Must We Suffer The Obama Depression?

The 2008 election will inspire books and articles for decades to come, and understandably so.  We have never before seen an election composed of so many twists and turns, so many unexpected surprises and overthrows, but as Bill Clinton discovered so long ago, the fundamental force behind Obama's triumphant victory boils down to the simple phrase: "It's the Economy, stupid!"

Yes, it surely is.  While America is the most religious developed nation, by far, its religiosity is a mere fraction of what it was back when Reagan was elected.  Americans care about moral issues, true; but far fewer, and much less intensely, than in years past.  The number one theme in the voting booth is looking out for Number One, and on that score, Mr. Obama's promises of government largess all 'round brought him victory.

The problem with government subsides of everyone and everything, as John McCain failed to explain, is that government has no money of its own.  Everything government spends comes out of your pocket if you pay taxes.

Even when the government spends freshly minted new dollars hot off the press, it's still taking value away from you by causing inflation and making the dollars you have worth less tomorrow than they were yesterday.  At a time when we are experiencing "the worst financial crisis since the Great Depression," one would hope that we might have a leader with at least a passing sympathy for that simple fact.  Alas, we don't.

The Business Cycle

This is all the more disturbing when you realize that large-scale depressions do not just "happen."  Contrary to the mainstream media, they are not the natural result of excessive cutthroat capitalism.  They certainly aren't caused by a failure of government to regulate.

There have always been booms and busts since long before governments understood enough economics to even attempt to regulate them, but financial busts tended to be relatively short in the days of laissez faire - so much so that they were known as "Panics."  The economic history of the nineteenth century is packed full of "Panics", sandwiched in between great booms.

This is what was known as the "business cycle", and for many years it was thought to be an inescapable natural law.  Then various economists, among them John Maynard Keynes, argued that governments can and should use their power to try to "smooth out" the business cycle so as to moderate both the extreme highs and the extreme lows.

What's not commonly understood is that this actually worked.  In fact, it still does work.  It didn't work in the 1930s for reasons that we'll get to in a moment, but since World War II, although we have still had booms and busts, they have not remotely approached the havoc of the past - certainly not of the Great Depression, but not even of the many Panics of the 1800s.  No, the economy isn't a smoothly even highway, but it has been far, far less volatile than before the invention of the Federal Reserve.

That brings us to the one thing that government, and only government, can do to mitigate the harm of a panic.

Liquidity and the Fed

As its name would imply, capitalism runs on capital.  For capitalism to work - not just to work well, but to work at all - capital has to be available for investments both large and small, both short-term and long.

The scarcer, more expensive, and less readily available capital is, the less investment will take place - and the fewer jobs, the less salaries to spend, and the weaker the economy.  Normally, capital flows smoothly from savers into banks, from banks to borrowers, from the rich into stockmarkets and thence into businesses of all sizes and types.

Every now and again, though, for reasons more related to human psychology than to market fundamentals, a financial panic is triggered.  This can happen when a bubble bursts, though there are other causes; we're experiencing a panic right now caused by two burst bubbles in a row.  Investors become frightened about the value of their investments - not merely that they are going down, but that they have no idea how far they may go.  Many investors attempt to pull their money out of the market, driving prices lower, and so on in a vicious cycle.

Eventually, you reach a point where no one wants to invest their money in anything at all more risky than a mattress, or possibly government bonds.

We have come dangerously close to this situation in recent weeks, because nobody knows who will fail next.  Lehman Bros, WaMu, Bear Stearns, and Fannie and Freddie looked perfectly strong and healthy the week before they collapsed. If the Wall Streeters can't read the handwriting on the wall, who can?  Better to pull your money out of everything and hoard it as cash, at least that way it can't be disappeared to nothing!

The problem is that if there is no capital on offer, perfectly healthy businesses can't function.  In the normal course of payments and receipts, virtually all businesses need to borrow small amounts of money to make payroll before checks from their customers arrive.  If these loans can't be had, the business will abruptly fail through no fault of its own, and while still possessing a fundamentally healthy ledger.  This is not only unfair, it's obviously devastating to the economy.

That is the one good office that the government can perform during a panic: providing liquidity.  The government alone has the credibility to loan any amount; it is still generally considered impossible that the United States Treasury would ever actually go bankrupt and fail to make its payments.

Fed Chairman Ben Bernanke, a serious student of the Great Depression, knows full well that the failure of the Fed to provide liquidity was a major reason the Panic of 1929 turned into a full-on Depression that lasted a decade.  That's why he's been trundling around with wheelbarrow-loads of cash, offering it to all comers.  Throwing cash around has worked so far, just as it worked in 1987 (a panic that did not turn into a depression) and at other times.

So, in the one area where government can do good and helpful work, the Fed has indeed been doing an excellent job.  What's more, thanks to the way Fed chairmanships work, Mr. Bernanke will be in his post for years to come.

Unfortunately, our politicians cannot be trusted to leave well enough alone.  The crash of 1929 became the Great Depression in part because of liquidity failures by a less-enlightened Fed; but there were three specific legislative actions of Congress which led directly to the length and depth of the disaster that resulted.

It's frightening to think this, but Barack Hussein Obama has promised to repeat each of the three legislative mistakes made in the 1930s.

Tariffs and Trade Wars

Whenever there is a financial panic, there are almost always job losses.  In a global economy, it's always tempting to look across the ocean to try to figure out where those jobs went.

America has long been towards the top of global wage scales - as, indeed, we must be if we are to maintain our standard of living.  This means that almost everyone else anywhere in the world can be employed more cheaply than an American, at least as long as you only look at the hourly wage.

