This talk was delivered at the Ludwig von Mises Institute's 2003 Supporters Summit, October 24, 2003.
Yes, it's true, I recently worked in a Bush administration for some 16 months as chief economist in the United States Department of Labor. I took a walk on the dark side, you might say, eager to sip from the cup of power. How could I do that? Let's just chalk it up to frustration over governmental policy, although it may have been more sinister. As Samuel Johnson observed in 1773 about human weakness: "Wickedness is always easier than virtue; for it takes the shortcut to everything."
Condemn me if you must, yet I saw economic policy and propaganda being made in close relief. My conclusion? The low opinion I held of government before I went to Washington was not elevated by participation in it. I saw a complete disconnect between reality—the economics of the business slump—politics, and proper policy. I repeat: there was a complete and total disconnect between economics and politics.
The more cynical of you here today will be nonplused by my observation. After all, FDR ridiculed the sign on his Treasury Secretary Henry Morgenthau's desk, "Does It Contribute to Recovery," with the rejoinder, "This is politics." The devious Mr. Roosevelt meant that the New Deal "was not about economic recovery, but about displacing business as the nation's predominant elite," according to Wall Street Journal columnist Robert L. Bartley (October 20, 2003). On the other hand, the more earnest among you realize that the continuing disconnect between intervention and our scientific knowledge of recessions is a disaster because "The main issues of present-day politics are essentially economic," as Mises observed.
Let us put this latest recession in context. (If we need definitions, a recession means a widespread, sustained decline in business output and employment while politics is the art of gaining, retaining and wielding governmental force in our representative democracy). When the Bush administration took office in January, 2001, a downturn was already underway. The president and his coterie said so and blamed Clinton but hushed up when accused of "talking down the economy."
That was a mistake—a dose of truth about the economy along the lines of the early '80s Reagan model would have worked better—but they learned an early lesson about psychology and confidence in Washington, D.C. Politics is all about (the) confidence (game) and prestige in the nation's capital. I was immediately struck by how Bush appointees greeted economic news with pompoms waving. Of course, "The people are most credulous when they are most happy," as economist Walter Bagehot (1826-77) put it.
Politicos and mainstream economists believe our fragile "capitalist" economy depends critically on sustaining "confidence." This month Martin Feldstein, once President Reagan's chief economic adviser, wrote in The Wall Street Journal (October 13, 2003): "Because confidence is so important for spending decisions, the declining number of jobs until September created the risk of a self-fulfilling prophecy of low demand and weaker employment. That's why the recent upturn in employment is particularly good news." Wall Street or Washington, D.C., these economists are all Keynesians now—they believe that spending and keeping it pumped up are the keys to prosperity. They know a lot that just ain't so, but they know enough is amiss in our "fundamentally sound economy" to have just named a "strong crisis manager," Timothy F. Geithner, as president of the New York Federal Reserve Bank.
Also, since September 11, 2001, a new war (or is it a portfolio of wars?) replaced the late, lamented end of the cold war and pushed the recession into a distant second place. So the public has cut the administration plenty of slack, though it may be exhausted come November 2004.
FDR did not invent "countercyclical" policy to "fix" a business slump. No, for that we can thank a Republican president, Herbert Hoover. The last so-called free-market recession was sharp but brief in 1920–1. The Harding administration followed federal tradition and stood by and did nothing because "everything was too high" after the world war and depression was something that "ran its course, like measles." There was political pressure to intervene, but the favored theory of earlier business crises carried the day one last time: "Businessmen got themselves into this mess, so let them get themselves out of it."
One of the activists urging intervention in 1921 was the Harding administration's "progressive" Secretary of Commerce, Herbert Hoover. When the roaring '20s ended with the stock market crash of October, 1929, the "Great Engineer" was in a much better position to administer his remedies. The "forward-looking" Hoover would take on the business cycle and stomp it flat with all the resources of government. The Wonder Boy recalled, "No President before had ever believed there was a governmental responsibility in such cases . . . therefore, we had to pioneer a new field" (Rothbard, p. 186).
The parallels between the Hoover and current Bush-Greenspan policies are remarkable:
- Hoover inflated credit and bullied banks into inflating.
- Signed the Agricultural Marketing Act to subsidize farming.
- Pursued a "high-wage" policy, including corporate pledges to avoid cuts in wage rates and signed the Norris-LaGuardia Anti-injunction Act to empower labor unions.
- Cut taxes heavily.
- Pushed federal expenditures up by 42 percent in one year (!), driving the burden of total government up from 16.4 percent in 1930 to 21.5 percent of the gross private product.
- Deliberately ran a huge deficit.
- Started more major public works in four years than in the previous thirty.
- Attacked the stock exchanges and urged the public to "invest on the basis of the future of the United States" rather than judging stocks according to earnings.
- Signed the punitive Smoot-Hawley Tariff Act.
- Lost the confidence of foreigners in the dollar, who began to pull out their gold.
After four years, the result of Hoover's "frenzied interventionism," was there for all to see: utter ruin, a ruin "unprecedented in length and intensity" (Rothbard, p. 295). At least he didn't resort to a shooting war. And what did our leaders in Washington, DC, learn? Hoover bragged: "We might have done nothing. That would have been utter ruin. Instead we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever involved in the history of the Republic." Rexford Tugwell, one of FDR's "impudent nobodies," finally conceded in an interview forty years after the event (1974): 'We didn't admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover had started."
We know how counterproductive these interventions are. "Whenever government intervenes in the market, it aggravates rather than settles the problems it has set out to solve," remarks Murray Rothbard (p. 204). "This is a general economic law of government intervention." Rothbard concludes his book on America's Great Depression: "Bravely [Hoover] 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."
At least Hoover had to refute a then-respectable, rival laissez-faire theory of the "reactionary liquidationists." Today, reputable economists on Wall Street and inside the beltway do not advocate laissez-faire as the right corrective, though their economic understanding is hardly more respectable than that of the "monetary cranks."
What they know in Washington is "smart politics." Policies consist of happy talk, reassurance that all is well, it's all under government control, and extravagant use of the Hoover-FDR tools. "All governments are firmly committed to the policy of low interest rates, credit expansion, and inflation," wrote Ludwig von Mises. "When the unavoidable aftermath of these short-term policies appears, they know only of one remedy—to go on in inflationary ventures." But explaining this tragic situation goes beyond the direct policymakers. Two additional groups outside of Washington, D.C., deserve mention too: economists and the public.
First, economists have treated monetary problems in a superficial way, failing to integrate money into their theory of markets. They naively embraced the neutral theory of money, failing to appreciate how monetary manipulation necessarily distorts markets and causes booms followed by corrective busts.
Hence, Benjamin Strong, governor of the New York Federal Reserve Bank in the 1920s, could say ignorantly and without guilt, "I will give a little shot of whiskey to the Stock Market," just as our revered Dr. Alan Greenspan ("Sureprintsalot") or Larry Kudlow can today. No misunderstanding in economic science has done more harm than the role of money and credit in business boom and bust.
Second, the myopic public disposition for lower interest rates by allegedly costless credit expansion creates an irresistible temptation for politicians, bureaucrats and economists to comply. H.L. Mencken's theory of democracy surely applies all-too-well here: the public gets what it wants, good and hard.
