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

Hoover, however, thought exactly the opposite way, that a “government-supervised monopoly power” would be more efficient than the invisible hand Adam Smith (1723-1790), the Scottish economist that is often called the “Father of Economics”, is talking about in his book “The Wealth of Nations”. This is the theory that the system of supply and demand is the only one that is able to guide a modern and innovative economy with all its complex and dynamic structures.

Among other industries Hoover strongly regulated broadcasting, which, he thought, couldn’t develop well enough without the hand of the state. Besides, he wanted to see less commercial ads, which, of course, made radio stations less profitable. He forced the corporations of this industry to share their technological information and granted subsidies to the giants in this business. Furthermore, he expanded his department’s influence on the program and other decisions and reduced the amount of advertisements. With all this he more or less created a broadcasting monopoly, which through the Anti-Trust law is actually forbidden to every industry and which neglected the smaller competitors. These then had no chance to survive and the employment rate of this industry decreased drasticly. This is only one example of a monopoly created by Hoover in order to eliminate “destructive competition” but the same style of interventionism Hoover employed in a bunch of other industries like the oil industry, the farming industry, airlines, railroads and so on.

Too much goverment interference

Besides, Hoover interfered with labor relations to a high degree by means of different laws “in favor of the working class”. For example, he got through the time-and-a-half pay for overtime, which again doesn’t have to do anything with capitalism. Naturally companies try to avoid having anyone work longer under these circumstances and those who favor the Austrian school of economics would argue that this takes away the opportunity to increase one’s own wealth by voluntarily working longer from those who are very ambitious.  Consequently the economic potential is reduced. Another regulation that opposes the ideas of capitalism is the Railway Labor Act passed in 1926, which says that the government plays a big role in solving disputes between employers and worker’s unions through the newly created National Mediation Board.

Up to now, I described several factors that certainly slowed down the economic growth but probably could never cause such a breakdown of the economy. The main cause of the Great Depression surely was the Federal Reserve System and its monetary policy, which I will come to in a later chapter.

Although this was only a slight glance at the policy before and during the Great Depression, we can now answer the question whether it was caused by capitalism or not. Paul Johnson summarized the answer to this question in one perfectly adequate sentence:

The Great Depression was a failure not of capitalism but of the hyperactive state

Since there was no capitalism it is simply impossible that it could have caused the Great Depression.

Uncategorized Capitalism, Great Depression, Monopoly, Subsidies, Supply and Demand

Capitalism

It is a commonly held belief that the Great Depression was caused by capitalism, which is “an economic system based on the private ownership of the means of production” which “also promotes a free market regulated by supply and demand.” Opponents of the Austrian economic school of thoughts, which was founded and developed by the three Austrian economists Carl Menger, Ludwig von Mises and Friedrich Hayak on the principles of capitalism, say that capitalism “suffers from certain inherent weaknesses” and “is by its very nature unstable.”

Therefore, according to them, in a free market economy a cycle of ups and downs is inevitable and occasional economic downturns like the Great Depression are the consequence. In the following I’m going to examine whether it is true that capitalism is to blame for the Great Depression and, if not, which the real causes were.

Laissez-faire or overregulation?

The person who made most of the important decisions regarding the economic policy in the 1920s and early 1930s in the United States was Herbert Hoover (1874-1964), first as secretary of commerce (1921-1929) and afterwards as president of the United States of America until 1933. He belonged to the Republican Party and was said to follow a policy of laissez-faire, which is hard to believe for me, knowing that the commerce department’s budget had more than doubled under Hoover and the number of bureaucrats also increased. Now, let’s have a look at what Hoover’s policy was like indeed:

From the day of his assumption of office Hoover started to regulate a lot of industries with the aim to reduce “destructive competition”. This way of thinking already shows that Hoover’s policy had nothing to do with laissez-faire, because the competition provided by a free market economy is characteristic and elementary for the Austrian economic school of thoughts. It is one of the most important capitalist lessons that competition is the source of any imaginable wealth, since wherever there is competition in the economy, companies will struggle for the consumer’s dollar by providing a better or a cheaper product for the consumer, this again leads to the incentive to innovate products and production methods. In short, competition makes companies more efficient and thus creates jobs and great prosperity.

