What if I asked you to forget everything you ever learned about the Great Depression?
You’d say I was crazy.
But hold on for a moment and consider a slightly different perspective. A perspective that you won’t find in too many history books. And, quite frankly, a perspective that could allow your portfolio to be much better positioned for the years ahead.
After all, with everything going on the world and the repeated references to the “worst downturn since the Great Depression,” learning the lessons of history is probably more crucial to your investment success than ever before.
Nobel Laureate Peal S. Buck probably put it best, “If you want to understand today, you have to search yesterday.”
That’s why I’m eager to share with you a different perspective on the Great Depression today from Dr. Robert Murphy – a “politically incorrect” one.
Dr. Murphy is a former economics professor and author of The Politically Incorrect Guide to the Great Depression and the New Deal.
In an exclusive interview with Andrew Mickey, Q1’s Chief Investment Strategist, Dr. Murphy reveals:
- The single biggest thing that made the 1930’s so awful
- The true “cost” of the $787 billion stimulus program
- Why unemployment is on the verge of going higher than anyone expects
- How some investors were able to profit handsomely during the Great Depression
- The real impact of a 200% increase in taxes and why it could be coming again
All that and more is discussed below in this irreverent and thoughtful look at the Great Depression.
Andrew Mickey: The biggest concern on everyone’s mind, despite the anticipated recovery, is that we’re headed for a long recession or even a depression.
So what do you see? Depression or recession? Do you see any similarities to what’s going on now and the Great Depression?
Robert Murphy: I think a lot of it is similar of course. For example, you had the depression set in under Herbert Hoover who was Republican. And the charismatic Franklin D. Roosevelt (FDR) came in promising to fix things.
So naturally, you have that similarity where people think that George Bush’s policies caused all of the problems and Barack Obama is coming in to rescue us.
But ironically, another similarity is that actually what FDR did in the New Deal was not a dramatic shift from Hoover’s policy, they were just an extension of what Hoover had done.
So it’s a complete myth that people said Herbert Hoover did nothing and that’s why the depression got so bad. Actually Hoover engaged in unprecedented deficit spending for peacetime. The Federal Reserve under Hoover cut rates down to record low interest rates and they pumped in all sorts of money. Hoover established the Reconstruction Finance Corporation which tried to prop up banks that had made unsound loans, and he engaged in public works spending.
What Hoover did under his administration, the Hoover Dam for example, was just like our so-called stimulus projects.
Mickey: That sounds very familiar…
Murphy: Right, it is.
You see all types of things that they are doing now which is exactly what Hoover did and then FDR just amplified it.
So in terms of avoiding the mistakes of the Great Depression, what the government is doing right now is what the government did back then, when we got a decade of depression.
Mickey: Do you see that most historians and economists believe the government didn’t do enough in the Great Depression and that’s why we will take even bigger action this time around?
Murphy: That’s certainly what the conventional wisdom is. And that’s what Obama’s economic advisors are presently telling him and telling the press. They’re saying the reason Great Depression lingered for so long was that they weren’t aggressive enough.
But as I pointed out in my book, it doesn’t really make that much sense. Because by everyone’s account, presidents before Herbert Hoover had really done very little. When recessions or depressions hit while on their watch, they let the healing occur naturally.
So it’s ironic that the one time that the presidents in office really rolled up their sleeves and tried to use the power of the federal government to fight the downturn, is the same time when we had the worst depression in history.
Fast forwarding to today, whether or not you think it’s enough or too little, what President Bush and President Obama have done has been to use unprecedented amounts of federal intervention to try to help the economy. Still though, everyone keeps telling us this is the worst economy since World War II.
So it just seems to be a big coincidence that the more money the government spends and tries to take over the private sector that’s when we get a worse and a worse economy. And yet they keep saying the remedy is to do more.
Mickey: Still though, the market continues to rally. It’s up 50% from the lows and everyone – from politicians to Main Street – is watching the market very closely.
