"This is the worst economy since the Great Depression." We always hear it. But is it true? What's different? What's the same? What can we learn about the Great Depression so that we can avoid another one?
These are all questions that require serious study, and serious knowledge about economics.
So, we caught up with Dr. Tom Rustici, Professor of Economics at George Mason University, and author of the book, "Lessons from the Great Depression." We asked him to answer 6 important questions.
We'll be rolling out all 6 parts for the next couple weeks. Here's Part One:
We constantly hear that our current economy is the "worst since the Great Depression," however there's rarely a discussion about what the Great Depression was. In a nutshell, can you explain what happened during the Great Depression and the 3 main lessons we can draw from it?
Our current economic situation in no way compares to the magnitude of the Great Depression with respect to the most important macro economic variables. In the Great Depression, for example, national income declined 36%, unemployment reached 25% and approximately 40% of all banks failed between 1929 and 1933. While our current economic crisis is certainly a cause for concern, it is not on the scale of the Great Depression. The Great Depression was an unmitigated catastrophe. Nevertheless, there are many public policy parallels that are eerily reminiscent of the period leading into the Great Depression and it is precisely these counter productive economic policies that Americans need to understand. While the magnitudes may differ, the directions government policies take us are in the similar direction with few exceptions.
For example, in the 1920s, the federal government pursued an active policy of steering U.S. agriculture through an avalanche of subsidies, import protection, special credits, etc. Our farm mortgage sector became heavily indebted and deliberately targeted to the world export market by government policy. Banks in agriculture regions making loans to these farmers absorbed enormous levels of risks and were vulnerable to any adverse exogenous shock. The Smoot-Hawley Tariff in 1930, one of the most protectionist tariffs in world history (average dutiable rates increased from 38% to 60%), was the hard shock that tumbled over these government placed dominoes. This tariff was catastrophic in its effects, because scores of foreign governments retaliated and ceased buying US exports (largely agriculture at this time). The volume of exports declined approximately 65% from 1929 - 1932 and net farm income declined 70%. Thus, these two policies, economic steering and high tariffs wiped out the farm sector of America. The consequence: massive spikes in farm mortgage delinquencies and foreclosures throughout the Midwest and southern United States. Banks in these regions, encouraged to make those loans to those farmers during the 1920s, were now in financial crisis. Thousands of rural farm banks collapsed every year creating an enormous credit and banking crisis of contagion that eventually spread into cities and larger banking structures.
As a note, the same phenomena occurred throughout most of Europe because their governments also pursued roughly the same policies at the same time:
(1) farm subsidies and special protections
(2) economic steering, by sector, through government planning
(3) abnormal bank risk exposure to a central banking system
(4) tariff wars
(5) waves of bank failures and financial crisis
(6) central bank incompetence and eventual abandonment of the international gold standard
(7) large fiscal deficits and tax increases
Government created central banks worldwide had failed in their functions and allowed the fractional reserve financial structure to implode. It is truly amazing the level of "gross incompetence" of central bank leaders at this time. The US money supply collapsed by about 30% from October 1929 to March 1933 because of a severe secondary deflation. The same collapse occurred with the weighted average world monetary aggregate M1 (the top 7 national currencies. Look at what we have here: monetary failure and massive tax increases on imported goods from the tariff wars of Smoot-Hawley.
In addition, in an attempt to balance the budget with tax increases, the 1932 Revenue Act doubled income taxes while in a major recession! To say that bad government policies destroyed much of the US economy is clearly an understatement. Everyone should take note of the truth in supply side economics: tax increases do not necessarily raise government revenues. In fact, they more often than not kill economic activity and the government's ability to collect revenues. Because of these tax increases, tariff revenue and income tax collections dramatically declined and the federal government ran even larger budgetary deficits and as a result expanded the national debt. My treatise, Lessons from the Great Depression, explores these connections and other destructive government policies in much greater detail.
