Imagine a financial planner who tricked his or her clients into behaviors that were against their long-term best interests, encouraging them to spend, when years of overspending had left them in perilous financial shape, and scheming to have them sell their safe, conservative assets and instead, have them invest their funds in unsuitable risky assets. Furthermore, what if all this was done to save some financially dysfunctional individuals who had gained undue influence over the planner by liberally spending their ill-gotten gains? Ah, you get the idea. I’m describing the Federal Reserve’s policy of penalizing savers and propping up declining asset values for the sake of poorly managed dysfunctional banks. But, I’m told by some ‘sophisticated’ people that my analogy doesn’t hold water because the policies that are appropriate for individuals are different from the policies appropriate for an economy. The economy, after all, is so much more complex than an individual. But is this really true? Isn’t the economy just a large number of individuals interacting together? If all these individuals (and don’t forget, the government is also made up of individuals) were in good financial shape would not the economy also be in good financial shape?
Of course ‘sophisticated’ media pundits and economists alike, will have none of this, because if life were so simple they would not be employed in well-paid jobs explaining this so-called complexity to the untutored masses. This is one reason at least, why the reputation of Warren Harding, 29th President of the United States (1921-23), has been the subject of ceaseless ridicule at the hands of historians. President Harding also shared the ‘naïve’ view that what was prudent behavior for an individual was also prudent behavior for the country.
Although it is not well known, the depression of 1920-21, following the distortions in the economy brought about by World War I, was one of the most severe in American history. GNP plunged 24 percent and prices declined by 18 percent between 1920 and 1921, making it America’s worst one year deflationary shock in 140 years. The 36.8 percent fall in wholesale prices was even more severe, and was the worst since the American Revolution. Automobile production fell by 60 percent and total production fell by 30 percent, while unemployment rose sharply from 5.2 percent to 11.7 percent. Businesses that managed to avoid bankruptcy saw a fall in profits of 75 percent. All in all, this was the largest drop of business activity of any recession between 1899 and the Great Depression.
Secretary of Commerce Herbert Hoover (later President Hoover), entreated President Harding to implement many of the same measures that former President Bush and President Obama have endorsed. These included bailouts of the large banks and ‘too big to fail’ companies, more government spending, increased taxes on the rich, and support for labor unions and additional business regulations. However, unlike Presidents Bush and Obama, President Harding was firmly set on striking “the shackles from industry” and against high taxes and government waste, and so he rejected Hoover’s recommendations, doing the exact opposite of what Hoover urged. Harding curtailed government spending and regulation, paid off government debt, eliminated government agencies and reduced taxes rather than increasing them. The strength and speed of the resulting recovery surprised even Harding’s staunchest critics. GNP rebounded, unemployment fell to 6.7 percent of the labor force in 1922 and continued to decline reaching an extraordinary low of 1.8 percent in 1926. Within 18 months of Harding taking office the Roaring Twenties had begun, a period of sustained economic prosperity and unparalleled social, cultural and artistic dynamism.
Financial planning isn’t rocket science and neither is the work of the Federal Reserve. If I, as financial planner, cannot solve an individual’s debt problem by giving him another credit card, neither can the Federal Reserve solve the country’s debt problem by printing more money. As hedge fund manager Mark Spitznagel opined in the Wall Street Journal, the one economist who wrote the book on the subject of economic depressions continues to be ignored because he, too, had certain ‘naïve’ beliefs such as the need to encourage savings rather than consumption and the importance of letting businesses fail. Spitznagel concludes by saying “Must we sit through yet another performance of this tragic tale?”
“True, governments can reduce the rate of interest in the short run. They can issue additional paper money. They can open the way to credit expansion by the banks. They can thus create an artificial boom and the appearance of prosperity. But such a boom is bound to collapse soon or late and to bring about a depression.” Ludwig von Mises