Do you see a potential impact of a strong stock market rally and the fact about 70% of Americans hold stocks and mutual funds now and in the 30’s it was closer to 3%?
Murphy: It’s certainly true that more people are involved in the stock market now, whether directly trading or because of the exposure they have in mutual funds and things like that.
So I think more Americans now are directly exposed to the stock market than was the case in the ’30s.
Mickey: Do you see this as helpful or could it make the situation even worse, or just as bad, as the Great Depression?
lf it were a 1931 kind of situation where all looks well, there are plenty of “green shoots,” and rising unemployment, then it would be a great time to get out of stocks pretty soon…
Murphy: Well, it’s true that if you look at the stock market level as it crashed in October of ’29. That was the great crash. The market fell something like 12% and 13% back to back. So that’s when everyone was panicking, people were literally jumping out of windows.
The early 1930’s was also the time Hoover called the big business leaders and told them not to cut wage rates. Initially, that’s what I think was the cause of unemployment going up so high. It’s the fact that the businesses wouldn’t let the wages adjust to the market level.
In any event, in the early 1930s the stock market did recover a lot of the lost ground. People at the time said, okay, we got through the storm and everything is behind us, and the ‘20s are now going to continue into 1930s.
And so they were lulled into a false sense of security…the calm before the storm, if you will. There were a few points during the 1930s when they finally thought they had hit rock bottom, and yet, they had no idea that the worst was still in front of them.
So I do think that the position we are in right now, people talking about green shoots and so on, and that maybe the economy has finally hit rock bottom, I don’t think it has. I think that three years from now people are still going to be saying, when are we going to get out of this thing?
Mickey: Right now, we’re being told at least, that we are seeing the impact of money printing, government spending, and other stimulative programs, but we know their effects are usually short-lived.
We’ve been through other economic downturns before. Bad ones too. The sharp recession of the 1920 to 1921 comes to mind. That was one that didn’t last long at all.
I know you’ve studied these quite a bit, so I’d like to ask, from a historical perspective, how long can the stimulus and all the extra spending keep things afloat and looking okay? Is there any historical precedent?
Murphy: It’s difficult to say because actually I would challenge the premise. I don’t think the stimulus is making things look okay; because, things right now are much worse than they were when they were arguing about the stimulus.
The only reason that we think the stimulus has cushioned the blow is simply because that’s what all the people who are passing it are telling us. If people remember when they were arguing about the stimulus they were saying things like, if we don’t do this, unemployment might get to 9%, but if we do this, it will keep the numbers below.
The current unemployment rate is above the number they said it would be if they did nothing. And this is the level given to their allegedly helpful stimulus. So of course, there is a new interpretation.
The people who pushed the stimulus said, well, the economy was worse than we realized so it’s a good thing we had that stimulus; otherwise, unemployment would be 11%. But as I point out in the book, it’s ironic that every time they put their policies through and things get worse, they assume it is because the patient was sicker than they realized. It doesn’t occur to them maybe it’s because the medicine they are giving the patient is making the patient worse.
I guess the way I would answer your question is to say that in earlier downturns, you mentioned the 1920-’21 depression, that was a very severe economic calamity. Unemployment went up to about 12% but as the name implies the 1920-’21 depression, it was over within two years.
Then we moved into roaring ’20s. And the reason I argue in the book that earlier depression was over so quickly was because the federal government really did sit back and do nothing, they actually slashed spending because this was right after World War I. The government cut its budget significantly and at the same time the Federal Reserve was hiking rates to stave off inflation, because they were trying to contain the price inflation from the war years.
It did the exact opposite of what we’re told are the correct things to do to cushion a downturn; and yet, that assured a decade of prosperity; whereas, in the early 1930s the government did the same thing the government is doing right now, and that of course assured a decade of depression.
Mickey: Interesting…so there is a pretty clear case to do the “wrong” thing.