In addition to monetary implosion and an abrupt halt to international trade; President Hoover also pursued an active policy to prop up wage rates with the White House Wage Rate Conferences from 1929 to 1931. The government coerced large private industries to maintain their wage rates even in the face of mounting unemployment. Hoover did this as an extended favor to labor unions. It has been estimated that these artificially high wage floors increased the unemployment rate during this period by approximately 10 percentages points! Franklin Roosevelt would later pursue many of the exact same policies as Hoover, only magnifying them.
During the Great Depression, Roosevelt imposed minimum wages twice, and this caused hundreds of thousands of people to lose their jobs on each occasion (NRA and FLSA). He increased income and corporate taxes on multiple occasions, created entirely new taxes that did not exist before such as Social Security taxes (which reduced the demand for private sector labor). He created legal business cartels to conduct central economic planning (NIRA), and encouraged unions with special privileges to artificially raise wage rates (Wagner Act). Like Hoover, Roosevelt pursed an aggressive government make-work jobs programs (that did not create any new net employment) (WPA). As a result, unemployment stayed at double digit levels throughout the entire Great Depression; while government ran huge budget deficits and accumulated enormous national debt. Any wonder why it was called the "Great Depression" or that it lasted so long?
Our current financial/economic crisis has many similar traits.
First, it is started with a home mortgage crisis. In the late 1970's the Community Reinvestment Act forced banks to lend to unqualified borrowers. Banks absorbed greater risk exposure by lending to people who could not afford their payments. Sound familiar? Just substitute the word "farm" for "home" in the mortgage crisis and you get the picture.
Second, the government sector enterprises, Fannie and Freddie spun off from the FHA, bought nearly a trillion dollars worth of home mortgages on the secondary market. Under pressure from HUD in the 1990s, these GSEs' lowered their credit standards and encouraged "creative financing" with sub-prime instruments. Few policy makers in government seemed to recognize or even care about the dangerous consequences that result from putting millions of people into homes they could not afford. The sum total of this steering, subsidies and government regulatory distortion was extraordinary and non-transparent risk exposure wildly out of proportion with free market standards. Fannie and Freddie repackaged these rotten assets and resold them all over Wall Street exposing the rest of the market to those bad assets and created collateral damage. Sound familiar?
Third, the Federal Reserve also deserves blame here as well since it consistently maintained artificially low interest rates after 2001. In its attempt to prop up the housing market, misguided fed policy disguised and then amplified the actual risk exposure throughout the financial system.
Fourth, the federal government is now wild and reckless with its finances as well. The astronomical budgetary deficits ($1.7 trillion) and exploding national debt can not be defended in any rational economic way. Sound familiar? Buying off a plethora of special interest groups for reelection purposes is now the routine politics that is bankrupting America. Thus, let me go on the record and say it loud and clear: government is responsible for causing the entire financial crisis.
Finally, the proposed solutions of the Obama Administration: higher taxes, more spending, more debt, more regulations, central economic planning and nationalizations, greater restrictions on trade, more favors to unions and higher minimum wage laws, will only make this economic crisis worse. Sound familiar?
The Obama economic policies are modeled after proven failure of central economic planning of the market. Eighty years ago, America tried an aggressive experiment with economic fascism in the Hoover and Roosevelt New Deal policies. The result was the Great Depression! As for me, this is way too close for comfort.
Dr. Thomas C. Rustici is the Freedom Professor of Economics at the Fund for American Studies located at Georgetown University and Assistant Professor of Economics and Undergraduate Coordinator for the Department of Economics at George Mason University.
He received his undergraduate and graduate degrees from George Mason University in both Economics and Public Policy. His areas of specialization are economic theory, economic history and applied public policy.
These are all questions that require serious study, and serious knowledge about economics. So, we caught up with Dr. Tom Rustici, Professor of Economics at George Mason University, and author of the book, "Lessons from the Great Depression." We asked him to answer 6 important questions.
We'll be rolling out all 6 parts for the next couple weeks. Here's Part One:
We constantly hear that our current economy is the "worst since the Great Depression," however there's rarely a discussion about what the Great Depression was. In a nutshell, can you explain what happened during the Great Depression and the 3 main lessons we can draw from it?
