do in coming days: create a mechanism to sort out banks and their holdings, to separate good assets from bad.

Such an office can shorten a crisis -- the Resolution Trust Corporation, created to deal with the 1980s Savings and Loan debacle did. There was nothing necessarily partisan about the process. Hoover's Treasury secretary, Ogden Mills, and Roosevelt's new Treasury secretary, William Woodin, sat together at the task, just as Republicans and Democrats presumably will now. The establishment of the SEC in 1934 likewise set the country up for recovery.

But like today's politicians, Roosevelt also used the downturn as a weapon to trash markets generally. The New Dealers even used the same mocking phrases Mr. Obama does today. The rich might think that wealth trickled down, Roosevelt's speechwriter Sam Rosenman would later note, but "Roosevelt believed that prosperity did not 'trickle' that way."

Read the whole thing, and you will find that the New Dealers' anti-wealth campaign ended disastrously for themselves and for the nation--so much so that they were forced to abandon their utopian domestic policy dreams and turn their attentions instead ot foreign affairs. In the meantime, the New Dealers engaged in policy persecutions and legal prosecutions designed to target and attack advocates for the free market for nothing more than having the temerity to disagree with the New Dealers. The targets of the New Dealers proved to be in the right, of course, but try telling that to the New New Dealers who want to replicate the entire calamitous experiment all over again.

As Shlaes herself puts it in this interview with Nick Gillespie:

One of the important things about the existing argument is that it's all about Keynesianism, about whether government spending can cure the economy when it's ill. Scholars have overlooked the cost of uncertainty in an economy, what we would now call the "unknown unknowns." Both the Hoover and Roo­sevelt administrations (but especially the Roosevelt administration) were so unpredictable. That hurt the economy very much, and when I went back and saw the extent I was astounded. Uncertainty is a factor that I thought needed to be explored. There were lots of people who said, "I will not invest 'til I know what's going to happen."

During the Depression, you heard the phrase "bold, persistent experimentation" all the time. We've been taught that was good. Somebody had to do something, was what we learned. But what I saw was this enormous cost, especially during the second half of the 1930s.

There's a second thing too. I look at the government's action using the lens of public choice theory. Very simply, public choice says that government is no better or worse than a business, it's a competitor. Sometimes I use a crustacean image; The government is like a lobster. It will eat anything, it wants to survive, it will compete with anything, and it can be a cannibal. When you look back at the '30s using the public choice lens, what you discover is the extent to which the Depression wasn't about a virtuous government and bad business people. Rather, it was about people in office competing with the private sector for power. Much of the struggle described in the book literally inhered in the power business: utilities. There's something about power that attracts strong people. And of course the government wins and the private sector loses in the form of the Tennessee Valley Authority, which was created in 1933.

I do not know how many people in high policymaking circles are reading or have read Amity Shlaes book. I certainly doubt that anyone in the incoming Obama Administration has read it. But they should read it. And if they refuse to, we should read it for the purpose of ensuring that we are an informed, engaged and active citizenry--one that can speak out when old policy mistakes are repackaged and the effort is made to sell them to us anew.