Liquidators vs. Interventionists
April 6, 2008
Doug Noland, of prudentbear.com, wrote a note last week that addressed the "liquidationist" approach to economic crises. Here it is:
This is a discussion that has been going on since the Great Depression. Andrew Mellon, the US Treasury Secretary from 1921-1931, abided by the libertarian "let things take care of themselves" approach, which has become known as the "liquidationist" approach. This is conventional wisdom today.
Mellon: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. … It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."
The term "liquidate" is a bit unusual today, as it sounds like a plan to carpet-bomb Fallujah or something like that. But what he meant was to allow businesses with excess labor to let people go, to sell off real estate in foreclosure, to allow the stock market to find a market-clearing price, and so forth. In this way, prices find their proper level, unprofitable activities are ceased, and new profitable activities are begun. The capitalist system naturally adjusts. The government is relatively non-interventionist.
In time, this was deemed to be a failed approach. The suffering during the Great Depression was so great that it was decided, at a political level, that the government should have "done something." But what? Many things were proposed and tried, from soup kitchens to make-work programs like the CCC, to Social Security, a currency devaluation, destruction of agricultural commodities, a mandated reduction in work hours, and so forth.
This debate has gone back and forth for decades, and we won't be able to resolve it completely here. But, here are some considerations of why the "liquidationist" approach didn't work as well as it should have, why an "interventionist" approach gained support, and where we stand with these things today.
First of all, one problem with a liquidationist approach in the early 1930s was that the problem was not merely one of a credit/speculation boom gone bust, but a major change in underlying macro fundamentals. The first major change was an explosion of tariffs worldwide, beginning with the Smoot Hawley Tariff in the US (which put a tariff of 60% on just about everything) and followed by similar retaliatory tariffs around the globe. This was, needless to say, rather bad for business. The system obviously can't "right itself" in this situation unless the tariffs are abolished.
Business actually turned down in early 1930, before the tariff was passed in June 1930. People saw where things were going. By 1931, the downturn had caused a falloff in tax receipts at governments worldwide, and budgets were also affected by the demand for welfare-type spending (or "stimulus" spending) in response to the downturn. This caused government budget deficits, which were addressed with rather dramatic tax hikes, notably in Britain in September 1931. The US followed with a huge tax hike in 1932 that took the top income tax rate from 24% to 65%. Ouch! Roosevelt followed with several more tax hikes. Clearly, the system can't "right itself" in the response to these kind of economy-crippling tax hikes. You have to legislate tax rate reductions.
This was no "hands-off" approach to the economy. Mellon's Republican buddies were dropping bombs on the economy right and left. Mellon was not necessarily a supporter of these policies, but Mellon is remembered as being part of the gang of bozos and losers who caused the Great Depression, and had to be broomed out of office.
Lastly, there was a round of "beggar thy neighbor" currency devaluations, beginning with Germany and Austria in August 1931. This was followed by Britain in September 1931 and Japan in December 1931. The countries that maintained a stable gold-linked currency (including the US and France) were immediately disadvantaged, in addition to all their other problems. The devaluers enjoyed some immediate "relief," one of the timeless attractions of devaluation and inflation.
There was no way for a "liquidationist" approach to address this major deterioration in economic fundamentals.
Now, let's look at the interventionists.
History indicates that, throughout the world but particularly in Europe, there has been a pattern of elites and a lower class in service to the elites. This has gone by many terms, whether the slaves of Rome, or the lords and serfs of medieval Europe, or the slaves of the Old South. During the industrialization of the 19th century, a new relationship emerged, that of employee/employer. Employees had it rough in the 19th century. Many worked incredibly long hours for subsistence pay. Child labor was common. In the US, for example, the 10-hour/6-day workweek was standard. The elites and the underclass had their usual back-and-forth. The uprising of oppressed serfs that led to the French Revolution was mirrored in violent and bloody battles between management and employees who would unionize and strike.
There have been some exceptions to this pattern, such as the egalitarian societies of the Native Americans, or also that of the U.S. during the colonial period and up to about 1850. People lived more-or-less independently. These have been relatively rare, however.
In each society, whether that of Rome, the Old South, the medieval serfs, or the employees of the 19th century, eventually the elites and the underclass came to some sort of agreement. They understood that a regular workweek would be so long, and that certain holidays were expected, and a certain level of sustenance and perhaps welfare assistance would be forthcoming. During the 19th century, the situation reached something of an extreme. It has been postulated by some that, never in human history have people worked so hard as they did in the 19th century. The slaves of Rome didn't work that long, nor did the medieval serfs.
These expectations may change and evolve over time. The industrialization of the 19th century resulted in greater productivity, and expectations for the working class. As overall wealth increased, it was expected that some of it would filter down to the working man. Compulsory education became expected, and in the 20th century, a certain level of health care.
