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What Really Brought Us out of the Great Depression?

Economics / Recession 2008 - 2010 Jul 15, 2009 - 11:29 AM GMT

By: Justice_Litle


Best Financial Markets Analysis ArticleDoes “stimulus” really work? Does quantitative easing work? The historical record suggests not. So what brought us out of the Great Depression? The answer might surprise, even though it shouldn’t...

A grumpy President Obama says that the $787 billion dollar stimulus package “has worked as intended.”

The President’s man at the Treasury, Tim Geithner, is also towing the party line. On Friday Turbo Timmy spoke of “substantial improvements” in trying to beat back the “worst recession globally we’ve seen in generations.”

Why the defensive posturing? Because the White House is feeling touchy and irritable as the polling numbers sink. The rotten jobs market, it seems, has cut into Mr. Obama’s popularity. A poll of Ohio voters showed approval numbers falling from 62% to 49% in a mere two-month span.

If the stimulus is “working,” then, heaven forbid how things might look had there been no stimulus at all.

Or hold on, wait a minute. How might things have looked really and truly with no stimulus? What would have been different?

Heads I Win, Tails You Lose

This is one of the challenges in dealing with a very sick patient (i.e. the U.S. economy). Sometimes the patient gets better all by himself. Other times, the medicine that is supposed to be helping actually makes things worse. Without the proper diagnostic tools, though, there’s often no way to tell.

And not all deeply ill patients die, of course. Some really do make a self-powered comeback. Shamans and faith healers often rely on this simple binary outcome to set up a “heads I win/tails you lose” type deal for themselves.

That is to say, if the sick patient gets better, then clearly it was the shaman’s powerful medicine that made it happen.

But there are other alternatives, each tailored to the situation at hand. If the patient fails to get better but still lives, then the shaman can take credit for keeping him from death’s door. And if the patient up and dies, well... then the shaman was called in too late. Or the family members did not have enough faith. Or there was a hidden mortal sin, or some other exculpatory thing.

That’s the trouble with big decisions and messy historical turning points. There’s no way to rewind the tape, so we can’t always be sure what helped or what hurt – or even which actions were justified in the first place.

The weight of history does suggest at least one thing. When it comes to intervention, the government’s track record isn’t so hot. In fact, not to put too fine a point on it, it stinks. And when you think about it, the logic as to why is fairly straightforward.

Take the whiz-bang idea of creating jobs, for example. Creating jobs – real, sustainable productive jobs – is no easy task. Just ask any hard-working entrepreneur. So why should the government be any good at it?

And if the government possessed half a clue when it comes to creating jobs, why wouldn’t that capability be rolled out in good times as well as bad? If the jobs genie is all he’s cracked up to be, why wait for history’s darkest hour to rub the magic lamp?

Quantitative Wheezing

And then there is quantitative easing, or QE for short. What does the historical record say about quantitative easing? Basically two things. “Japan tried it... didn’t work.”

Hugh Hendry, co-founder of London-based Electica Asset Management, had this to say about QE in a recent Financial Times interview:

...There is no precedent, no precedent, that says quantitative easing succeeds. None. I’ll give you one actually, there is one, because there was some quantitative easing exercised by the Federal Reserve in 1933-34, and it did initiate a dramatic economic recovery without inflation. But I hesitate to say that was actually a success of quantitative easing, because it was preceded by a 46% collapse in nominal GDP.

So perhaps if you’re telling me that nominal GDP will collapse by 46% next year, then I would believe, and I would come back to you and I’d say then quantitative easing might have a chance in succeeding.

For the record, U.S. GDP (gross domestic product) was an estimated $14 trillion to $15 trillion in 2008. A nominal 46% collapse would nearly cut that in half, taking us back to 1996 levels. The Dow was around 5,000 back then.

So What’s Worked Before?

This leads to an important question. What can history teach us about getting out of jams? The last economic jam we faced of comparable size and scope was the Great Depression. How did we beat it once and for all?

There are many different theories as to how America finally beat the Great Depression. Some give credit for the comeback to FDR (Franklin Delano Roosevelt) and his far-reaching policies. Others say no, FDR really didn’t help much at all (or even made things worse) – it was World War II that finally pulled us out. And still others say, simply, that “time heals all wounds,” even economic ones, and we simply had to slog our way through.

History rarely obliges historians by providing neat, packaged answers. Most sea-change type events have many factors involved, not just one. But still, your humble editor suggests there is one very powerful, yet generally overlooked element that brought us out of the Great Depression. That element was consumer savings.

Here is a statistic that will make you blink. According to journalist-historian William Greider, personal savings levels hit a whopping 25 percent of income in 1943 and 1944.

World War II played a clear role. As Greider writes, “with so many millions conscripted for war, unemployment vanished and scarcity became the problem.” Those who were not drawn into the WWII effort saw their income levels rise. Women saw as much demand as men, a new development for the times. And because the country was on a war footing, a sort of forced saving effort was in place. Families had to make do on an “austerity budget,” and wound up banking much of what they earned.

This huge build-up of savings – 25 cents out of every dollar earned – set the stage for an explosion of consumption in the years to follow. After the war, an era of new products came rushing in. And consumers had both the pent-up savings and pent-up desire to spend, spend, spend.

A Long, Long Road

So what does history have to say about our current predicament? Mainly that, when it comes to getting an economy back on track, there is little that the government can do (case in point Japan).

And secondly that, short of starting a new World War and railroading the nation into a forced austerity program, the country’s best hope probably resides in the U.S. consumer getting his fiscal house in order.

As Tom Petty once sang about love, “it’s a long long road.” That lone dip on the chart above shows where consumer savings rates actually went below zero at the height of the bubble. The impressively tall bar on the far right – representing one of the fastest savings upswings in more than a decade – tops out at just 4%.

U.S. consumers will probably never again save twenty-five cents out of every earnings dollar. There is too much financial innovation and benign leverage built into the system to dial back the clock that far. (And a little bit of leverage, like the kind that lets a young couple make affordable car payments, is a good thing.)

But could the consumer once again save at double-digit savings rates, as we saw not 20 years ago? Could the savings rate more than double from here, even as a hefty chunk of income goes towards paying off a serious overhang of debt? Absolutely.

And that’s why the U.S. economy is never, ever going back to “the way it was” – if by “the way it was” one means the gross runaway excesses of the past two decades. There will be new mistakes, new insanity, new

By Justice Litle

Copyright © 2009, Taipan Publishing Group

Justice Litle is editorial director for Taipan Publishing Group. He is also a regular contributor to Taipan Daily, a free investing and trading e-letter, and editor of Taipan's Safe Haven Investor, which helps guide readers to new global investment frontiers and safe harbors.

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