LIBERTARIAN SUS: Talking ourselves into depression? [updated]

She’s back! Susan Ryder addresses a frequently asked question: aren’t we doing this to ourselves?  (Originally published in the Franklin E-Local.)

When Wall Street crashed in October 1929, my maternal grandmother was 16 years old. Like many of her generation in New Zealand, she had been working since she was 13, having left school after completing Standard 6, (Year 8).

By 1932 she was 19, the misery of the Great Depression was well underway, and Nana was working as a nurse/housekeeper for the local doctor in a small Taranaki town. In order to be able to keep her job, her weekly wage was slashed by 25% from 10 shillings to ‘7 and 6d’ and stayed that way until she finished work to marry my grandfather in 1938.

I blanched at the drastic cut. “How did you manage?” I asked. “Well, it wasn’t easy”, she replied, “but you learned to make do. You learned to live within your means. The easy part was making the decision to accept it. It was either accept it, or no job. And 75% of something was a damn site better than 100% of nothing.”

There is a lot of wisdom in those few sentences. It has been only a few months since the global credit crunch started to bite and much has been written by economists, politicians and journalists of all persuasion, all largely quoting each other and all largely saying the same. In reality, though, there is little wisdom to be found in much of it.

What happened? One day, the developed world seemed to be chugging along quite nicely and then we awoke to find the fiscal sky starting to fall, just as Chicken Little said it would. It started in the US with major financial corporations exhibiting various stages of collapse, which spread quickly to major corporations within all industries -- of note the parlous American auto industry. Treasury Secretary Henry Paulson and Federal Reserve Chairman Bernard Bernanke leapt into action throwing money – and lots of it – at everything that looked like it might have stopped moving. It wasn’t even their money, but the US taxpayers’.

Well, it would have been, had it existed, but it didn’t. It was created out of thin air via the Federal Reserve’s printing presses -- which have been running red hot ever since. The US taxpayer has now been landed with the additional debt – on top of the mountain of debt that already existed – which has further served to diminish the dollar in the process - while the US economy remains as critical as ever.

So will all this intervention help? Well, it hasn’t to date in spite of all the cash. Personally, I think it is only going to make matters worse, to ultimately extend the life of the upcoming hardship. For proof, we should look back to the last recession on this scale, known as the Great Depression of the 1930s.

There is an old saying that warns of those ignoring the lessons of history being doomed to repeat them. Talk of doom could be frighteningly prophetic in that the prescriptions recommended for the current crisis are looking alarmingly like those adopted 75 years ago. US President Franklin Roosevelt (popularly known as FDR) followed his predecessor Herbert Hoover’s policy of increased government intervention in the marketplace and increased public expenditure, all of which served to stretch out the misery of the Great Depression for a long, dark decade.

There are some things that cannot be denied.  One is that what goes up must come down – especially if the ‘up’ is created artificially.  Drug takers know this stuff, and the ‘users’ of Alan Greenspan’s easy credit now know it too.  Economic cycles fuelled by easy credit ensure a bust will always follow a boom, particularly if that boom has been artificially fuelled by a ‘bubble’ such as the “Tulip Mania” of the 17^th century or the Dot-com bubble of the 1990s . . .  or the housing bubble of the 2000s.

The housing bubble blew up all over the developed world. (In New Zealand and elsewhere, it was exacerbated by restrictions to the residential land supply and ever-increasing local council compliance costs, which helped to inflate the bubble.) Credit was cheap and easy to get, attracting both market speculators and buyers. Tradesmen were kept busy with the demand, as were their suppliers and so on.

But what goes up artificially, must come down in reality.  When prices become too high for the market, the latter will adjust, resulting in a drop in prices.

If only it were that simple.

What goes up too highly would come down, if only politicians didn’t interfere so. The truth is that there is a better chance of winning Lotto than of politicians keeping their hands to themselves. US Congressman Ron Paul tells the story of FDR’s meddling with the market.  FDR was determined he would not run the risk of losing the large agricultural vote by letting prices fall naturally to the levels that market conditions demanded, a fall which would have helped the recovery but reduced farmers’ returns. So instead he propped prices up.  Unfortunately, the poor people struggling financially could not afford the artificially high prices and went hungry, even as the growers were ploughing their unsold produce back into the land.

Welcome to the Law of Unintended Consequences.

Everybody is always screaming for affordable housing and houses certainly would be affordable if only prices were allowed to meet the existing market. The same applies for all commodities. But there are also other factors at work. If the market was left to sort itself out, a fall in prices would go hand in hand with a fall in costs. However, trade unions will almost certainly resist all efforts to see government interference such as the minimum wage laws that keep wages at inflated levels, abolished. And it is a safe bet that they will strenuously oppose any general reduction in wages, no matter how necessary it is, all of which means that both prices and wages are kept artificially high.

US businessman Peter Schiff has been an outspoken advocate of letting the market work instead of chaining it up and burdening it with regulation, and then screaming when it goes wrong. He predicted the current crisis more than two years ago and was roundly ridiculed. His many detractors are not laughing now. He is the author of several books including Crash Proof: How to Profit from the Coming Economic Collapse. Schiff opposes the concept of a ‘government-led’ recovery, believing that the problem with recovery lies chiefly in what governments are doing to hinder it. He points for example to the brokerage/banking industry being one of the most highly regulated -- and bankrupt as a result. Like his ideological twin in academia George Reisman, Professor Emeritus of Economics from Pepperdine University, Schiff refutes the concept of increased consumer spending being the solution to the crisis, in that spending per se does not create economic growth. The truth is the converse: it is real economic growth via increased productivity that makes spending possible.

To that end, Schiff, Reisman and Ron Paul all believe that a recession is the natural adjustment by which to prune the poor performers, re-establish real values (ie., let prices fall) and then start again as quickly as possible.

A recession is not pleasant and only a fool would suggest otherwise. No decent person likes to see anyone go out of business or lose a job. But the sooner a recession is allowed to evolve, the sooner it can pass – and the fewer bankruptcies and job losses we will have.

The alternative is to continue to interfere and to subsidise what doesn’t deserve to be propped up. Subsidisation creates too much of what is not wanted. Anytime that government subsidises industry, for any reason, it gets expensive. The longer the recession, the more likely it will bleed into an outright depression.

In this global age it is too much to hope that a small economy like New Zealand will dodge the coming crisis, but with the application of sound economic principles we can prepare ourselves to face what comes and to could emerge from it as quickly as we can.

Living within one’s means is common sense, surely. It means the application of that dirty word ‘discipline’ in both the home and the Beehive.  It means letting wages and prices to fall, instead of propping them up.

In plain speech, I guess it also comes back to my grandmother’s viewpoint of 75% of something being preferable to 100% of nothing.

* * Read Susan Ryder every Tuesday here at NOT PC * *

UPDATE:  Read ‘How Government Prolonged the US Depression,’ summarised at Anti Dismal.