Obama's failure to tackle the recession is becoming more and more apparent with each passing day. His childish mantra of blaming Bush for every lousy economic statistic that emerges no longer washes with the great majority of Americans. Perhaps the time is not far off when it will be seen that the Democrats' relentless commitment to building a statist juggernaut is the real obstacle to a sustained recovery that will bring prosperity in its wake.
Meanwhile the economy's deepening recession has not caused Fed officials to reflect on their economic prescriptions. Janet Yellen, President of the San Francisco Fed, appears completely baffled as why anyone should be silly enough to think America could be facing a severe inflation. Let me give her a clue. Bernanke doubled the monetary base virtually overnight, the fastest increase in US monetary history.
Right now the gap between the actual money supply* and the monetary base is practically nonexistent, indicating that if the excess reserves that Bernanke created reach the public the money supply will explode followed by surging inflation. What baffles many observers is why the likes of Yellen cannot make the connection between the Fed's monetary policy and prospective inflation.
Not content with telling us to ignore Bernanke's monetary mismanagement Yellen warns that the mistake of the 1937 should not be repeated when the Fed stopped the recovery in its tracks by tightening the money supply which sent the economy spiraling into another depression. Balderdash.
Nothing of the kind happened. Huge gold imports from Europe greatly inflated the banks' reserves. (I'm referring to the member banks). Rather than raise the discount rate or sell securities the Fed thought it better to avoid a massive credit expansion by doubling the banks' reserve requirements.
It must be understood that these excess reserves were just that — excess. They were in effect idle balances. In fact, after the banks' reserve requirements were doubled they were still left with $1 billion in excess reserves.
Moreover, these reserves continued to grow as more gold entered the country from Europe. If the Yellen view were correct then the Fed's actions would have resulted in a sudden rise in interest rates. It didn't. It can be seen from the following table that commercial paper stayed below 1 percent.
This was ridiculously low. From 1900 to beginning of the depression the lowest rate for paper was 3.12 percent, and that was in 1916 and 1924 respectively. (Commercial rates reflect the short-term rates at which business borrows).
At a glance, I would say the average rate for that period exceeded 4 percent. The figures for the 1930s reflect the depressed state of the economy and are so low that a small movement in any direction would have had no effect on the demand for funds. It can be easily seen that that there is no correlation between these rates and changes in the rate of unemployment.
However, there is a correlation between movements in productivity adjusted real wages and unemployment.
What caused the 1937 economic collapse was a huge union wage push — fully supported by FDR — that drove real wages even further above their productivity levels. The result was horrific. The Federal Reserve Index showed industrial production dropping from 115 in August 1937 to 76 in May 1938. Car production dived from 3.9 million in 1937 to 2 million in 1938. The situation was saved by the outbreak of war in Europe in 1939.
Australia's experience is very instructive. Her economy started to slow in 1927. By 1930 unemployment had risen to more than 12 percent and then rapidly accelerated, hitting 23 percent in 1932 (some people think the real rate was much higher), after which it began to fall dropping to about 9 percent in 1938. Throughout the 1930s real wages remained constant though, as the chart below shows, productivity fell. (C. B. Schedvin, Australia and the Great Depression, Sydney University Press, 1988, p. 350)
Obviously, if productivity falls while real wages are maintained then the productivity adjusted wage rate must rise, meaning that unemployment will increase, which is exactly what happened. It also follows that if productivity rises again while real wages remain unchanged then this should increase the demand for labor and drive down the rate of unemployment. This also happened. The conclusion is inescapable: unemployment closely tracked changes in the productivity adjusted wage rate.
Note: The table clearly shows that the unemployment rate tended to fall in tandem with a decline in Consumption as a percentage of GDP. According to the commonly held view the reverse should hold. In addition, government purchases held up during this period, falling by a 0.3 percentage point from 1936 to 1937 before rising again. Yet it is still being suggested that this meager reduction in government spending caused another depression.
Compare this to the immediate post-war situation where between 1945 and 1947 the Truman government slashed Federal annual spending from $95 billion to $36 billion — a $59 billion cut in two years, a 62 percent reduction that amounted to 26 percent of GDP as it stood in 1945. Instead of the mass unemployment that Paul Samuelson confidently predicted would emerge when the war ended and government spending was slashed America entered an unprecedented period of prosperity.
Yellen said that policymakers need "wisdom and patience". I strongly suggest that she take her own advice
*I use the Austrian concept of the money supply: Cash plus demand deposits with commercial banks and thrift institutions plus government deposits with banks and the central bank plus demand deposit at foreign commercial banks and foreign official institutions plus sweeps.