Our current economic situation in no way compares to the magnitude of the Great Depression with respect to the most important macro economic variables. In the Great Depression, for example, national income declined 36%, unemployment reached 25% and approximately 40% of all banks failed between 1929 and 1933. While our current economic crisis is certainly a cause for concern, it is not on the scale of the Great Depression. The Great Depression was an unmitigated catastrophe. Nevertheless, there are many public policy parallels that are eerily reminiscent of the period leading into the Great Depression and it is precisely these counter productive economic policies that Americans need to understand. While the magnitudes may differ, the directions government policies take us are in the similar direction with few exceptions.
For example, in the 1920s, the federal government pursued an active policy of steering U.S. agriculture through an avalanche of subsidies, import protection, special credits, etc. Our farm mortgage sector became heavily indebted and deliberately targeted to the world export market by government policy. Banks in agriculture regions making loans to these farmers absorbed enormous levels of risks and were vulnerable to any adverse exogenous shock. The Smoot-Hawley Tariff in 1930, one of the most protectionist tariffs in world history (average dutiable rates increased from 38% to 60%), was the hard shock that tumbled over these government placed dominoes. This tariff was catastrophic in its effects, because scores of foreign governments retaliated and ceased buying US exports (largely agriculture at this time). The volume of exports declined approximately 65% from 1929 - 1932 and net farm income declined 70%. Thus, these two policies, economic steering and high tariffs wiped out the farm sector of America. The consequence: massive spikes in farm mortgage delinquencies and foreclosures throughout the Midwest and southern United States. Banks in these regions, encouraged to make those loans to those farmers during the 1920s, were now in financial crisis. Thousands of rural farm banks collapsed every year creating an enormous credit and banking crisis of contagion that eventually spread into cities and larger banking structures.
As a note, the same phenomena occurred throughout most of Europe because their governments also pursued roughly the same policies at the same time:
(1) farm subsidies and special protections
(2) economic steering, by sector, through government planning
(3) abnormal bank risk exposure to a central banking system
(4) tariff wars
(5) waves of bank failures and financial crisis
(6) central bank incompetence and eventual abandonment of the international gold standard
(7) large fiscal deficits and tax increases
Government created central banks worldwide had failed in their functions and allowed the fractional reserve financial structure to implode. It is truly amazing the level of "gross incompetence" of central bank leaders at this time. The US money supply collapsed by about 30% from October 1929 to March 1933 because of a severe secondary deflation. The same collapse occurred with the weighted average world monetary aggregate M1 (the top 7 national currencies. Look at what we have here: monetary failure and massive tax increases on imported goods from the tariff wars of Smoot-Hawley.
In addition, in an attempt to balance the budget with tax increases, the 1932 Revenue Act doubled income taxes while in a major recession! To say that bad government policies destroyed much of the US economy is clearly an understatement. Everyone should take note of the truth in supply side economics: tax increases do not necessarily raise government revenues. In fact, they more often than not kill economic activity and the government's ability to collect revenues. Because of these tax increases, tariff revenue and income tax collections dramatically declined and the federal government ran even larger budgetary deficits and as a result expanded the national debt. My treatise, Lessons from the Great Depression, explores these connections and other destructive government policies in much greater detail.