Uncategorized Capitalism, Great Depression, Laissez-Faire

The Great Depression is the most famous example of a worldwide economic downturn in modern history. It was preceded by a time of great prosperity and satisfaction among the population of the United States and a lot of other countries predominantly from the western world; therefore it was called the Roaring Twenties. As we will see in this chapter and in chapter 5 this wealth was of very artificial nature and unsustainable because a stable base was missing.
 

Uncategorized Great Depression, Roaring Twenties

Since not only laymen but also experts in this field are talking about the chance of another Great Depression, I’m going to start my work examining the course of the Great Depression of the 1930s. Then I also want to take a glance at the depression of 1837, since it shows up a different way of dealing with a depression of major significance. Finally, after having dealt with these two crises, I want to see which aspects regarding both the causes of the depressions and the reactions to them that could also apply to the current Financial Crisis.

With good reason I will especially concentrate on banking and the Federal Reserve System and determine where the flaws of the whole system are. To find out some of the mistakes that were done during the 1920s and 1930s I will mainly refer to Thomas J. DiLorenzo’s “How Capitalism Saved America”, which includes two chapters about what went wrong before and during the Great Depression.

Furthermore, I’m going to evaluate the different actions and ideas of politics during the Financial Crisis regarding their practicability, their prospects of succeeding and their fairness to different groups of people. Here I will refer to several newspaper articles and Henry Hazlitt’s “Economics in one lesson”. Finally I will discuss how such crises might be prevented in the future.

Uncategorized Depression, Financial Crisis, Great Depression

Is the concern about another Great Depression realistic or do people panic without a reason? The fact of the matter is, anyhow, that a lot of those who wanted to save money for old age by investing in stocks have lost about everything and even people who saved money at the banks are worried about not getting it back, or at least not all of it. And this is not nearly all, since a lot of companies will have to dismiss workers because of the Financial Crisis and therefore a large number of people fear to lose their jobs.

The more severe the current Financial Crisis becomes the more enthusiastic people look for a scapegoat and the easiest way to find it is believing the media that have been telling us about the managers and supervisory boards having done a bad job and capitalism making it possible. I don’t want to deny those mistakes but I believe that this is only a little part of it and by its own could never cause a Financial Crisis of such an extent. That’s why I want to go deeper into all the different causes of the current Financial Crisis, which everyone should know about before making hasty judgements and above all, I want to find out whether the Financial Crisis is a product of capitalism.

Of course, the whole situation gives grounds for harsh discussions about how to deal with the current problem not only to politicians but also to big parts of the population of all the countries that are affected. Governments all over the world have already passed reflationary programs, which are approved of by some experts but sharply criticized by others. They are very expensive for the tax payer while their effectiveness is questionable. Is it right to let the tax payer pay the bill for the mistakes that have been made? Is there any other choice at all? Is a solution that helps the economy particularly well preferable to one that distributes the burden in a chiefly fair way? How far is it possible to have both at the same time? And finally, which is the most effective, the fairest, the best solution? These are the questions millions of people take a close look at these days and so do I in this work.

Uncategorized Capitalism, Financial Crisis, Great Depression, Reflationary Programs

Here you will soon find a detailed report and discussion about the current Financial Crisis.

I’m working on a paper for school and want to publish it when I’m done. It will include a description of the course of events before and during the Financial Crisis. Furthermore I’m going to compare it with the Great Depression of the 1930s and point out the parallels between theese two economic crises. Finally, There will be a discussion about different possibilities to deal with the crisis.

If you’re interested in this topic, just visit FinancialCrisisReport.com again in a couple of weeks.

The Financial Crisis Great Depression