Catastrophe - Dick Morris [10]
To understand this, it’s helpful to review a bit of economic history.
The theory that spending equals stimulus was first popularized by the British economist John Maynard Keynes. Writing in the 1930s, he theorized that government should run deficits in times of depression to pump money into the economy and surpluses during times of inflation and prosperity to pull money out and avoid upward pressure on prices.
Before Keynes, economists had advised balancing the budget, particularly during tough economic times. The classical economists felt that running a deficit would undermine confidence in the economy and cause businesses to sit on their hands and not invest. A balanced budget, they reasoned, would induce businessmen to feel greater confidence in the economy and to put up their money for new jobs.
The classical theory was daft. Like the doctors of old who bled their patients with leeches to drain off evil spirits, the classical economists weakened the markets by raising taxes and cutting spending. Like the poor patients being bled years ago, however, the economy needed more blood, not less. It needed more spending and lower taxes, not the opposite.
The flaws of classical economic theory became glaringly apparent under President Herbert Hoover. After the stock market crash at the end of 1929, the economy seemed to be pulling out of depression as 1931 dawned. But then the economists started to bleed the patient. In order to attract more gold into the country (at that point the United States was still on the gold standard) and generate confidence in the U.S. currency, the Federal Reserve Board raised interest rates two points. To cut the deficit, Hoover raised income taxes on the top bracket from 25 percent to 63 percent and on the bottom bracket from 1 percent to 1.5 percent. To make matters even worse, Congress responded to the depression by passing the Smoot-Hawley Tariff Act in 1930, imposing sky-high tariffs to kill off foreign competition and protect American jobs. The result, of course, was to provoke retaliation from other countries and dry up foreign trade, depriving the economy of the stimulus that exports would have provided.
These “cures” made the disease worse, and the depression resumed with a vengeance. The stock market crashed. Unemployment soared to 23 percent. And by the time FDR took over in March 1933, banks were failing across the country.
Onto this stage burst the new theories of what became known as Keynesian economics. Keynes reasoned that if government increased spending on public works and other projects, more jobs would be created. The increase in the number of jobs and the extra paychecks flowing into consumers’ pockets would get the economy going again. The process was called “priming the pump.” The point was not to replace the private sector but to shock it back into working as it should. Like a shock from a defibrillator, the money would induce the economy to pump normally.
But it turned out that there was one problem with Keynsian economics: it didn’t work. During the 1930s—its heyday—large, persistent deficits did not end the depression. They helped a bit, lessening unemployment and easing the pain, but they failed to bring back prosperity.
The lesson of the 1930s is that when government provides jobs through deficit spending, the people who get regular paychecks are personally insulated from the worst of the depression; but the rest of the world gets little help from the change, if any. The government jobs created during the 1930s did little to stimulate the rest of the economy. The cycle Keynes predicted—in which government spending would increase purchasing power, generate more consumer spending, expand production, and lead to more private employment—never really happened.
Not until World War II broke out in 1939 did the American economy recover from the Great Depression and begin its rapid march back to full employment—a trend catalyzed by increased defense contracts and expansion of the military. The unemployed of the 1930s became the soldiers of