Friday, March 28, 2014

Saving to prosperity

David Stockman gave an amazing talk to the Committee for the Republic, presenting an alternative interpretation of the Great Depression:

The Great Depression was born in the extraordinary but unsustainable boom of 1914-1929 that was, in turn, an artificial and bloated project of the warfare and central banking branches of the state, not the free market.

Nominal GDP, which had been deformed and bloated to $103 billion by 1929, contracted massively, dropping to only $56 billion by 1933. Crucially, the overwhelming portion of this unprecedented contraction was in exports, inventories, fixed plant and durable goods—the very sectors that had been artificially hyped. These components declined by $33 billion during the four-year contraction and accounted for fully 70 percent of the entire drop in nominal GDP.

So there was no mysterious loss of that Keynesian economic ether called “aggregate demand”, but only the inevitable shrinkage of a state-induced boom. It was not the depression bottom of 1933 that was too low, but the wartime debt and speculation bloated peak in 1929 that had been unsustainably too high.

He claims the Great Depression was over by 1932, but President Roosevelt revived it in 1933.

Hoover’s bitter-end fidelity to fiscal orthodoxy, as embodied in his infamous balanced budget of June 1932, got blamed for prolonging the depression. Yet, as I have demonstrated in the chapter of my book called New Deal Myths of Recovery, the Great Depression was already over by early summer 1932.

At that point, powerful natural forces of capitalist regeneration had come to the fore. Thus, during the six month leading up to the November 1932 election, freight loadings rose by 20 percent, industrial production by 21 percent, construction contract awards gained 30 percent, unemployment dropped by nearly one million, wholesale prices rebounded by 20 percent and the battered stock market was up by 40 percent.

So Hoover’s fiscal policies were blackened not by the facts of the day, but by the subsequent ukase of the Keynesian professoriat. Indeed, the “Hoover recovery” would be celebrated in the history books even today if it had not been interrupted in the winter of 1932-1933 by a faux “banking crisis” which was entirely the doing of President-elect Roosevelt and the loose-talking economic statist at the core of his transition team, especially Columbia professors Moley and Tugwell.

The truth of the so-called banking crisis is that the artificial economic boom of 1914-1929 had generated a drastic proliferation of banks in the farm country and in the booming new industrial centers like Chicago, Detroit, Youngstown and Toledo, along with vast amounts of poorly underwritten debt on real estate and businesses.

When the bubble burst in 1929, the financial system experienced the time-honored capitalist cure—a sweeping liquidation of bad debts and under-capitalized banks. Not only was this an unavoidable and healthy purge of economic rot, but also reflected the fact that the legions of banks which failed were flat-out insolvent and should have been closed.

Indeed, 10,000 of the 12,000 banks shuttered during the years before 1933 were tiny rural banks located in communities of less than 2,500. Most had been chartered with trivial amounts of capital under lax state banking laws, and amounted to get-rich-quick schemes which proliferated during the export boom.

Indeed, a single startling statistic puts paid to the whole New Deal mythology that FDR rescued the banking system after a veritable heart attack: to wit, losses at failed US banks during the entire 12-year period ending in 1932 amounted to only 2-3 percent of deposits. There never was a sweeping contagion of failure in the banking system.


During the middle 1930s, the natural rebound of the nation’s capitalist economy continued where the Hoover Recovery left off—notwithstanding the New Deal headwinds. Yet the evidence that FDR’s policies retarded recovery screams out of the last year of pre-war data for 1939: GDP at $90 billion was still 12 percent below 1929, while manufacturing value added was off by 20 percent and business investment by 40 percent.

If it wasn’t New Deal/World War II stimulus that ended the depression, what was it?

The national debt did soar from less than 50 percent of GDP, notwithstanding the chronic New Deal deficits, to nearly 120 percent at the 1945 peak. But this was not your Krugman’s debt ratio—or proof that the recent surge to $17 trillion of national debt has been done before and had been proven harmless.

Instead, the 1945 ratio was an artifact of a command and control war economy which had banished civilian goods including new cars, houses and most consumer durables, and tightly rationed everything else including sugar, butter, meat, tires, shoes, shirts, bicycles, peanut brittle and candied yams.

With retail shelves empty the household savings rate soared from 4 percent in 1938-1939 to an astounding 35 percent of disposable income by the end of the war.

Consequently, the Keynesians have never acknowledged the single most salient statistic about the war debt: namely, that the debt burden actually fell during the war, with the ratio of total credit market debt to GDP declining from 210 percent in 1938 to 190 percent at the 1945 peak!

This obviously happened because household and business debt was virtually eliminated by the wartime savings spree, dropping from 150 percent of GDP to barely 60 percent and thereby making headroom for the temporary surge of public debt.

In short, the nation did not borrow its way to victory via a Keynesian miracle. Measured GDP did rise smartly because half of it was non-recurring war expenditure. But even then, the truth is that the American economy “regimented” and “saved” its way through the war.

So, a decrease in consumption returned the economy to overall good health, and put it in a better position to deal with inevitable cuts in military spending. The post-war “recession” saw GDP fall 12.7 percent, but non-farm unemployment peaked at a disarming 5.2 percent in 1946, according to the National Bureau of Economic Research.

Reflecting an increasingly consumptive economy, the personal savings rate fell from 12 percent in 1981 to 2 percent before the 2008 crash. Household debt grew by an average of 10 percent annually from 2003 to 2007, supported by the housing bubble. Since then, a paring back of non-federal government spending has more than offset the fantastic ballooning of the federal budget. Rex Nutting of Marketwatch reported on this in June 2012:

As a share of the economy, debt has plunged as a consequence of rapid deleveraging by families, banks, nonfinancial businesses, and state and local governments. The ratio of total debt to gross domestic product has fallen from 3.73 times GDP to 3.36 times.


In the U.S., household debt has now fallen to 84% of GDP from a peak of 98%. Nonfinancial corporate debt has fallen to 77% from a peak of 83%. Financial sector debt has plunged from 123% of GDP to 89%. Public debt has risen to 89% from 56%.

Including the rest of 2012 and 2013, household debt has shrunk by an average of 1 percent annually since the recession, according to the Federal Reserve. It’s a repeat of the ’40s. It may not be wartime, but we are regimenting again.

Because of the high savings rate, Keynesian “stimuli” have trouble circulating through the economy. The money accumulates in sinks, usually the accounts of government contractors and large banks. Despite record low interest rates the last 6 years and Federal Reserve injections of $3 trillion worth of digital paper into the economy, inflation has been historically low, averaging 1.75 percent, and coming in even lower at 1.2 percent last January.

This is well below the Fed’s long-term goal of 2 percent inflation; however, Fed chair Janet Yellen knows intuitively she cannot prime the pump forever. She is tapering quantitative easing, and interest rate hikes will follow later.

Contrary to recent Fed thinking, when monetary policy tightens is when inflation will hit. Just as loose credit buoyed housing, loose monetary policy buoys equities, fueling stocks’ historic 5-year bull market. Since bottoming out in March 2009, the NASDAQ composite index has more than tripled. Minus an inflow of funny money, the equities bubble will burst and capital will come flooding out of the stock market into the real economy.

Still, the deflationary pressure of savings, spurred by higher interest rates, will keep inflation in check.

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