In addition to monetary implosion and an abrupt halt to international trade; President Hoover also pursued an active policy to prop up wage rates with the White House Wage Rate Conferences from 1929 to 1931. The government coerced large private industries to maintain their wage rates even in the face of mounting unemployment. Hoover did this as an extended favor to labor unions. It has been estimated that these artificially high wage floors increased the unemployment rate during this period by approximately 10 percentages points! Franklin Roosevelt would later pursue many of the exact same policies as Hoover, only magnifying them. During the Great Depression, Roosevelt imposed minimum wages twice, and this caused hundreds of thousands of people to lose their jobs on each occasion (NRA and FLSA). He increased income and corporate taxes on multiple occasions, created entirely new taxes that did not exist before such as Social Security taxes (which reduced the demand for private sector labor). He created legal business cartels to conduct central economic planning (NIRA), and encouraged unions with special privileges to artificially raise wage rates (Wagner Act). Like Hoover, Roosevelt pursed an aggressive government make-work jobs programs (that did not create any new net employment) (WPA). As a result, unemployment stayed at double digit levels throughout the entire Great Depression; while government ran huge budget deficits and accumulated enormous national debt. Any wonder why it was called the "Great Depression" or that it lasted so long?
Our current financial/economic crisis has many similar traits.
First, it is started with a home mortgage crisis. In the late 1970's the Community Reinvestment Act forced banks to lend to unqualified borrowers. Banks absorbed greater risk exposure by lending to people who could not afford their payments. Sound familiar? Just substitute the word "farm" for "home" in the mortgage crisis and you get the picture. Second, the government sector enterprises, Fannie and Freddie spun off from the FHA, bought nearly a trillion dollars worth of home mortgages on the secondary market. Under pressure from HUD in the 1990s, these GSEs' lowered their credit standards and encouraged "creative financing" with sub-prime instruments. Few policy makers in government seemed to recognize or even care about the dangerous consequences that result from putting millions of people into homes they could not afford. The sum total of this steering, subsidies and government regulatory distortion was extraordinary and non-transparent risk exposure wildly out of proportion with free market standards. Fannie and Freddie repackaged these rotten assets and resold them all over Wall Street exposing the rest of the market to those bad assets and created collateral damage. Sound familiar?
Third, the Federal Reserve also deserves blame here as well since it consistently maintained artificially low interest rates after 2001. In its attempt to prop up the housing market, misguided fed policy disguised and then amplified the actual risk exposure throughout the financial system.
Fourth, the federal government is now wild and reckless with its finances as well. The astronomical budgetary deficits ($1.7 trillion) and exploding national debt can not be defended in any rational economic way. Sound familiar? Buying off a plethora of special interest groups for reelection purposes is now the routine politics that is bankrupting America. Thus, let me go on the record and say it loud and clear: government is responsible for causing the entire financial crisis.
Finally, the proposed solutions of the Obama Administration: higher taxes, more spending, more debt, more regulations, central economic planning and nationalizations, greater restrictions on trade, more favors to unions and higher minimum wage laws, will only make this economic crisis worse. Sound familiar?
The Obama economic policies are modeled after proven failure of central economic planning of the market. Eighty years ago, America tried an aggressive experiment with economic fascism in the Hoover and Roosevelt New Deal policies. The result was the Great Depression! As for me, this is way too close for comfort.
Dr. Thomas C. Rustici is the Freedom Professor of Economics at the Fund for American Studies located at Georgetown University and Assistant Professor of Economics and Undergraduate Coordinator for the Department of Economics at George Mason University.
He received his undergraduate and graduate degrees from George Mason University in both Economics and Public Policy. His areas of specialization are economic theory, economic history and applied public policy.
I can’t imagine a more frivolous comparison than today’s economic situation and that of the Great Depression. You are comparing an on-going situation with a worst case of a historical event. It is like comparing the height of Yao Ming with that of a high school student. This is the worst economy since the Great Depression, but that information isn’t terribly meaningful.
There is little in common between the economy of the Great Depression and today. At that time, we were a young country with vast natural resources and enormous wealth. Today we are an aging population with large debt loads, that has to import commodities with which to survive.
The only thing I can say to your source is Great, we aren’t repeating the mistakes of the past. We are making brand new ones. We are diverting capital away from productive uses to banking which in the best case is a commodity and at worst is simply a hole where foolish taxpayers throw money. So I wouldn’t throw terms like “Gross Incompetence” around so easily.
What is comical about your piece is that you are much closer to a financial meltdown than you realize because the 6’ 6’’ freshman in high school may well one today look down on Yao and call him punk.
