Leithner Letter No. 39
26 March 2003

I’m going to put two quotes on the screen and ask you if this was an honest mistake on the part of the White House, or if the speechwriters had no sense of history. The first quote is, “The economy is fundamentally sound.” Herbert Hoover [uttered that memorable sentence in] 1929. And here is George W. Bush today, “The fundamentals of our economy are sound.” Is this an honest mistake by White House speechwriters, who must know the difference or similarities in this case?

Brian Williams interviews historian Robert Dallek
CNBC’s The News with Brian Williams (30 July 2002)

Mr President, I am put up here to speak a kindly word for the solvent and the damned; or, as the more advanced thinkers say, for the Rotten Rich.

H.L. Mencken to Franklin D. Roosevelt
The Gridiron Club, Washington (7 December 1934)

George W. Hoover and the Distemper of Our Times

Once upon a time, prices on the stock market – particularly the capitalisations of “New Era” companies – fell drastically. This rude awakening, which seemed to portend the interruption if not the end of a long era of gilded prosperity, shocked many and vindicated a few. Whatever the reaction, high-flying paper fortunes were lost, prominent people were humbled and bad times threatened.

During his election campaign, which to all but the most observant preceded the appearance of economic storm clouds, America’s president, a staunch Republican, was eager to disprove the stereotype that politicians of his partisan stripe were doctrinaire champions of laissez-faire capitalism. After his election he was equally impatient to demonstrate that he was neither oblivious to nor unmoved by the loss of savings and employment of people of modest means. He therefore responded to the economic turmoil promptly, decisively, extensively (in terms of the changes they sought to effect), intensively (in terms of the money his interventions required) and – in his view – humanely.

Within months of taking office, the President summoned the leaders of America’s biggest corporations to an emergency summit. He also beseeched Congress to approve measures that sought to return economic conditions to the state to which people had become accustomed; denounced stock market speculators and unethical businessmen (and laid much of the blame for the country’s sombre circumstances at their feet); changed significantly the rules that governed the behaviour of Wall Street; and after 1-2 years, when his policies failed to produce their intended consequences and instead the situation worsened, he hectored the country about “corporate responsibility.”

The president in question, as Amity Shlaes of The Financial Times recently reminded us in an excellent article entitled Hoover’s Disasters Revisited, is not George W. Bush: it was Herbert Hoover. The relevant election occurred in 1928 and the economic difficulties and responses thereto occurred between his inauguration in 1929 and departure from office in 1933.

Many will be startled and perhaps disquieted at this juxtaposition of the attitudes and actions of America’s thirty-first and current presidents. This is perhaps because the comparison is foreboding: Hoover, after all, lost office ignominiously in the epochal landslide election of 1932. Moreover, in the ensuing seventy years Hoover has been denigrated – particularly but not exclusively by FDR, New Dealers and their descendents – as the man whose intransigence, errors, oversights and omissions turned a slump into the Great Depression. Hoover, it is said, fiddled whilst America and much of the rest of the world burnt. According to the conventional wisdom, he obstinately refused to recognise that only the government – and particularly the national government – can rescue the economy when the trouble is truly serious. He did nothing whilst trade and commerce collapsed and “Hoovervilles” (i.e., shantytowns of the dispossessed) mushroomed around him.

Yet an inspection of the historical record demonstrates that Herbert Hoover, like George W. Bush, neither advocated nor practiced laissez-faire capitalism. Hoover was called “the great engineer” not only because he studied engineering and used what he learnt to establish a worldwide professional reputation and amass a substantial fortune (not least in remote areas of Western Australia); but also because the very reason for his rise to prominence and accession to the White House was his record of robust intervention during emergencies. Before America’s entry into the First World War, he orchestrated food aid to the starving children of Belgium. After the Armistice, he headed the American Relief Administration and organised assistance to hungry millions across central Europe. In 1921 he directed aid to famine-stricken Soviet Russia. When a critic implied his humanitarian actions were abetting Bolshevism, Hoover roared: “twenty million people are starving. Whatever their politics, they shall be fed!” In the early 1920s, after the massive flooding of the Mississippi River and before becoming Secretary of Commerce in the Harding and Coolidge administrations, he co-ordinated an extensive program of aid and reconstruction in the American South (Craig Lloyd, Aggressive Introvert: A Study of Herbert Hoover and Public Relations Management, 1912-1932, Ohio State University Press, 1972, ISBN: 0814201814).

Secretary Hoover constantly urged Presidents Harding and Coolidge to “manage the economy,” and the Department of Commerce was the only federal government department whose numbers and power expanded steadily during the 1920s. Alas, the depression of the early 1920s ended before Hoover’s interventionist itch could be scratched. Hence his advice was directed at Warren Harding’s successor. Calvin Coolidge, a small government man and normally a man of very few words, was moved towards the end of his term of office to complain: “for six years that man has given me unsolicited advice – all of it bad” (Joseph Brandes, Herbert Hoover and Economic Diplomacy: Department of Commerce Policy 1921-1928, University of Pittsburgh Press, 1962).

