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  • Eco-Political Lessons from 1937 0 comments
    Nov 9, 2010 11:06 PM

    So now that the election is out of the way, what's the U.S. economic prognosis given the new political landscape?

    The sweeping changes to the House and Senate initially buoyed the markets, and for good reason. The Republicans ran as the “party of business.” Indeed, Dems in general and President Obama / Nancy Pelosi in particular have have demonstrated an irresistible urge for anti-business, populist rhetoric. Arguably, this has prolonged the Great Recession by stagnating business growth through sowing the seeds of uncertainty. Businesses do not invest upon the shifting sands of unknown future taxes, regulations or government mandates.

    Is the Republican sweep just what the doctor ordered?

    Instead of spouting off political slogans and talking points, let's begin by reviewing history: not election history, but economic history. We will focus upon the late 1930s. Specifically, the “Recession-within-a-Depression,” also called, “The Roosevelt Recession.” I picked this episode in American history since it came after the acute economic dislocation of the early 1930s; similarly involving the banks, real estate, and the Great Crash.

    We will set the stage with some earlier background history:

    From 1933 to 1936, the economy had begun to recovery from the depths of the Depression. President Roosevelt instituted a large number of economic and social policies, dubbed “The New Deal.” Arguably, they had helped to bolster the nation. These include F.E.R.A., or the Federal Emergency Relief Organization, who made federal loans and outright grants to cash-strapped States and municipalities. The W.P.A. (Works Progress Administration) and the C.C.C. (Civilian Conservation Corps) focused upon jobs: primarily national infrastructure improvement projects. Banking and investment reform were tackled, including the the creation of the FDIC and the SEC. The Social Security Act of 1935 was a crown jewel of F.D.R.'s first term.

    Critics argued the government was running deficits each year, threatening to bankrupt the nation. Indeed, an endless chorus complained that the policies were destroying American self-reliance, were federal “boondoggles” that wasted taxpayer money, and were creating a socialist welfare state.

    In 1937, upon a fresh landslide election, Roosevelt felt he had a mandate to continue his progressive policies. When he took office for a second term, most economic indicators had regained much of the ground lost since the late 1920s, with the notable exception of the unemployment rate.

    Several key policies were pushed that jolted a fragile economy into a second recession.

    Between March 1937 and 1938 the stock market fell 49 percent. The U.S. GNP declined 4.5 percent in 1938. A crisis of confidence ensued.

    What happened?

    Several government policy decisions enacted early in Roosevelt's second term that contributed to a second business shock:

    • The curtailment of governmental stimulus in an attempt to balance the federal budget

    • Additional government regulation; in the 1937 case, this included, amongst other federal meddling, increasing the power of labor unions, who in turn drove up wages beyond what the market could bear, and increasing bank reserve requirements, contributing to a refreezing of credit and liquidity

    • Raising taxes further depressing job creation, employment and capital formation

    The 1938 mid-term elections slowed down the Roosevelt Express. The public, while supportive of President Roosevelt, felt that some of the progressive policies had gone too far. A Republican mid-term landslide along with Roosevelt stepping back from some leftist policies changed the economic course. Unfortunately, it was after considerable damage was done to both Main Street and Wall Street.

    Does any of this sound familiar some sixty years hence?

    If history has the propensity to repeat itself, or we can learn from it, let's grade the Republicans on some key historical issues. While we cannot be sure of the final outcomes, we can project some likely results from their campaign rhetoric.

    Balancing the Federal Budget

    Republicans have generally espoused the need to “balance the budget” and “cut runaway spending” to “avoid bankrupting the country.”

    Federal actions around similar rhetoric was a fundamental reason the economy tanked in 1937-38. Fed Chairman Ben Bernanke knows this history lesson all too well. While the idea of continuing federal spending to prop the economy is a political loser, the alternatives include a recessionary relapse and/or deflation. Deflation could derail the U. S. economy for years. It is extremely corrosive. True deflation is not the effect of price reductions in certain commodities, for instance tech gadgets. This is a false comparison. Deflation is when the prices for nearly all goods and services move downward at once. No one wants to buy anything today, since it will be cheaper tomorrow. Salary and wages go into the tank. Business growth heads into reverse, as both the top and bottom lines contract.

    The Fed understands it must avoid this outcome, even to the point of risking future inflation. QE2 is a smart historical gamble. If the Republicans try to score voter points by dissing Bernanke, they flunk the course.

    Grade: “I” for Incomplete. The author worries the GOP will not do their history homework and flunk the exam.

    Government Regulation

    Republicans tend to emphasize job creation and business growth over government regulation. It's likely that they will continue to advocate a pro-business stance instead of promoting the government to solve America's economic woes. I envision decent GOP responses to managing the details of FinReg, energy policy, and labor policy.

    The Republicans will tend to seek more reasonable financial bank regulation than the Dems; looking to close the gaping holes versus punishing banking “fat cats.” I do harbor a concern they may try to score political points by grandstanding the anti-banker sentiment.

    Republicans with will advocate a pro-America energy policy, including resumption of deepwater oil drilling and the use of our vast reserves of shale gas.

    Private sector job creation will take the front seat.

    Labor “Card Check” legislation is dead.

    Grade: B      Republicans are making the right gestures.


    The GOP has been consistent about their desire to keep taxes down while the country is emerging from a recession. This lesson should be well-learned from the evidence from 1937-38.

    The Republicans understand that whether we like it or not, and regardless of our personal thoughts on social “fairness,” the creation of jobs and capital formation in a capitalistic society is generated by “the rich.” The poor do not create jobs. While government can and should encourage temporary growth through targeted programs, the engine of a democratic capitalistic country are the people with extraordinary drive and a willingness to work hard. Those who take risks seek rewards.

    The government may likewise attempt to spur growth through subsidizing new businesses. Indeed, this is also fleeting, unless it becomes a long-term handout. Sustained business activity and development is spurred by the hope by investors for future cash and recognition, not by the federal government “picking winners and losers” through tax engineering.

    Grade: A      The GOP will get this one right. Their success pivots upon getting their ideas through Congress.  The author is optimistic.

    Disclosure: none

    Disclosure: none

    Disclosure: none
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