Depression Fear Mongers Obscure the True Concerns: Amity Shlaes
This year is supposed to be like 1932. That’s what you would believe after reading commentators who compare current patterns in the Dow Jones Industrial Average to those at the end of Herbert Hoover’s presidency.
To focus on these stock patterns is to be like weather forecasters who talk about the heat index or wind chill. They are gilding the statistical lily. The ungilded reality: today the Dow is down about 30 percent from its 2007 high, nowhere near its decline of 89 percent between September 1929 and July 1932. Today, joblessness in the U.S. is a bit less than 10 percent; in 1932 it was 25 percent.
While these differences set today’s slump apart from the Great Depression, there are other issues that may be holding back a recovery.
Instability in the international currency arrangement is the first one. Today doubt that the euro will survive is affecting the dollar and the stock market. The issue is whether Europe will make the fiscal repairs necessary to preclude an otherwise inevitable collapse of the European currency. It isn’t clear whether or when the euro can be restructured. This, as we’ve seen recently, can hurt U.S. stocks.
In the early 1930s an unsustainable monetary construct likewise jeopardized recovery. In that instance, the teetering house wasn’t the euro but the international gold standard. Depositors concerned that the whole arrangement would break apart were pulling gold out of U.K. banks at a rate the country couldn’t afford. When the U.K. did go off gold in September 1931, the investor panic migrated to the U.S., where depositors also started withdrawing gold. Another wave of bank failures ensued.
The second factor is trade. Today most of us doze off when the topic comes up, whether the issue is a bilateral free-trade agreement with a Latin American country or the lack of progress in the Doha Round of trade talks.
This lack of concern resembles many Americans’ disregard for the effects of the Smoot-Hawley Tariff Act, signed into law by Hoover in June 1930. Republicans told themselves that the tariff couldn’t hurt much since trade was a small part of the U.S. economy at that point.
But that view overlooked the signal that markets were sending. Long ago Jude Wanniski noticed that the progress of the Smoot-Hawley legislation tracked declines in the stock market. More recently Scott Sumner, a professor of economics at Bentley University in Waltham, Massachusetts, has argued that the tariff reduced investment all over the world, and therefore produced deflation.
New Tax Trends
The third factor is taxes, perhaps the most important 1932 parallel. Today, U.S. taxes are set to march higher. From the income tax to the dividend tax, all will rise in the next year or so. Also a challenge, albeit less discussed, are the increases in state and municipal taxes in the name of reducing shortfalls in public coffers. This change represents a reversal from the tax-lowering trend of the first part of the decade.
In 1932, a similar reversal occurred. Then-Treasury Secretary Andrew Mellon presided over an enormous tax increase. The top rate on personal income taxes rose to 63 percent from 25 percent. Add in new levies on telegraph and telephone use and, in an obscenely bad error for a recession, a tax on checks. In addition, corporate taxes moved up, as did levies on tobacco. Mellon, who had earlier personally crafted a series of rate cuts, consoled himself about this switch by calling it a temporary emergency measure. The revenue was a disappointment and the economy didn’t recover.
Fourth is the subtle issue of employee pay. Today President Barack Obama is applying upward pressure on compensation where he can -- in federal contracts, for example. The president is being egged on by various academics. This week Christopher Edley, dean of the University of California-Berkeley’s Boalt Hall School of Law, published an article in the Los Angeles Times titled “The Economic Power of Obama’s Pen,” urging the president to sign an executive order encouraging federal contractors to pay the so-called living wage, government code for wages higher than it might otherwise have paid.
Hoover likewise advocated keeping wages high during periods of economic decline. Even while still Commerce secretary, Hoover argued that worker spending was key to fostering recovery. Shortly after the 1929 crash, the new president hauled corporate heads to Washington and exhorted them to keep wages as high as they could. Henry Ford served as cheerleader for this policy, telling the press as he exited the White House, “Wages must not come down.” In short, Hoover and Ford were Keynesians before John Maynard Keynes.
In addition, Hoover signed the Davis-Bacon Act, which was passed in 1931 and requires that federal contractors pay the “prevailing wage,” government-speak for relatively high wages. As labor scholars Lowell Gallaway, Lee Ohanian and Harold Cole have shown, the wage pressure increased unemployment. Rather than disobey Washington, not to mention Ford, companies hired fewer people, or postponed rehiring.
The takeaway from 1932? Resetting the euro’s criteria for existence and member countries’ obligations when it comes to bailing out one another should happen sooner rather than later. Democrats and the president should ignore unions and cut trade deals with Latin America. John F. Kennedy, a Democrat, supported tax cuts. Obama can too, or at least block rate increases. The president might also want to suppress his lawyer- Keynesian reflexes and reconsider policy when it comes to wages. But the 1932 crisis talk actually impedes such consideration.
(Amity Shlaes, senior fellow in economic history at the Council on Foreign Relations, is a Bloomberg News columnist. The opinions expressed are her own.)
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