With that in mind, what do you think of the public weariness of deficit spending right now?
In the Great Depression was there ever decline in confidence that the actual government programs will work as opposed to right now where we are still kind of in the period where belief that they will work is fading?
Murphy: I understand what you are asking, and to be perfectly clear, I am not exactly sure because it would be difficult to gauge what the average man thinks at various points in time. It’s hard to say, you know, you can’t read people’s minds. You could try reading the news from the time but how do you know whether they are accurately reflecting what the majority of people think?
What I will say for sure is that the government did have constraints on it but people were much wearier of deficit spending in the 1930s than they are right now.
So to give you an example, even at the height of FDR’s New Deal deficit spending, the budget deficit made up about 6% of GDP – at the most. Right now, this fiscal year the federal budget deficit is supposed to be about 14% of the economy and GDP.
So that shows how much they are borrowing and spending right now. It really is unprecedented for peacetime. So the government did borrow more during World War II, but in terms of just borrowing money to try to stimulate the economy, what they are doing now is literally unprecedented by a factor of two.
Back then there was this idea that they thought it was really reckless if the government borrowed a bunch of money and had no plans to pay it back.
Back then the idea was the government, I think, was more of a giant corporation in people’s minds and just like a corporation if it needs it, it can borrow money for something important but then it needs to pay off the debt. That was the mentality back then.
So the government ran huge deficits during World War I but then they started paying it off. Every year in the 1920s the government actually ran a budget surplus and paid down a portion of the national debt; whereas, nowadays for some reason or because of changing economics, I think people have this idea that when the government runs a deficit that somehow makes us richer. And if the government borrows and spends money it’s good for the economy. Whereas if Kodak or IBM is losing money and they borrow money to cover their costs, people normally don’t think “oh, that’s an economic sign of strength,” they think “that’s a sign of weakness.”
I think back in the ’30s most people still had the mentality that there isn’t anything special about government spending – it just uses up resources.
Mickey: Thanks for bringing clarity to the public acceptance of debts so far. That makes a lot of sense. Makes me think of the Vice President’s line about borrowing money to make money – or something like that – he’s tough to listen too.
Anyways, getting back to the Great Depression and how it relates to today, let’s talk about how the government actually gets its money to spend – taxes.
FDR launched a number of social programs. The programs were paid for by taxing the wealthy. So that’s one thing on a lot of people’s minds right now and that’s the current tax situation.
Do you have any thoughts here about how it all could play out this time?
Murphy: Sure, I mean there are a lot of economists who – when they try to understand why the 30s were so awful – think the single biggest thing was the tax policy. And actually again, to fit the pattern they have been telling you that it started under Herbert Hoover, a Republican.
In 1932, he signed in the law a bill that raised the top marginal income tax rate. It was originally 25% and in one year he jacked it up to 63%. That’s an incredible increase. It’s more than doubling the tax rate on the top earners in midst of the worst depression in US history. It’s no wonder to me that the following year, 1933, was the single worst year in terms of unemployment levels (they averaged 25%) and so on.
So in terms of whether raising taxes in the middle of a depression helped, they made the depression the worst it has ever been.
Then FDR came in and just continued the process. He let marginal rates go up to about 75% or so. And then, during the war years they went to ridiculous amounts like 92% on the top earners. So clearly, just naively looking at history and saying, what did they do in the depression, well, they jacked up taxes on the wealthy and we had the longest depression in US history.
So it takes us all back to what I am saying, everything they are doing now is exactly what they did in the 30s and why would we expect the results to be different this time?
Mickey: Exactly. And the recent minimum wage increase – is that another similarity or a potential mistake?
Murphy: Yes it is, but it’s a bit different. They did not have a minimum wage back in the early 30s, but they certainly did implement a high wage policy.
