Times are not good, but pundits should really stop talking about us being in another Great Depression. Sure there is a banking crisis on, but they have happened before. Sure the government is doing silly things like bailing out industries and passing ineffectual “stimulus” packages. However, the government reaction to the current crisis is by no means comparable to the combined stupidity of the Hoover and Roosevelt Administrations. When the Great Depression hit, the government sprung into action (especially Hoover who is often wrongly labeled as doing nothing). Unfortunately, the government proceeded to take the worst possible actions. Below is a list of three broad categories of actions taken, which, if they did not make the Depression worse, certainly prolonged it:
1.Higher Taxes: The Revenue Act of 1932 raised taxes across the board with the top rate going from 25 to 63 percent. The law also doubled the estate tax and raised the corporate rate to 13.75 percent. Subsequent revenue acts in 1935, 1936, and 1940 added further increases with the top rate eventually reaching 79 percent. Although corporate taxes only rose to 22.1 percent, the 1936 Act provided for the taxation of undistributed profits (those not paid out in dividends). Furthermore, the 1940 Revenue Act created a 50 percent top rate on “excess” corporate profits. Despite these draconian tax measures, the hikes produced little in the way additional government revenue, nor did the nation achieve any significant gains in the way of decreasing inequality.
2.Higher Tariffs: Passed in 1930, the Smoot-Hawley Tariff raised tariffs on 20,000 items to record levels. Foreign governments retaliated with tariff hikes of their own, and world trade contracted an astronomical 66 percent between 1929 and 1934. Both U.S. imports and exports declined dramatically, and the breakdown of international comparative advantage took a heavy toll on the world’s total economic activity.
3.Tight Credit: Although it is difficult to characterize the government’s confused monetary policy in the 1930s in a single paragraph, the end result was that the money supply contracted by about one-third, which led to deflation. Furthermore, as government had pressured businesses not to cut wages, deflationary pressure on wages manifested itself in massive unemployment. Rather than easing rates, the Federal Reserve raised interest rates, while insisting that banks hold higher reserves. Those banks that did not fail (and prohibitions on branching meant that thousands did) ceased lending.
With the disasters above in mind, let us take a look at what is being done now:
1.No (or fewer) Higher Taxes: Congress has apparently lost its stomach for higher taxes, and talk has shifted away from raising taxes and towards postponing any pending rollbacks of the Bush tax cuts. Even if taxes were to be “unlowered,” then the top rate would revert to the old rate of 39.6 percent, which, while steep, ain’t 80 percent. At 35 percent, American corporate taxes are already some of the highest in the world, so there is not much room for them to go higher. Furthermore, the stock market slump has promptly silenced most calls for an increase in the 15 percent capital gains tax, which would—at worst—revert to the old rate of 20 percent in 2011.
2.No Higher Tariffs: While valuable free trade deals with South Korea and Columbia are on hold, no Smoot-Hawley-like tariffs appear in the works. In fact, the one solid thing to come out of the recent G-20 Summit was a pledge by member nations not to raise tariffs. Even if nations do begin to raise tariffs, unlike in the 1930s, the World Trade Organization (WTO) exists to moderate disputes and hopefully prevent the catastrophic trade wars of the 1930s. U.S. tariffs are low and will likely remain that way. Despite the tough anti-trade rhetoric of the presidential campaign, it is likely just rhetoric. When a campaign pledge to renegotiate NAFTA caused concern in Canada, Ottawa was essentially told privately that it really was not serious.
3.Ample Credit: Rightly or wrongly, the Federal Reserve and the Treasury have provided ample liquidity to financial institutions. Despite cries that the credit market has “seized up,” inter-bank lending remains high. Banks are willing to extend credit to those with good credit ratings—just not as much to those who should not be lent money in the first place. Although the current crisis springs from many causes, a major implication is that the repackaging and backing of mortgages created an unnaturally high mirage of widespread credit worthiness, which (considering that these mortgages were backed by valuable assets—as in homes) was perhaps not altogether unreasonable. Yes, many banks are in trouble, but the credit will be there to stave off most collapses, while drastic deflation (despite huge drops in demand) is unlikely to materialize.
Of course, there is much to write about this subject, which is complicated and even not fully understood. However recessions happen. They can be sharp and quick or long and shallow. The deciding factor is often government reaction. The Great Depression did not just happen, poor policies took a recession and stretched it out for 11 to 20 years (depending on who you talk to). So while we complain about the bailouts, it is important to remember that much dumber things have been tried in the past. The current economic slump maybe painful, but it will not be another Great Depression. Markets are tremendously creative and resilient forces. They will always fix themselves—as long as they are allowed to.
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