It is likely that Hoover the engineer’s energetic management of humanitarian crises helped to save hundreds of thousands and perhaps millions of lives. Yet not all problems yield to the methods and mindset of an engineer; and for this and other reasons President Hoover’s activist economic policies were disasters. Indeed, logic and evidence suggest that it was these interventionist policies – and not the inactivity and indifference of which he has been falsely accused – that helped to turn the slump into the Depression (see in particular Murray N. Rothbard, America’s Great Depression, 1963, 2000, Ludwig von Mises Institute, ISBN: 0945466056). According to Rothbard,

Mr Hoover met the challenge of the Great Depression by acting quickly and decisively, indeed almost continuously throughout his term of office, putting into effect “the greatest program of offense and defence” against depression ever attempted in America. Bravely he used every modern economic “tool,” every device of progressive and “enlightened” economics, every facet of government planning, to combat the depression. For the first time, laissez-faire was boldly thrown overboard and every governmental weapon thrown into the breach. America had awakened, and was now ready to use the State to the hilt, unhampered by the supposed shibboleths of laissez-faire. President Hoover was a bold and audacious leader in this awakening. By every “progressive” tenet of our day, he should have ended his term a conquering hero; instead he left America in utter and complete ruin – a ruin unprecedented in length and intensity.

Hoover, it is important to recognise, was hardly alone: His Majesty’s Government, the Bank of England and the U.S. Federal Reserve, among others, also intervened actively and calamitously after 1929 (indeed, in the case of these British institutions, throughout the 1920s). Hence these bodies also deserve a significant amount of the culpability for the length and severity of the Depression. The general point, then, is that well-intentioned but misguided economic planning and interventionism can have unintended and invidious consequences.

Enduring Myths About the Great Depression

According to Shlaes, the similar attitudes and actions of Herbert Hoover and George W. Bush is “a reminder that benevolent action can sometimes be more destructive than inaction when it comes to a fragile economy. The story is important for [today’s] Republicans, who tend to tell themselves, as Hoover did, that economic crises warrant a suspension of free-market principles.”

Because we are three generations removed from it, and perhaps also because the images it evokes are so unpleasant and discomfiting, the Great Depression seldom intrudes explicitly into our thoughts. At the same time, however, and in ways that are rarely recognised, certain beliefs and habits that most of today’s investors hold dear were moulded during the late 1920s and 1930s. Their conceptions of recession and depression; their views about the cause of the Great Depression; their opinions about what ended the Depression; and perhaps most importantly, their beliefs about the proper role, benevolence and general efficacy of government economic management – all have been strongly influenced if not determined by ideas and action which gained currency between 1933 and 1945 (see, for example, Sean Corrigan’s Six Myths of the Crash).

John Meynard Keynes wrote in The General Theory of Employment, Interest, and Money (Prometheus Books, 1936, 1997, ISBN: 1573921394) “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. ...”

It is ironic and perhaps tragic that Lord Keynes has arguably become the chief “academic scribblerc and “defunct economist” whose ideas presently dominate the thinking and actions not just of “madmen in authority” but also of businessmen and participants in financial markets. Since the 1930s, students have been generally taught and members of the public have typically accepted that the collapse in 1929 of a pillar of capitalism, the stock market, dragged America and much of the rest of the world into an unprecedented economic depression. The crash, according to the conventional wisdom, caused the Depression. President Hoover, an advocate of “hands-off” economic policy, stoutly refused to use the power of government to intervene in the economy and relieve the suffering. As a result, economic conditions worsened. Fortunately, Hoover’s successor, Franklin D. Roosevelt, introduced desperately needed government interventions into economic activity. By the mid-1930s, these policies had begun to steer America and the rest of the world towards recovery.

The lesson taught to students and believed by the general public is therefore that capitalism is inherently unstable and prone to booms and busts; that private enterprise cannot be trusted and instead must be feared and controlled; that government, particularly the central government, which can be trusted, must implement activist and interventionist economic policies (i.e., a “leading” and “steering” role in the economy) in order to avert economic instability, bust and catastrophe; and that since they were first adopted in the 1930s these policies have produced their intended effects. Indeed, to converse today about politics, economics and foreign affairs with an American “conservative Republican” is quickly to realise that this species of conservative seeks ultimately to conserve FDR’s New Deal and its legacy.

Alas, much of what we think that we know about the Depression may be false; and many of the lessons we have learnt from it may be mistaken (see in particular Gene Smiley’s summary of scholarship brought to bear on these matters, Rethinking the Great Depression: A New View of Its Causes and Consequences, Ivan R Dee, 2002, ISBN: 1566634725; and also a publication of the Minneapolis Fed entitled The Great Depression in the United States from a Neoclassical Perspective). In Smiley’s words, “those readers who have not been introduced to recent scholarship on [this] subject may find some surprising conclusions. The Great Depression is often said to demonstrate the instability of market economies and the need for government oversight and direction. The evidence can no longer support such assumptions. Government efforts to control and direct the gold standard for national purposes brought on the Depression. Once it began, government actions, particularly in the United States, caused it to be much longer and much more severe. When the contraction finally ended, government interference in U.S. markets brought on a ‘depression within a depression.’ The 1930s economic crisis is a tragic testimony to government interference in market economies.”