Right after the stock market crash in ’29 Herbert Hoover called all the big business leaders and he told them, don’t cut your wage rates, that’s the worst thing you could do. Because Hoover had this idea that if you pay the workers less, then they have less money to spend on products and that just causes a vicious downward cycle. And so businesses kept the wage rate that they paid their workers the same, and ironically, that actually is what caused unemployment to go up so high.
If you think about it, you had people who were paying workers, they weren’t spending money on other investments. They were pulling the money out of the banking system so the overall money supply was shrinking and prices were falling in general in the early 1930s. That’s why people now are warning us about deflation because that’s what happened in the ’30s.
The one price that wasn’t dropping year after year was the price of labor. Under Hoover’s policy, workers became more and more expensive compared to everything else. So it’s no wonder that businesses cut back in how much they hired.
That’s why unemployment went up to the record high levels of 25%; whereas, in other downturns that hadn’t happened because workers saw their salaries fall along with other prices in earlier points in US history.
And then under FDR he continued it through various mechanisms. The National Recovery Administration allowed businesses to set up what they call codes of fair competition. They raised prices and the unions were involved with that. So they raised how much pay union workers got and in various measures the New Deal implemented were very favorable to unions. This allowed union membership to grow and so it raised the wages in various industries. It’s not surprising that it took longer and longer for people to get hired again because the wage rate was much higher. The labor was artificially expensive so to speak.
Nowadays, that’s exactly what’s going to happen. What people need are jobs. With the minimum wage increase kicking in it’s going to be tougher to get a job.
So if you are someone who’s unemployed and you are looking for work, you are trying to find someone who wants to hire you. The government is saying, okay, someone who is going to hire you now we are going to insist they pay you more. So that makes it harder to get a job.
In other words, if you are having trouble getting a job don’t increase your salary demand, that’s not going to make you more likely to get the job. If anything, you would lower it.
So, yes it’s true, people who have a job and keep it, their pay goes up. That helps them but it makes it harder for people who are unemployed to get a job.
Mickey: Also, state governments at the same time, were they facing the same issues they are today? Obviously we have the massive pension liabilities and all that stuff coming up next, but were state governments in equally poor of a situation?
Murphy: I don’t know off the top of my head exactly what their levels and indebtedness and so forth, but they certainly – the governments across the board – did not take on as many responsibilities as they do nowadays. Certainly their spending as a share of the economy was much lower across the board back then.
It wasn’t even considered that the government at various levels was supposed to take care of your education and take care of your pension fund and all these other things. So you know those have evolved since then.
In fact, a lot of that was ushered in because of the New Deal era. But certainly, whatever the government’s budget traditionally had been, the revenues got hit during a massive economic downturn because people aren’t making as much money. So the income taxes are lower, property taxes are lower, sales taxes are lower and that’s really the problem. The one difference, of course, is that state governments, I think just about all of them, they are not allowed to even issue debt nor are they allowed to have a printing press the way the federal government does.
So I think that’s actually a good thing that sort of each of the state government is more honest this way. They really do need to live within their means, at least over the long run. So yeah, it’s true that the governments got some new authorities and responsibilities, but everyone had to cut back across the board just like they do now.
Mickey: During the Depression, were there any asset classes which performed exceptionally well or safe havens where people could actually keep their savings during those times?
Murphy: Yes, there certainly were. But it wasn’t like there was one particular thing that did well for the entire 1930s.
The stock market actually had some very strong runs. So if you were clever and timed it correctly then you could have made a fortune in the stock market. For example, right after FDR came in, stocks actually rebounded fairly significantly for a while until there was another major downturn.
One thing that people point to is gold. And unfortunately FDR confiscated it, but if you had been allowed to keep your gold that would have done well.
Originally, gold had been $20.67 an ounce. Basically, in the course of one year after FDR confiscated everybody’s private holdings of gold in 1933, he fiddled with the gold price before re-pegging it at $35 an ounce. A big jump in terms of how many dollar bills you could now fetch per gold ounce. So it went up significantly in a short period of time, but again, the government first made sure it held all the gold before it did that.
