The belief that we are headed for another depression is being tossed around, so I wanted to help clear up some questions about the current state and direction of the economy. Let me put a few fears aside, but then bring up a few that you may not be aware.
How do Depressions Happen?
First, Depressions don’t just happen. They are not a random and inevitable byproduct of a free market. In fact, the opposite is true. As I have written before, the free market is simply a system where individuals, not government, make personal financial decisions that are often extremely complex, based on what makes the best sense to them. When the government interferes, they are telling individuals that they are wrong and that a few people are smart enough to make decisions for society as a whole. Because each human life is so complex, a small group of government planners will make so many errors that the more they try to fix the economy the more havoc they will cause.
A Quick History Lesson
In 1929, the stock market plunged in widespread panic. This was not unique, as it has happened many times before and afterwards throughout the years. In 1987, the stock market dropped even more precipitously than in 1929 and the economy kept on humming for several more years. In fact, the market recovered so dramatically that the Dow Jones Industrial Average actually recorded a gain for the year.
What actually happened was a collision of new socialist ideas and the hubris of Presidents Herbert Hoover and Franklin Roosevelt. In 2001, we saw the stock market drop and the economy slow after the attacks on September 11th. Within days, the Federal Reserve lowered interest rates to help the economy get back on its feet. After the crash in 1929, the Federal Reserve decided to stop following the rules of the Gold Standard and increased interest rates. The Fed poured cold water on an already cooling economy.
Herbert Hoover knew what always followed a financial panic in America: companies would slash their worker’s wages so that they could stay in business. Hoover, in his infinite wisdom, decided that this was bad and convinced thousands of companies not to lower wages exchanging union promises to not strike. Lo and behold, hundreds of companies started to go out of business because they couldn’t afford the promises. The mistakes by President Hoover continued as he and his cabinet tried to “fix” the economy.
As the economic malaise dragged on the American people soured on Capitalism. Roosevelt easily won election in 1932. Unfortunately, instead of seeing Hoover as fool hardy, he saw Hoover’s error as not going nearly far enough. Roosevelt’s government attempted one fruitless attempt after another. Not until Pearl Harbor did President Roosevelt’s experiments end and the country’s focus moved to the war. Afterwards, President Truman was not nearly as interested in market interference as Roosevelt, and America’s economy quickly rebounded.
Are Our Leaders Repeating History?
Ben Bernanke, the current President of the Federal Reserve had this to say to the famously free market Milton Friedman on his 90th birthday on the role of the Federal Reserve in starting the Great Depression:
“You're right, we did it. We're very sorry. But thanks to you, we won't do it again.”
Is he right that they will not do it again? I believe so. I am not a fan of the Federal Reserve or much of what they do, but I do think that they will likely avoid the horrible mistakes that occurred during the Great Depression. Mr. Bernanke is renowned as an expert on the Great Depression and his admissions on the numerous mistakes that the government made encourages me to believe that we will not make the same mistakes.
As a number of other economic writers have recently noted in various articles, there is also no brewing intellectual movement endorsing the socialist ideas rampant amongst the intelligentsia during the late 1920’s. This too gives me comfort that history will not repeat itself.
However, what happened in a few short years after the onset of the Depression that gives me concern today was that millions of Americans, who had more faith in the free market than understanding, lose the faith in tough economic times. Unfortunately, in our own time, we have seen a significant bump in support for solutions that ignore free choices and responsibility by individuals.
Many of our leaders exhibited the same vices of Hoover and Roosevelt when it came to the recent $700 billion bailout, but not all. While President Bush admitted that the bailout went against his free market instincts, few in the Democratic Party, nor their candidate Senator Obama, took pause at such a gargantuan interference. Their concern was not whether the government should interfere in the market, only the distribution of the benefits.
It is not repeating old mistakes that concern me so much, as it is committing new ones. There are many people in power with a friendly disposition towards market interference. Unemployment is heading upwards and inflation continues to be a problem. Will recent decisions make these situations worse? Will Americans lose just enough faith in the free market to vote people into power whose first instinct is to interfere in the market and expose us to the risk of a much deeper recession? Will our leaders, guided by fear, succumb to ill-conceived economic ideas? I hope not.
Another Depression? Not yet.