In 1929, facing an unprecedented drop in the stock market and a mounting recession, Herbert Hoover took action. For years, he had been advocating government intervention in markets and industry to stabilize prices and wages. "Government and industry should work together," was his mantra. Now was his chance to prove himself.
In past bust periods, industry would slow production, reduce prices, lay off workers and reduce wages until markets cleared. Some companies were even allowed to go bankrupt, a seemingly foreign concept these days. Once profits started to rise again, industry would hire back workers and increase production. The recession or depression was often painful, especially for marginal workers who had less skills then others, but it happened relatively quickly and the mistakes made by industry were fully corrected.
But Hoover and others, backed by new economic theory, thought they had found a cure for the bust part of the cycle. They called for price and wage stabilization in a recession, expansion by industry (as opposed to contraction), and public works programs to employ the newly unemployed. The theory was that consumption, not the quest for profits, drove the economy. Therefore, if wage rates and prices were sustained, and unemployment contained, consumers would pull the economy through.
Herbert Hoover bought into these ideas. During the beginning years of his presidency and the Great Depression, he dramatically increased government spending on public works programs, pressed industry to voluntarily maintain wages, and created programs intended to sustain prices. Industry agreed to maintain wages and some companies even agreed to expand their businesses. Their ideas and theories however, failed.
One of the most eye opening examples of this failure were the attempts to stabilize ag prices, most notoriously wheat. As wheat prices declined, the government sought to prop up prices by loaning companies money to hold wheat off the market for a time. They also bought wheat and stored it until prices rose. This actually worked in the short term, but not for long. Since wheat prices were high, farmers planted more wheat. The next season, there was an great abundance of wheat which drove prices down once again. On top of this, companies and the government holding wheat off the market had to sell it, driving prices farther down. To correct for over production, the government bought more wheat and asked farmers to voluntarily stop producing as much. Unfortunately, many farmers had to earn a living and continued to planted more. In the end, much food rotted away at a time when Americans found themselves hungry.
Today, we are essentially doing the same thing except to a greater degree. The government is trying to prop up prices, wages and employment and is encouraging us to consume. Like in the 30's, it won't work. Take for instance the "Cash for Clunkers" program. A local car dealer here in Lincoln reported record sales in July due to the Cash for Clunkers program. They even hired two new sales people. But let's look at what this program is actually doing. The government is taking valuable products (used cars) off the market and destroying them. They are encouraging people who owned their cars to buy new cars and go into the very thing that caused our recession - consumer debt! Since they are targeting fuel efficient cars, these prices will rise, making fuel efficient cars more expensive due to higher demand. When the money runs out (unless the government continues to buy us cars of course), sales will decline, less people will be looking for new cars, and the newly hired sales people will have to be laid off.
In October of 1930 (before wheat and other agricultural prices began to slide) with unemployment up to 9% (sound familiar?), Hoover patted himself on the back.
I determined that it was my duty, even without precedent, to call upon the business of the country for coordinated and constructive action to resist the forces of disintegration. The business community, the bankers, labor, and the government have cooperated in wider spread measures of mitigation than have ever been attempted before. Our bankers and the reserve system have carried the country through the credit . . . storm without impairment. Our leading business concerns have sustained wages, have distributed employment, have expedited heavy construction. The Government has expanded public works, assisted in credit to agriculture, and has restricted immigration. These measures have maintained a higher degree of consumption than would otherwise have been the case. They have thus prevented a large measure of unemployment. . . . Our present experience in relief should form the basis of even more amplified plans in the future.
Of course unemployment was not prevented in large measure, in subsequent years unemployment rose to over 25% and the Great Depression dragged on until WWII.
Right now, after an unprecedented amount of government spending, GDP for the previous quarter declined at only at -1%. But nothing has changed. The government is encouraging new debt, is destroying valuable assets in order to increase the sale of new cars, and is not allowing vital corrections in our economy to happen. And the Obama administration is patting itself on the back.
Next up, what corrections need to happen and why they aren't.