Mickey: What about real estate? Did anything else hold out well during those times?
Murphy: I am not sure of the specific ups and downs that real estate went through. But I don’t think that was necessarily a national trend during the 30s. Real estate during the 20s was actually booming. It was a booming stock market and the real estate boom actually popped around 1926 and then basically a lot of speculative energy went into the stocks as opposed to real estate.
So people were a bit wary about real estate, but I think that it did relatively well (prior to the government policies that were crippling the economy) in terms of putting your money somewhere or investing in things which are more tangible and less prone to the government’s interference.
Real estate or commodities was always relatively safer as opposed to putting your money in the stock market. But again it was tricky. You’ve got to be careful with the statistics because the government took the dollar off gold and so the rules sort of changed halfway through the game.
Mickey: Do you see any kind of silver linings in all of this, anything positive?
Murphy: Well, I think, yeah, in a sense because I see these major changes coming. People who agree with my analysis of the causes of the Great Depression are able to get in position to protect themselves.
So I think that yes, we are going to be in a very severe recession for several years to come, just from all the things that the government has done under Bush at the end of his term and now the Obama administration.
If you think that free markets work better than central planning then how can you not think we are in store for an awful economy for years to come?
In other words, the government has taken over so many different sectors, or they are in the midst of trying to take over so many sectors, that it has to hurt the economy for years to come. Otherwise, what’s the big deal whether you believe in capitalism or socialism?
And at the same time I think that there is going to be large price inflation. I don’t know exactly when it’s going to kick in, but I am sure your readers have seen some of these charts showing how much money Bernanke has pumped into the banking sector.
So far the banks are sitting on it. But I think that when this initial panic subsides a little bit more, and banks start lending money again, and interest rates rise a little bit, that money is just going to start flowing out and raising prices. So the sort of silver lining I suppose is if you are very cynical about government officials and you don’t believe Bernanke when he says, don’t worry, I have this inflation under control and I will pull out those reserves when the time is right, then you can prepare yourself and be ready for the coming inflation and know that the economy is going to be awful for years to come.
So I guess in that sense there is a huge movement coming. People who see it coming can benefit relative to everybody else who is caught flat footed.
Mickey: That’s a very interesting take – let your beliefs guide your investments. And if you believe the government can successfully operate, or de facto operate and control through regulation of the healthcare, automakers, banks, etc., then you’ve got to get ready for a true, long run recovery. Of course, the much more likely scenario is the exact opposite.
Aside from that, what are a couple of real indicators of why this recession is structurally different than, worse, and more protracted than the recessions of the early 1980s, the early 1990’s, and the early 2000?
Murphy: That’s a good question and there are a couple of things.
One sign is that my theory of the business cycle is that when the Fed cuts interest rates it pumps money into the system that it basically creates out of thin air. That pushes up the market. It causes a temporary period of prosperity, and then the bust period happens when the Fed puts on the brakes, raises interest rates, and people realize that with a lot of the projects they started there is not enough real savings to complete them.
So then they have to stop processes in mid-process, lay off workers and so on. And that’s basically what the business cycle is. So it’s not put in motion by the free market but it’s caused by the Fed manipulating things. So that boom-bust cycle that we just saw now, was one of the more severe ones in that the housing boom and the stock bubble were extremely amplified.
And so, I think the resulting downturn is going to be a lot more serious than it had been in previous ones.
On top of that, this time around, the government has literally done things that it hadn’t done since the 1930s. And that’s in terms of the Federal Reserve cutting the interest rate down to basically zero and that’s literally never been done. The lowest they went to was 1% during the 30s. And the Fed coming in and just guaranteeing and propping up all these investment firms.
We’ve also got the federal government directly taking over car companies, and owning shares in major investment banks and town banks, telling them what they can pay their employees, threatening to takeover healthcare, and putting a cap and trade system on the energy markets.
