(This article appeared in the Wall Street Journal on 10/31/08)
People ask me if the current mess feels like 1929. But the right comparison is 1932, when Herbert Hoover was desperately trying anything, anything at all, to get the economy going. The stock market had crashed. The economy was starting to follow it down. So what did Hoover and his fellow policy makers do?
In 1930, Congress passed a massive tariff increase, in hopes of protecting American jobs. Hoover signed it. But it simply accelerated the economy’s slide. The Federal Reserve contracted the money supply, taking a recession and making it into a depression. By 1932, real GDP was 25% lower than three years earlier.
Hoover increased federal spending steadily, including an increase in real terms of about 40% in 1932. At the same time, fearful that deficits were harmful, Hoover raised income taxes.
Nothing worked. So Franklin Roosevelt came into office pledging stronger medicine. Enter even bigger increases in government spending. Government nationalization. Bigger deficits. Destruction of crops and livestock in the name of raising prices. Government-organized cartels. A greater empowerment of unions. It was a whirlwind of activity without any real plan.
It worked for a while, but then, in 1938, the economy turned sour again. Unemployment, which had been falling, spiked again, reaching 19%. Consumption didn’t recover to its prewar levels until 1945.
Today, President George W. Bush plays the role of Hoover, the so-called free market ideologue who is trying anything to avert disaster. He signs a $700 billion bill putting Treasury in charge of buying troubled assets. A week later, the money is used to partially nationalize the banks. Some companies, like Bear Stearns, are bailed out. Others, like Lehman Brothers, are not. Some companies are sold. Some are allowed to fail. There is no plan, no rules, nothing to count on.
It’s just like the New Deal: a massive accumulation of power in Washington justified by the need to do something. There is every reason to think this trend will accelerate regardless of whether Barack Obama or John McCain wins the election.
Back in March, Henry Paulson, Ben Bernanke and the experts assured us that Bear Stearns had to be propped up. If not, the whole system could come crashing down. It is crashing down anyway. Just as in the 1930s, there is no evidence that the policy makers have any understanding of what they are doing. They need to make way for the natural forces of repair.
They need to let housing prices fall. They need to let firms go bankrupt. They need to let firms that are healthy thrive. They need to let healthy firms buy the sick firms. It is time to let the imprudent fail and the prudent pick up the bargains.
A recession is coming (or has already arrived) no matter what happens in Washington. The question is whether the attempt to forestall it is going to make it worse and turn it into another Great Depression.
By acting without rhyme or reason, politicians have destroyed the rules of the game. There is no reason to invest, no reason to take risk, no reason to be prudent, no reason to look for buyers if your firm is failing. Everything is up in the air and as a result, the only prudent policy is to wait and see what the government will do next. The frenetic efforts of FDR had the same impact: Net investment was negative through much of the 1930s.
The next administration is unlikely to do any better. Mr. Bernanke is perhaps the greatest living authority on the Great Depression, yet he has failed to stem the damage. Messrs. Paulson and Bernanke are confronted with a sick patient. They have antibiotics. They have a scalpel. But is there any evidence from the last seven months that they understand the underlying cause of the illness, or how to cure it?
Worst of all are the political incentives that are unleashed when Washington promises to spend a trillion dollars (and counting). No one can spend such money wisely even if they want to. The information about who needs to be bailed out and who needs to fail is too complicated. Inevitably, such decisions will begin to be more about politics than economics.
The banks were first. Then the insurance companies. The car makers are getting a cut. Who’s next? The governors, probably. Homeowners are waiting. Then there will be the hedge funds. Once the line forms, companies will stop trying to save themselves and focus on being saved by Washington. The resulting spiral will be devastating.
Unfortunately, there is no consensus about a preferable alternative. The economists are almost as clueless as the politicians. At such a time, inaction may be the wisest course of action.
Mr. Roberts is a professor of economics at George Mason University and a research fellow at Stanford University’s Hoover Institution. His latest book is “The Price of Everything: A Parable of Possibility and Prosperity” (Princeton University Press, 2008).