I would say we're going to have stagflation before we have a depression, at least at first.
Adam, Your article is somewhat flawed in that it fails to make the case. Your article has sweeping statement, but aren't qualified or supported with statistics.
"First, it is started with a home mortgage crisis. In the late 1970's the Community Reinvestment Act forced banks to lend to unqualified borrowers." First, the law didn't have an impact for 20 years. Why? The same could be said of the HUD pressure in the 90s. Second, why did the rating agencies rate some of this stuff as AAA?
I think that the statement "Under pressure from HUD in the 1990s, these GSEs' lowered their credit standards and encouraged "creative financing" with sub-prime instruments." is simply wrong. I don't believe that the GSEs ever lowered their standards sufficiently to cover sub-prime borrowers, FICOs 580 and less. I think borrowers had to be alt-A or better. If that was lowered it wasn't in the 90s.
Even so, the entire sub-prime mortgage market was about 500 billion. We are at nearly 2 trillion in writedowns. If every sub-prime loan in America went bad, it would account for about 15% of the total bad loan portfolio.
I think most everyone agrees that sub-prime and the securitization process played a part in our problems, but is a serious stretch of credibility to say that it is the primary or even a leading cause of our problems.
I interpret Dr. Rustici's answer, to this part 1 of 6 questionnaire, to say that today's current situation is not yet at the magnitude of the situation of the Great Depression. However, we didn't call it the Great Depression until it had completed its course. Upon reading Dr. Rustici's answer, I understand him to be saying that the course map that was taken by administrations and policy makers leading up to the great depression is similar if not almost parallel to the course map being taken by the current administration now. So this is cause for concern if we want to avoid a depression now. Even I (a person with little secondary education) can figure this out. Even restaurants and department stores will project what they will purchase for the week/month based on what was sold that week/month the year before. We should use this same strategy (to some degree, after weighing all similarities/differences) when dealing with our economic policies. But it doesn't appear to me that this is happening. On the contrary, it would appear to me that the Obama Administration has such admiration of past presidents, that they are dangerously trying to mirror them.
@Brenton Smith
"I can't imagine a more frivolous comparison than today’s economic situation and that of the Great Depression." - I believe Dr. Rustici is comparing the economic variables and public policies that tuned a downturn in the '20s and '30s into the Great Depression with the variable and policies in play today, not claiming that we are in the G.D. II. I find the tone of your comment odd considering that you seem to recognize at the end that Yao may be headed for trouble, which I think is exactly the point of the article. Yao is watching this kid lift the same weights and drink the same milk (or Kool-Aid?) that he did coming up, only now the milk may have HGH in it; should he ignore him until he hits seven feet?
"There is little in common between the economy of the Great Depression and today." - This statement has some truth to it; the economy of 1929-'30s was different in many ways from what "the economy" is today. I'm not sure what your point is, however, because government policies that: distort economic calculation through manipulate of the money supply; create moral hazard and adverse selection through implicit (at least) guarantees of bailouts and insurance without regard to risk; protect politically favored factions at the expense of the general public; increase the State's own unproductive spending whilst simultaneously scaring private entrepreneurs into hoarding and withdrawing from the "legitimate" economy; and outlawing or persecuting those who try to adjust wages or prices to reflect the new reality (not to mention stealing the actual money from the population [gold then] or stealing and redistributing the purchasing power of the mandatory money substitute [Fed. Res. Notes now] - all of these things will destroy an economy whether regardless of a countries age, natural resources, or wealth. To use your simplistic metaphor, Yao Ming is going to dunk on me whether I'm wearing a Cowboy suit or a Brooks Brothers.
"[W]e aren’t repeating the mistakes of the past. We are making brand new ones." - I think it's pretty clear that we (no, make that the wise bureaucrats) are doing a good amount of both- some old, some new, some borrowed, some... Some policies (read: mistakes) of the current administration are eerily similar to what has been tried before. But in the end, the point isn't whether the mistakes are new or not anyway, it's whether the actions ARE mistakes. Though you don't need history to tell you the answer to this question, it doesn't hurt to point out that it does.