Among the many activities of the US government in the 1930s were a series of actions to rectify some of these imbalances that had built up over decades. These didn't necessarily have that much to do with the immediate economic situation, but the environment allowed a new arrangement -- a New Deal between elites and the underclass -- to take shape. Working hours were reduced. Certain safety-net programs such as unemployment insurance, Social Security, food (today's food stamps), and so forth were provided.
Eventually, the desperately overworked and exploited employee of the 19th century evolved into the relatively fat and happy factor worker of the 1950s and 1960s, with a 40-hour workweek, three weeks of vacation, health insurance, a pension, and a salary that afforded a lifestyle that, for what had previously been the underclass (now turned middle class), reached an unprecedented level of material comfort.
Today, even the more libertarian-leaning, conservative Republican voters would not complain too loudly about the provision of a government-funded (if not necessarily government-provided) primary education, the principle of a two-day weekend, and basic safety-net provisions such as unemployment insurance, food stamps, some minimum level of medical care, or even Social Security (if not necessarily Medicare).
Thus, the Roosevelt government gets some credit for remedying this imbalance between the elite class and the working class that emerged during the 19th century.
However, none of these things fixed the economic problem either -- the problem of explosive increases in tariffs and taxes worldwide, combined later with "beggar thy neighbor" currency warfare. While welfare-type provisions such as today's food stamps can be very welcome in an economic downturn (and accounts for some of the popularity of the "interventionist" politices of the Roosevelt government), there is no way to paint this as an economic solution.
During the 1930s, two basic approaches to the economic problems evolved. They are actually quite ancient, but their popularity enjoyed a resurgence in response to the problems of the 1930s. These are a) government spending, on public works for example, and b) currency manipulation.
These two approaches have basically been a failure, giving interventionists a bad name. Government spending is really a sort of welfare program, and typically a rather expensive one at that. The spending leads to budget deficits, and the reaction to budget deficits is quite often higher taxes, which causes even more economic problems. You really can't "jump start" or "pump prime" an economy with government spending. Economies improve when their basic operating conditions -- taxes, regulation, money -- improve, or at the very least when they find a new equilibrium at a depressed level. All in all, some government spending of this sort can be worthwhile, as long as expectations are in line with what these policies can produce, and as long as the reaction to larger budget deficits isn't higher taxes.
There is probably not too much I need to say about currency manipulation as a means of economic management. It either does a lot of damage or a tremendous amount of damage, although the initial effects can feel good for a while.
We might add a final interventionist consideration, that of "systemic breakdown." This is economic damage of such an extent that it causes more damage to entities which may otherwise be in good shape. For example, there were many people in the 1930s who had accumulated savings for retirement or the economic rainy day. However, if their bank went bust, as many hundreds did, they were suddenly left with nothing. This led to such things as deposit insurance and Social Security. Or, if a company's bank went bust, they may be unable to pay bills and be forced to declare bankruptcy, even if their financial health was otherwise in good shape. There are a lot of "systemic" things related to the financial system, which is one reason I think that today's efforts to maintain financial system viability, as opposed to a "hands off" stance, are probably a good thing on balance.
Neither Mellon nor Roosevelt had all the answers. Today, we can summarize the best points of the Andrew Mellon approach as: "Keep taxes low, money stable, and regulation sensible, and the economy will naturally prosper (with some ups and downs)." The best points of the Franklin Roosevelt approach could be: "workers need fair treatment, some welfare-type activity is necessary, and the government has a role in maintaining systemic stability."
The present situation is rather unusual. Rarely does a credit boom reach such proportions that it threatens systemic stability. Nevertheless, government must deal with the cards they're given. Ideally, they will experiment with these positive approaches, rather than the policy mistakes of the 1930s, especially higher taxes and monetary instability.
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Is it hyperinflation yet? When does inflation become hyperinflation? There's no easy line -- it's mostly an "I know it when I see it" type thing. However, there is, actually, an official definition. SFAS 52 (an accounting rule) defines hyperinflation as a 100% increase in general prices (the CPI for example) over a period of three years. Using the Rule of 72, that works out to 24% per annum. We're still quite a ways from that.
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The World's Best Kitty Litter: Remember SWheatScoop? It's kitty litter made from pure wheat. (www.swheatscoop.com) I just can't help telling people about that one. But...is it still for sale? I figured that pure grain kitty litter might have disappeared by now. So, I was quite delighted when my wife came home -- just last week -- with another pure grain kitty litter. It's called World's Best Cat Litter. Yes, that's the name. (World's Best Cat Litter) It's made from 100% corn. Wow! I get tingles just looking at it.
Monthly CBOT corn.
Grain prices are going much higher.
I was inspired to send some $$$ to a charity organization. I distrust large organizations like Oxfam, so I found a little one: Bhaktivedanta International Charities. Their website is at foodrelief.org. They feed about 6000 families in rural India. I sent them enough to buy about 200 lbs of corn, which, even at today's prices, doesn't cost much.