The first reaction of politicians to job losses caused by overseas competition is to get rid of the overseas competition.  The easiest way to do that is by enacting trade barriers and tariffs - extra charges that foreign companies must pay to import their goods.  If we make steel for $100 a ton and the Chinese can do it for $50, then slapping a tariff of $50 a ton on imported steel should even things up, right?

Wrong!  Because the reason we import steel (or anything else) from China is because someone in the U.S. wants it.  A tariff doesn't take anything from foreigners, though it does harm them - it is a tax on the American who buys foreign goods.  American tariffs drive up prices paid by American consumers.

Think about it for a moment - we complain about all the Chinese imports, but if we put a tariff on them, everything for sale at Wal-Mart would instantly go up in price to cover the bill.  Is that what we want?  When the economy is shaky, is making everything more expensive to buy a recipe for prosperity?

No.  It wasn't in the 30s, and it isn't now.  Against his better instincts, Herbert Hoover signed the Smoot-Hawley tariff act in 1930.  This raised rates on all sorts of imported goods, making them more expensive for Americans.

The world didn't stand still; other countries raised their tariffs as well in a trade war, making American imports more expensive for their citizens.  The end result was that everything got more expensive for everybody; nobody could afford what they used to; and consumer demand stalled.

What happens when consumers stop buying?  Factory layoffs - and the people who are laid off buy even less.

In a weak economy, positively the last thing you want to do is raise tariffs.  Quite the contrary: you want to remove all possible barriers to trade, both so your own people can buy things more cheaply and so that other countries will be more welcoming of your exports.

Barack Obama's prescription is the same as Hoover, Smoot, and Hawley, which led directly to the Great Depression.  He has said he wants to renegotiate NAFTA, our free trade agreement with Canada and Mexico.  Nancy Pelosi's Democrats spiked a free trade agreement with Colombia, who is now pursuing it with Europe instead.  The handwriting is already on the wall.

Tariffs don't save jobs and they don't create wealth.  They destroy both, and are bad at any time; but they are at their worst when we can least afford more financial mayhem.

Unions and Unemployment

Of course, when there is economic chaos, the first response of ordinary people is "I don't want to lose my job!"  This seems, on its face, to make sense - stopping layoffs reduces unemployment, doesn't it?  The trouble comes when business need to reduce costs in order to survive.

During the Great Depression, President Roosevelt attempted to hold up the economy by all manner of regulations even more intrusive than those we have today.  Wage and price controls covered most industries and union power was strengthened greatly.  This was obviously helpful to the people who were already employed - they could not easily be fired, nor could their wages be reduced.

Fixing wages at high levels did great harm to those who had no job, of course.  Consider for a moment the vast numbers of unemployed during the Depression.  Most of these men were desperate for work - they would do anything at any wage.  Why should a factory have to pay high union wages when there were hundreds of unemployed who would do the job for less?

Hiring workers from such a labor pool offers tremendous benefits to the companies and to the newly employed.  By lowering wages, production costs are lowered - and thus prices.  Lower prices mean more people can buy the goods, leading to greater demand, which leads to greater production, then more employment: the virtuous cycle of recovery!

By preventing this recovery response, Roosevelt's policies prolonged the Great Depression.

President-elect Obama has prescribed the exact same poison.  Via the Orwellian-named Employee Free Choice Act, Obama's Democrats intend to make it possible for unions to force themselves on companies and workers that don't want them, and to allow the government to dictate what the pay contract shall be!  The only possible result of increasing the cost of labor will be lower employment and less investment - the exact opposite of what we want.  On a national level, this alone has the potential to turn recession into long-term depression; it certainly did last time.

Government Winners are Losers

The most dangerous mistake of all is the idea that government can and should choose winners and losers in the economy - by industry, or by specific company.  In the days of the Depression, FDR established the National Recovery Administration, which granted special privileges for companies that complied with his liberal programs.

This led to economic inefficiency; companies could prosper better by being "politically correct" than by competing efficiently in the open market.  As with the government regulation of wages and encouragement of unions, the NRA decreased employment and discouraged new firms from forming.

Obama has proposed exactly the same principle, though for a different reason: protection of the environment.  In the waning days of the campaign, Obama's views on the coal and power-generation were revealed:

"So if somebody wants to build a coal-powered plant, they can; it's just that it will bankrupt them because they're going to be charged a huge sum for all that greenhouse gas that's being emitted." Obama said, "That will also generate billions of dollars that we can invest in wind, solar, biodiesel and other alternative energy approaches." [emphasis added]

Obama has decided that coal is Bad and that alternative energy is Good.  He will take from the Bad and give to the Good - and by doing so, ensure that the government, not the free market, will decide which companies prosper and which will be ruined.  He clearly understands what that will do to energy costs:

Under my plan of a cap and trade system, electricity rates would necessarily skyrocket. Even regardless of what I say about whether coal is good or bad. Because I'm capping greenhouse gases, coal power plants, you know, natural gas, you name it - whatever the plants were, whatever the industry was, uh, they would have to retrofit their operations. That will cost money. They will pass that money on to consumers. [emphasis added]

Raising overhead costs, picking winners and losers by government fiat, increasing regulations, starting a trade war - Presidents Hoover and Roosevelt did all these things in the 1930s.  We know what happened then.  Why are we voting to have the same exact mistakes be made a second time around?

Hoover made only two of the four mistakes; it took Roosevelt and the other two to create a decades-long nightmare.  Obama plans to make three of these mistakes all by himself.

A majority of Americans clearly chose Obama, but it's pretty clear that those with money know the truth: we have just seen the largest day-after-election stock market plummet in history.

Yet for all that the market appears to "know" something, nobody is talking about the hard future realities; why worry about Barack when you can blame everything on the last guy?  Aside from academics, everybody "knows" that the Depression was Hoover's fault.  Will that be Mr. Bush's unjust fate?