Finally, please keep in mind that this is the first answer to six questions, and that maybe all the points haven't been made yet.
Mr. Steele,
You have a lot so let me break my response into parts.
- I believe Dr. Rustici is comparing the economic variables and public policies that tuned a downturn in the '20s and '30s into the Great Depression with the variable and policies in play today, not claiming that we are in the G.D. II. I find the tone of your comment odd considering that you seem to recognize at the end that Yao may be headed for trouble, which I think is exactly the point of the article."
I sensed that Dr. Rustici downplayed the depth of our problems when he said "Our current economic situation in no way compares to the magnitude of the Great Depression with respect to the most important macro economic variables." I think is a faulty reasoning to judge the magnitude of our economic situtation based on the outcomes of Depression : "In the Great Depression, for example, national income declined 36%, unemployment reached 25% and approximately 40% of all banks failed between 1929 and 1933." It is faulty reasoning because the government stepped in to prevent bank failures. It is faulty reasoning because these are historic peaks, and we haven't reached the peak of current problems. It is faulty reasoning because the causes of our circumstances are very different from those of the G.D. Judging our current situation by that of the G.D. is like looking at an orange on a tree and guessing how large it will become based on the size of a grapefruit. Yes both are fruit but they aren't the same.
Mr Steele part II,
I am not comfortable with the broad brush, pop-economics applied here.
"First, it is started with a home mortgage crisis. In the late 1970's the Community Reinvestment Act forced banks to lend to unqualified borrowers. Banks absorbed greater risk exposure by lending to people who could not afford their payments. Sound familiar? Just substitute the word "farm" for "home" in the mortgage crisis and you get the picture"
It isn't familiar or even close to familiar. The article needs to explain why the CRA was around for 20 years without causing any problems. Did the CRA encourage rating agencies to apply a AAA rating to some of this junk.
I happened to work in credit decisioning for a mortgage company in 1997. At the time, the GSEs would not buy our sub-prime loans for any reason. I think the minimum cut was 620. So the statement "Under pressure from HUD in the 1990s, these GSEs' lowered their credit standards and encouraged "creative financing" with sub-prime instruments." is either wrong or misleading based on my experience.
I am not sure what is his work and what is Adam's work, but someone feels comfortable blaming our current problems on the sub-prime lending practices. If he is, he hasn't looked at the data on sub-prime loans. All of them could go bad, and it is about 1/8th of the total bad loans.
Mr. Steele, Finally
- I think it's pretty clear that we (no, make that the wise bureaucrats) are doing a good amount of both- some old, some new, some borrowed, some... Some policies (read: mistakes) of the current administration are eerily similar to what has been tried before. But in the end, the point isn't whether the mistakes are new or not anyway, it's whether the actions ARE mistakes.
I just found the comment "It is truly amazing the level of "gross incompetence" of central bank leaders at this time." fairly amazing considering what we are doing. We are diverting capital away from productive businesses and into banking, which is a commodity, which are by definition bad businesses. In the midst of a capital crisis we are pulling capital out of the markets and forcing into the hands of poor capital managers.
Comically enough, capital doesn't encourage banks to lend. It simply makes holding foreclosures less costly. So the TARP in some respects simply encourages banks to foreclosure on homes and hold them.
Thanks, Adam, for presenting the 6 part series briefly reviewing the Great Depression and comparing it to the current Great Recession.
I find it rather profound that so many are so lacking in a greater understanding of the past and current financial situations . . . not knowing that they know not . . . yet, so quick to criticize; giving the appearance of lacking the desire and or ability to perform further due diligence to understand the Great Depression and the Great Recession . . . all the more reason to appreciate George Santayana's comment that 'those who cannot remember the past are condemned to repeat it'.
And to think it possible, believable or realistic that the US Government, to this very day, has the best credit rating available of AAA from Moodys . . . TRIPLE A ? !