The New Deal did not end the Great Depression. This statement will come as no shock to Freeman readers, but it will to the many people who have never encountered it before. Now people are encountering it—in newspaper columns and news-talk shows.
Why, after years of being taught that Franklin Roosevelt’s economic intervention saved the country from disaster, is the general public now being told—by FDR fans, not critics—that this is not the case?
It’s the Rooseveltians’ way of helping President Obama get over any fear he has of deficit spending. Paul Krugman, the newest Nobel laureate, a Keynesian, and a New York Times columnist, is explicit about this. “[H]ow much guidance does the Roosevelt era really offer for today’s world?” Krugman asks. “The answer is, a lot. But Barack Obama should learn from F.D.R.’s failures as well as from his achievements: the truth is that the New Deal wasn’t as successful in the short run as it was in the long run. And the reason for F.D.R.’s limited short-run success, which almost undid his whole program, was the fact that his economic policies were too cautious.”
By “too cautious,” Krugman means that FDR’s deficits were too small. Roosevelt ran deficits (except for one year), but they were about the same size as those run by his predecessor, Herbert Hoover. Roosevelt’s biggest deficit, in 1936, was “only” 4.4 percent of GDP, Jim Powell points out in FDR’s Folly. Both Hoover and Roosevelt were big spenders—FDR doubled spending by 1940—but they were also big taxers, which kept the deficit from growing. This is confirmed by University of Arizona economist Price Fishback, who wrote, “Once we take into account the taxation during the 1930’s, we can see that the budget deficits of the 1930’s and one balanced budget were tiny relative to the size of the problem. . . .”
Roosevelt was quite a tax enthusiast. He levied or raised taxes on liquor, tobacco, gasoline, corporate dividends, estates, incomes (top rate 75 percent versus Hoover’s 63), “excess” profits, and undistributed profits. (The last tax was repealed in 1939.) And then there was the payroll tax that came in with Social Security. All in all, the New Deal more than tripled the tax burden from 1933 to 1940 raising it from $1.6 billion to $5.3 billion. Serious deficit-spenders don’t raise taxes. But Roosevelt did. Is it any wonder that net investment dropped $3.1 billion during the decade or that unemployment was about as high in 1939 as it was in 1932?
This raises the question of whether big-time deficit spending would have ended the Depression. Krugman and others think so. But how could it have done so? Deficits are financed either by borrowing or by creating money out of nothing. When the government borrows money, that’s money no one else can borrow and invest. Where’s the gain? Moreover, the money is put to purposes selected by politicians, not entrepreneurs trying to please consumers.
When the government creates money, three things happen. First, the new money lowers interest rates below the level justified by society’s time preference; that creates perverse incentives to invest in longer-term projects far from the consumer-goods level. Second, the money changes relative prices (rather than raising prices evenly) because particular economic interests get it earlier than everyone else. Third, prices later rise generally, reducing everyone’s purchasing power. The result is a distorted structure of production and a boom that is unsustainable because it is based not on real savings but on fiat money. When the inflation stops, the bust follows.
Since the New Deal didn’t end the Depression and a New Deal on steroids wouldn’t have done so, President Obama should pay no heed to Krugman and his Keynesian economic advisers. The way to wake up the economy is reduce the total government burden on producers and consumers by, among other things, slashing spending, taxes, and borrowing.
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Years ago economist Bruce Yandle identified a phenomenon that accounts for a good deal of government intervention. Tacit alliances form between those who seek a particular intervention for moralistic reasons and those who seek it for financial advantage. Since Yandle first noticed such an alliance in efforts to outlaw Sunday liquor sales, he dubbed this phenomenon “Bootleggers and Baptists.” In this issue he applies this principle to the “affordable housing” policies that have pushed the economy into turmoil.
Government deserves the lion’s share of blame for this turmoil, but private market actors don’t escape all culpability. As Max Borders points out, many cocksure investors let themselves be blindsided by a black swan.
Is it too much of a stretch to call this the Age of the Bailout? You may not think so after reading Lawrence White’s catalog of federal largess and its likely consequences.
Of course all these bailouts are necessary because the rescued firms are “too big to fail.” Is there a more ridiculous doctrine? Michael Heberling thinks not.
Commentators frantically trying to blame the free market for the economic mess think they have found a culprit: the unregulated market for derivatives. Are they right? Robert Murphy takes up that question.
Most free-market advocates attribute the infamous housing bubble at least in part to Alan Greenspan’s easy-credit policies at the Federal Reserve. But not everyone. David Henderson and Jeffrey Rogers Hummel offer a dissenting view.
Here’s what our columnists have come up with this issue: Lawrence Reed provides a timely reminder of FEE’s credo. Thomas Szasz demonstrates that psychiatry isn’t medicine but rather the medicalization of conflict. Stephen Davies counsels against auto bailouts. John Stossel warns against inflation. David Henderson traces the unintended consequences of fuel-efficiency standards. And Gerald O’Driscoll, reading that Alan Greenspan claimed to be shocked by risky lending, replies, “It Just Ain’t So!”
Books occupying our reviewers deal with the imperial presidency, free trade, the rich, and energy independence.