No, I am not getting ready to join the
ranks of those clever economists and financial prognosticators who
periodically cop a book deal by peddling a hyped-up title that feeds
our perverse appetite for scary scenarios—Financial Armageddon, Get Rich While All your Neighbors Go Broke, How To Prosper From the End of the World As We Know It.
I’m sure I’m passing up a lucrative opportunity. In fact, given the
jarring financial convulsions in recent months and the potential for
further damage, the timing could hardly be better for the publication
of financial doomsday books. They’ll be coming soon to a bookstore near
Are we embarking on our country’s second Great
Depression? Possibly. There is way too much debt out there—debt that
has resulted in the mispricing of key assets, such as
houses—unproductive debt that must be dramatically reduced if future
economic growth is to be vigorous. Most ominously, there are
significant parallels to 1929.
The Great Depression started with the massive
stock market crash of 1929. It was greatly aggravated by President
Hoover’s panicky deficit spending, adoption of protectionist tariffs
(Smoot-Hawley Act of 1930), and an enormous tax increase in 1932.
Today, there is the potential for an even more devastating financial
collapse—that of the trillions of dollars of essentially worthless
derivatives that I wrote about on December 27 (“Anatomy of a Financial
Crisis: Part I & Part II”).
The current stimulus plan shows that both parties still believe that a
flood of red ink in Washington is the proper response to economic
downturns. Protectionist sentiment in Congress is riding high and
opportunistic politicians are itchy to blame foreigners for our
economic woes. If the Bush tax cuts are not made permanent, then their
expiration in 2010 will result in a gargantuan tax increase.
Do these parallels mean that we are doomed to
repeat the Great Depression? Not at all. It may or may not be possible
for the king’s horses and all the king’s men to prevent a
derivative-based financial debacle from occurring. If such an event
happens, we will have to go through massive financial adjustments and
considerable economic distress. However, a financial wipeout wouldn’t
compel us to resort to protectionism, increase the tax burden, or have
Uncle Sam go on another disruptive spending spree.
Even if we sadly repeat the blunders of the
Hoover administration, they still wouldn’t be sufficient to sentence us
to a 12-year depression like the one that spanned 1929-1941. That could
only happen if we then went on to repeat Roosevelt’s many policies
errors, too. There is nothing inevitable about another depression. We
have a simple choice: We can repeat the errors of the past or we can
The most important fact to understand about
economic depressions is that they are not natural phenomena of market
economies, but the product of repeated, ongoing government interference
with markets. The defenders of FDR (who, though they will deny it, are
also defenders of Hoover, because economic illiteracy is bipartisan and
both presidents embarked on parallel paths of massive government
interventions) claim that the Great Depression was caused by market
failures. What nonsense! This is like blaming someone for dying if you
shoot him. The tragedy of the 1930s is that markets weren’t allowed to
work. First Hoover, then FDR, caused massive economic dislocations
through repeated federal interventions. The Great Depression was a case
of government failure (a distant cousin of the decades-long depression
in the centrally planned Soviet economy), not market failure.
This is not to claim that free markets don’t
experience bumps in the road. Markets bring supply into balance with
demand through the language of prices. Any healthy, growing economy
will have bankruptcies, shifting employment patterns, etc., but in a
market economy, freely set prices quickly balance supply and demand.
Even during our country’s pre-Great Depression periods of wrenching
economic readjustments, the process generally was over in a year or
two. Only government interference with markets can prolong the
necessary corrective process and make it last 12 years. (Well, maybe an
asteroid hitting the earth would rock us back on our heels for that
long, too, but if you ask me whether the odds are greater for an
asteroid to hit the earth or for government to screw up, I’ll bet on
government. There’s something very persistent about human error.)
The main lesson we need to learn from the Great
Depression is that government programs prolong rather than correct
depressions. Government couldn’t spend our way out of economic problems
in the 1930s, and it can’t do it today. The only way we will have
another great depression is if we cling to the 1930s ideology of
trusting government more than free markets for our economic well-being.
It would be an unnecessary and entirely avoidable tragedy to make the
same policy mistakes again. The good news is that, like Scrooge on
Christmas Eve, we still have a chance to recognize our past mistakes,
change our course, and spare ourselves a grim and unhappy fate.