These massive interventions were not done in any post-war recession. And so, the ability of the economy to bounce back from the distortion that was caused during the housing bubble is being hindered and the government’s using it as an excuse to just grab all sorts of power. So that’s what I am saying, the private sector is not going to be able to bounce back from this very easily because the government is just coming in and basically crippling it and just taking as much as they can.
Mickey: Were government workers hit with pay cuts during the Great Depression? That’s kind of a hot issue right now with the combination of deficit spending, rising unemployment, and government workers still getting pay raises…
Murphy: Right. I am not sure if it was the case that someone who had a government position in 1929 and that person’s pay went down by 1935, but clearly the amount of people who were working for the government went way up in the 1930s, especially if you include the Work Progress Administration (WPA).
The government just expanded the number of people who were on public works assistance by basically hiring people to just give them a job to go build a bridge or fix up a school or pick up some litter. So the government did really expand how many people were getting money from the government’s “make work” jobs during the 1930s.
Of course the proponents of that say, that was a very good thing because those people were unemployed and otherwise they would have starved.
I argue in the book that’s one of the things that prolonged depression. Because how you get out of a depression is when people who are unemployed get jobs back in the private sector where they are doing something useful, and not by the government coming along and basically taking money from taxpayers then using it to pay people to go pick up litter, plant trees, and they are just sucking away, siphoning away resources and valuable labor from private sector outlets.
But that’s partly why the depression lingered on so long, it’s because the government came in and started sabotaging all the ways of the market to recover from the depression.
Mickey: That makes a lot of sense. There is one more thing…you mentioned the cap and trade earlier.
I know you’ve done some extensive research on that a few weeks ago. Do you think there is a way to quantify the impact of pending legislation on carbon emission? It’s a more complicated scheme which, as with everything else, will have some unintended consequences…
Murphy: I did a lot of work trying to show that the cost estimates they were using were actually very optimistic and are actually going to be a lot higher.
With the Waxman-Markey cap and trade bill, we were seeing things like the Congressional Budget Office come out and say that it was only going to cost an average family a few hundred dollars per year.
The way they came up with that number was a bit misleading though. Let me explain.
So let’s say that the government auctions off permits giving people the ability to emit carbon dioxide. Then the government has all this money from issuing those permits. And then the government goes and spends whatever, a $100 billion funding alternative fuel and spends money over here and spends money over there.
The CBO estimate counted those expenditures as going back in the households. I mean technically, no matter what money is spent, there is some household getting that.
And so when they were giving the price estimates of the impacts they were recycling all the money back into it. So by the gross numbers actually households are going to be paying about $870 a year in terms of higher energy prices. The reason the official number was only like $100-and-change is because they were assuming that households are going to get that money being spent on solar panels and so on.
So that’s one major way which was very misleading because when people heard that number, I think they thought, oh, my monthly electric bill is only going to go up $10 a month, but no, that’s not what they were saying, your bill is going to go up a lot but the money they are spending on politically favored groups that’s going to raise per capita income. So that was one thing that they did.
To you give a specific number, the Heritage Foundation came out and said that by 2030 the average US family of four would probably see higher energy prices, about $1500 per year. We don’t know what’s going to happen 20 years from now, but I think that that number was at least capturing what most people had in mind as opposed to the CBO number, which was adding in various things and I think it gave people a misleading idea.
Mickey: Very interesting. You’re right, the original cost estimates numbers didn’t seem too terrible, but when you add in the redistribution of wealth…it seems a lot more costly.
Finally, is there anything else or any sources where we can find more information on what we went over today?
Murphy: Well, in addition to my book, The Politically Incorrect Guide to the Great Depression and New Deal, I am also affiliated with the Mises Institute, it’s mises.org which is a great place for free market commentary. I also have a blog called Free Advice where I deal with all of these issues.
Mickey: Thanks Robert, I think you’ve helped provide a bit of insight into where we are, where we’re going, and what to do.
Murphy: Thanks, it was my pleasure.