Repeating Our Forebears’ Errors

As an example of an ancient fallacy resuscitated during the Depression and accepted largely uncritically thereafter, consider the proposal put by President Bush to the National Association of Manufacturers in October 2001. “On the one hand, we’ve got to make sure that we bolster consumer demand by both accelerating the tax cuts that now exist, as well as providing rebates for non-taxpayers, but who filed. ... And Congress ought to act as quickly as possible to get that money into people’s hands as quickly as possible to bolster demand.”

A characteristic of Keynesian-inspired politicians and commentators, which comprise the vast bulk of politicians and panjandrums, is the attribution of the downward leg of the business cycle to weak or insufficient demand. (Conversely, in academic circles since the 1970s, most self-described Keynesians have increasingly rejected the spending-driven theory of Keynes and favour “New Keynesian” theories that emphasise maladjustments of wages and prices.) Another is the uncritical assignment to government of the responsibility, in Lew Rockwell’s words, “to give the economy a kick-start, change public psychology, spend money on anything and everything, stop the money hoarding and start the buying, inflate a bit here and there, drive down interest rates, run deficits for a while and fool the workers into thinking they’re getting raises though their real wages are falling. That’s the traditional mix of policies that has been employed during every recession between the early thirties and the current day.”

The notion that the demand for goods and services can at times be deficient derives from a chain of economic reasoning that before the 1930s was regarded as faulty. According to “under-consumptionists,” sometimes total spending will not be sufficient to provide employment to all resources (including people who seek employment). Two giants of classical economics, David Ricardo and Thomas Malthus, disputed this point. In the eyes of most of their contemporaries and for the remainder of the nineteenth century, Ricardo’s logic and evidence prevailed over Malthusian “demand side” economics; further, Jean Baptiste Say is remembered for his demonstration (“Say’s Law”) that the demand for goods and services derives from the supply of those goods and services to markets. If Say’s Law is correct, then under-consumption and oversupply are logical absurdities.

Ricardo and Say, then, slew these dragons; and they remained slain until Keynes refashioned them in The General Theory. Since then “demand management” has become not just uncontroversial but a foundation stone of public policy in most countries. Yet the basis of the contention that demand can at times be deficient is more apparent than real. Indeed, although many deride the Austrian alternative to Keynes, one need not be an Austrian in order to reject Keynes. Chicago School neo-classicists, particularly Nobel Laureates Milton Friedman and Robert Lucas, re-shattered the deficient demand myth decades ago. As Sean Corrigan irreverently asks, “do you have the exact model of car you want? Is your house fitted out as luxuriously as you would wish? Do you get enough beer to drink? Do your kids tire of sweets, or your wife of new shoes? Do you have access to all the medical care you want, when you want it? If you can answer ‘Yes’ to any of those you are either a hermit, a liar, or Larry Ellison.”

Only if one can answer these questions in the affirmative, in other words, is “under-consumption” a reality. Further, and in Lew Rockwell’s words, “let’s say that every one of us emptied our bank account today and just bought something. And let’s say we used all our assets and leveraged them to the hilt to borrow as much money as possible, and then spent that. What would happen? Well, shelves would empty and prices would go up and the business pages would roar with approval. But what about tomorrow? There are no savings left to fund new projects that would be undertaken after this little boomlet. Products on shelves would languish. Long-term projects would have no customers. We would have spent ourselves straight into recession again. This plan boosts the economy in the same way that an amphetamine boosts one’s mood. It’s an illusion that must end.”

George W. Roosevelt?

Economic blunders can have not just tragic economic consequences but also chilling political ramifications. Paul Johnson wrote in his Introduction to the fifth edition of Rothbard’s America’s Great Depression that “the Wall Street collapse of September – October 1929 and the Great Depression which followed it were among the most important events of the twentieth century. They made the Second World War possible, though not inevitable, and by undermining confidence in the efficacy of the market and the capitalist system, they helped to explain why the absurdly inefficient and murderous system of Soviet communism survived for so long. Indeed, it could be argued that the ultimate emotional and intellectual consequences of the Great Depression were not finally erased from the mind of humanity until the end of the 1980s, when the Soviet collectivist alternative to capitalism crumbled.”

People, in short, act upon ideas; and the ideas adopted at critical junctures, whatever their correspondence to reality, tend to become deeply entrenched. Bertrand Russell once said “most men would rather die than think. Many do.” Most of today’s politicians, economists and market participants think and act like their fathers and grandfathers. To do so usually makes good sense: we benefit immeasurably from the cultural and economic inheritance bequeathed to us. But not all of our inheritance is sacrosanct, and for this reason Sean Corrigan’s recent injunction to investors and custodians of capital is apposite. Given the tragic and enduring errors committed during the 1930s, today is “a time for the careful and conservative stewardship of [capital] and for those charged with this to display a willingness to challenge prevailing myths, whether these arise from economic sophistry or from institutional prejudice and intellectual inertia. If we can all become convinced that these are aims well worth achieving [then] this recession might actually turn out to have been fully worth the cost.”

Chris Leithner


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