Back to The Future: Government Should Do Less to Fight Recessions

AP Photo/John Amis

Americans can be forgiven if we’ve forgotten what economic recovery looks like. It’s been so many years since the economy felt normal that even feeble economic growth can seem like something to cheer about.

And the cheerleader-in-chief is cheering.

“It’s not an accident that our manufacturers are creating jobs for the first time since the last time a Democrat was president. It’s not an accident that health care inflation is running at the lowest rate in almost 50 years, and that our deficits are falling faster than they have in 60 years,” President Obama explained before a partisan gathering in Chicago.

But things aren’t actually rosy.

Fewer Americans work these days: The government says the labor force participation rate in January was 62.9 percent. That’s up a touch from December’s 62.7 percent, when a “record 92,898,000 Americans 16 years and older did not participate in the labor force.”

When President Obama took office, 65.7 percent of Americans were in the work force. So we have a smaller percentage of a larger population working now, six years into his presidency. That equals millions of missing jobs. Even at that, the president is oddly eager to add to the population by offering amnesty to millions more illegal immigrants.

From ObamaCare to amnesty to the nearly $1 trillion economic stimulus, it’s clear that federal intervention in the economy simply hasn’t worked.

But if we’d like to try a different approach, what is there? After all, since Nixon announced “I am now a Keynesian,” virtually everyone in government has agreed that Washington needs to manage the economy.

That’s where James Grant, editor of Grant’s Interest Rate Observer, comes in.

His new book, The Forgotten Depression, takes a look at a recession that began around January of 1920 and ended in July of 1921. Faced with increasing unemployment and declining prices, Grant says, the federal government did: nothing.

“I propose that constructive federal inaction contributed to the relatively satisfactory outcome,” he writes. “A bipartisan determination to pay down the federal debt and to protect the purchasing power of the U.S. dollar thus likely contributed to a belief that the bad times couldn’t and wouldn’t last.”

The federal government was involved in the recession, but more in creating it than in trying to eliminate it. “In January 1918, America’s economy was stymied and half frozen. Coal was in short supply in the coldest winter in half a century,” Grant writes.

That was because of President Woodrow Wilson’s wartime price controls on coal. He set the price at $2 per ton, when producers told him they needed $3 per ton to make a profit. At the lower price, plenty of mines closed and coal became scarce. Socialism 101.

In the presidential election of 1920, neither side took much notice of the brewing recession. Nobody proposed “a plan to stimulate consumption or investment or otherwise to anticipate modern macroeconomic management,” Grant writes. Both parties supported a balanced budget and “believed that business was better served with less government interference than with more.”

After he was elected, President Warren Harding went right to work slashing the size and scope of the federal government. “His first priority was to restore something like prewar order and balance in the nation’s finances,” Grant explains. That meant a balanced budget, not a “stimulus package.”

Of course, the leaders of the 1920s didn’t get everything right.

The weak economy led then-Commerce Secretary Herbert Hoover to declare “war on unemployment,” perhaps the first example of an unwinnable “war” launched by the federal government against an abstraction. Wars on Drugs, Poverty and so forth would follow in train. And Harding signed a highway bill that would supposedly “create” 150,000 jobs (they were presumably “shovel ready,” unlike President Obama’s in 2009). But by the time the bill was signed, employment was swinging upward anyway.

Grant’s prescription is painful, but crucial. Because there was no minimum wage, employers could slash compensation. “The ‘liquidation of labor’ turned out to be a paradoxical secret of American success. Wage rates had falled—evidently far enough to make industry profitable again,” he writes. When they started hiring again, employers “had to pay market wages, or higher than market wages, to attract the better cut of employee. By and by, the 1920s roared.”

But not everywhere.

Across the pond in England, Grant writes, “stability of wages came at the price of persistently high unemployment.” If the American approach is a how-to manual for dealing with recession, the British approach is a how-NOT-to.

“In Britain, the institution of unemployment insurance, in place since 1911, afforded the idle factory hand a viable option of not working. By 1923, the dole paid well enough to preset stiff competition to low-paying employers.”

Note that the 21st Century United States looks more like 1920s Britain than 1920s America.

The government’s response to unemployment was to expand the length of unemployment benefits. Exactly the wrong approach. Consider a case study. As Patrick Gleason wrote last year in Forbes:

Since ending long-term unemployment benefits, the rate of job growth in North Carolina has seen a marked uptick, and the unemployment rate has gone down at a much faster rate than the nation as a whole. The state’s unemployment rate dropped from 8.1 percent in July of 2013, the month extended federal unemployment benefits ended in North Carolina, to 6.4 percent in February of this year. This 20 percent reduction in the state’s unemployment rate is well over double the eight percent drop in unemployment that occurred nationally during that time.

Gleason adds, “economists from across the political spectrum agree that extended unemployment insurance (UI) benefits impose perverse incentives that reduce employment; it is only the magnitude of the distortion where there is disagreement.”

And yet that’s usually the first thing the federal government does. Oh, and the left always wants to jack up the minimum wage.

Grant’s book show just how little the “experts” often know.

One cause of the downturn was an amazing run-up in farm prices after World War I. When those prices collapsed, so did the economy. At least until things returned to balance. Yet experts expected prices to remain high, right up until they collapsed.

Another similarity to today is in poor banking decisions. City, the forerunner of today’s Citi, was heavily invested in Cuban sugar in 1920. Like real estate in the mid-2000s, experts knew sugar was rock-solid. It could only increase in value. Until it didn’t. When prices collapsed, only the bank — not American taxpayers — took the loss, though. That’s a far cry from the modern setup.

Ironically, by doing nothing, the government of a century ago allowed the market to work, and a rebound to occur. As Grant shows us, the 21st Century could use some of that “don’t do” spirit from Washington. It might engender “can do” spirit everywhere else.


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