Financial Crisis Report

No, we didn’t.

Although a high number of the comments made about the causes of the Financial Crisis suggest that deregulation and a lack of control of the economy by the government led to the current Financial Crisis, it is exactly the other way around. It is the same misconception that was commonly accepted in the 1930s regarding the Great Depression.

The development before the current Financial Crisis was very similar to the years before the Great Depression. Again it was not laissez-faire what happened during that time but a high level of government intervention. Government spending of the United States has been over 40 percent of the national income for several years before the crisis, whose effects were already explained in an earlier chapter. Further evidence that there was no deregulation is the fact that to the Federal Register of regulations were added some ten thousand pages since 1978, now counting more than seventy thousand.

The main cause of the Financial Crisis, however, is the same as the one of the Great Depression: A poorly thought-out monetary policy. That’s not surprising because the Federal Reserve System still exists and works more or less the same way it did 80 years ago. It is not only the System that has certain flaws though; it is also the unwise way it is used.

Although the US economy is based on a market economy and has a lot of capitalist structures, it was not predominantly capitalism that caused the crisis but rather the Government interventions in the market.

Uncategorized Deregulation, Financial Crisis, Government Intervention, Government Spending, Great Depression, Laissez-Faire

There has already been a depression in the United States of America in 1837, which is far less famous than the Great Depression for two reasons. The first is that it was a long time ago, so  people don’t put the long-past crisis in connection with the current Financial Crisis. The second, however, is a much more interesting reason with regards to this work. The depression of 1837 was a far shorter lasting Financial Crisis than the Great Depression, which might have to do with the way the government dealt with the situation.

The problem back then was that the banks abandoned the gold standard, which means that the paper money that was given out by the banks was not backed up by an equivalent amount of gold or silver anymore. A lot of depositors wanted to withdraw their capital from the banks at the same time, and these were not able to meet the demands and thus the banks went bankrupt. Once this happened to the first bank and people got to know about it, a real panic broke out. Everyone suddenly wanted to withdraw their deposits from the banks because they feared there wouldn’t be anything left when it was needed. Although the amount of money available might never have been a problem for most of the banks, it caused a severe crisis due to the panic-driven run on the banks due to a lack of trust to them.

President Martin van Buren, in contrary to what governments do right now or did in the Great Depression to get on top of the current crises, didn’t intervene in the economy and interestingly it recovered pretty soon; first improvements could be noticed at the end of 1838. Instead of injecting money into the economy to “save” it van Buren even immediately cut government spending by 21 percent. The fact there was no Goverment Intervention helped the economy to recover on its own.

Uncategorized Depression, Financial Crisis, Government Intervention, Great Depression

Obviously Hoover and the US government did not think that the Economic downturn and the stock market crash in 1929 were caused by too much government intervention and started intervening even more in the economy.

One of the early reactions to the Financial Crisis was the Smoot-Hawley tariff passed in June 1930, initially meant to protect American Farmers against imports from foreign countries but at the end including almost every industry. It “raised U.S tariffs to historically high levels”  and thus started a “trade war that greatly exacerbated the Great Depression.” The tariff rates on about 800 different items were increased pushing up the average rate to almost 60 percent and since other countries didn’t want their industries to have a disadvantage, they answered in the same way. International trade immediately decreased drastically so that in 1933 the volume was only a fifth of what is was in 1929.

Although tariffs might help certain industries or companies of a country, the economy as a whole can’t possibly benefit from them. While one industry is “protected” against cheaper imports, the consumer is harmed due to the higher price he has to pay for a certain product. He would have money left after buying the cheaper imports and spend it in a different way supporting another industry and increasing his own wealth. At the same time, another industry of this country that is especially efficient there and can provide a cheaper product or one of better quality could export more of its goods and create jobs.

Another misconception of Hoover’s, at least according to the advocates of laissez-faire, is that artificially high wages can maintain the purchasing power and stimulate the economy and thus also reduce unemployment. He “persuaded” companies not to cut wages and forced them to practice so called “work sharing”, which means having more workers that work less hours, and this at remaining wages. The effect was that “unemployment was just spread around”, because in times of an economic downturn wage adjustment is necessary for companies to stay in business. In times of increasing consumer demand, production and wages will increase, too.

Another attempt to maintain the purchasing power was public works spending, which was increased to 13 percent of the total Federal Budget under Hoover and even further amplified during Roosevelt’s term as president.  What most people forget is the opportunity cost of public spending. To get money for it the government has to tax, i.e. pull money out of the private sector, which decreases the purchasing power there and does not let the consumer decide what to use the money for.

While millions of people suffered from hunger during the Great Depression Hoover thought it was a great idea to create a Farmer cartel and artificially prop up food prices. Initializing the Agricultural Marketing Act, he founded the Federal Farm Board in order to help the depressed farming industry. On the one hand it subsidized all American Farmers, which, of course, was an incentive to grow more; on the other hand it cornered agricultural products to decrease the supply and increase the prices. The high prices were again an incentive for Farmers to grow more and to solve this problem Hoover paid Farmers not to grow anything. Altogether, this system swallowed a tremendous amount of money that could have stayed in the private economy boosting consumption and thus production.

Hoover’s successor Franklin Delano Roosevelt (1882-1945) wasn’t able to improve the situation, either. His so-called “New Deal” wasn’t new at all, for he continued Hoover’s kind of interventionism, only to such a high extent that parts of it were eventually ruled unconstitutional. He thought that the Great Depression was caused by too low prices and wages and so he started to dictate them above market value. The principle of supply and demand determining prices was completely abandoned through the price controls and the economic system was becoming very similar to the one of the Soviet Union. The economic dynamism was reduced further and the cartels and price controls left no room for competition that was needed to improve the situation.

Furthermore under Roosevelt the number of Americans employed in public work programs went up to some ten million. Nevertheless, the unemployment rate remained at around 20 percent until the end of the 30s. Although these programs offer jobs to some people, they harm the economy. Money had to be extracted from the private sector, which probably would have used the resources more efficiently and provided more jobs.

Recovery

The economic situation in the United States did not improve significantly before the end of World War II when finally a lot of Hoover’s and Roosevelt’s regulations were abolished. In 1946 the federal budget was cut by two thirds, giving a huge impulse to the private sector economy, whose production immediately grew by one third. From then on prosperity was installed again in the United States and the unemployment rate finally shrunk.

Uncategorized Financial Crisis, Government Intervention, Great Depression, Public Spending, Purchasing Power