Lecture 13. DEPRESSION, WAR, & POST-WAR STIMULUS

The Past is Prologue
Ordinarily, the GDP grows with workforce and productivity.
But market imbalances may cause a recession: a period of 
GDP decline or slow growth.  It is the cause, depth, and 
durability of this current recession that troubles us and 
our creditors. 
 
Recessions stimulate fear.  Fearing unemployment, 
consumers consume less.  Fearing unsold inventory, 
producers produce less, lay off workers, and increase the 
fear. Keynes called this downward spiral the paradox of
thrift, whereby individual frugality yields collective
poverty.  We are trapped in a gridlock and need a way out.
 
Usually, recessions end with the replenishment of 
exhausted inventory accompanied by the Fed's reduction of
the prime interest rate and other measures. Unfortunately,
this is not an ordinary recession.  Like the Great 
Depression, this crash brought not only the failure of our
financial system, but also a global collapse.  It is 
impossible to compare this Great Recession to any 
other post-World War II (WW II) recession. For example, 
interest rates are already near zero and cannot be 
reduced.

So, what finally ended the Great Depression and brought 
prosperity?  Not tax cuts, spending cuts, and 
deregulation.  Deficit spending!

The Great Depression
A 1929 stock market crash began the Great Depression. To 
gain a good understanding of a very complex subject, 
google it and look into Wikipedia. It has a thorough 
bibliography.

Here, we touch on the major points. As in all recessions, 
unemployment rose and a downward spiral began. For various
reasons, the downward spiral continued into a deflationary
stage that fed upon itself with widespread mortgage 
foreclosures of homes and farms. It spread throughout the
world and finally caused the collapse of the banking 
system.

Contrary to his reputation, President Herbert Hoover, a 
Republican elected in 1928, was a devoted and effective 
public servant. He was quite progressive in several ways: 
he was for national parks and regulation and against 
laissez-faire. Today, he would be to the left of "Blue 
Dog" Democrats.

As the crisis mounted, he promoted various infrastructure
projects, including the Hoover Dam, which was initiated by 
President Coolidge. He also initiated important federal 
administrative programs that were continued under FDR. But
it was never enough.
 
At that time, economics, as a science, was not equiped to 
deal with the depression. The lack of economic measuring 
tools led Hoover and the Federal Reserve to restrict the 
money supply when it should have been expanded.  Insisting
upon a balanced budget with declining revenue, Hoover 
pushed a tax increase through Congress. He signed 
the Smoot-Hawley Tariff Act to favor US production, but it
only stimulated retaliation by other nations. 

Favoring private charity and volunteer efforts, Hoover was
philosophically opposed to federal spending for direct 
federal relief for individuals. As the 1932 election 
approached, bank failures destroyed his popularity and 
chances for a second term.

This period of history, including World War II (WW II), is
one of much controversy between pro- and anti-Keynesians. 
In non-technical language, the anti-Keynesian position 
most touted by conservative politicians is “The 
Forgotten Man: A New History of the Great 
Depression” by Amity Shlaes (HarperCollins, 464 pp.,
$26.95).

For the non-technical, pro-Keynesian position, the easiest
reference is Jonathan Chait’s review of Shlaes’ book,
published in The New Republic: Wednesday, March 18,
2009 and available here.

The essential point to remember is that without 
sufficient federal stimulus, the unemployment rate climbed
and the GDP dropped continuously to one third of its peak
value over a three-year period.

Taking office in 1933, Franklin Delano Roosevelt (FDR)  
faced 25% unemployment. His economic team included both 
Keynsians and anti-Keynesians (as we would call them now),
with the result of vacillation between policies. With 
deficit spending, “Big Government” hired three
million workers directly to build federal offices and 
improve national parks.  The army-managed Civilian 
Conservation Corps planted 2.3 billion trees.  Huge dams 
electrified rural America.

By 1937, the unemployment rate was below 15%.  But that 
year, inflation fears induced Congress, FDR, and the Fed  
to decrease spending, to increase taxes and the interest 
rate, and to otherwise impose so much austerity that the 
unemployment rate climbed again. In 1939, when WWII began,
it was over 17%.

Also taking office in 1933, Hitler (the first 
Keynesian!?!?) ended Germany’s depression by 1934 
with work on the autobahn and other infrastructure.  
Because FDR’s opponents did not let him spend enough
on infrastructure, our Great Depression dragged on until 
WW II began.  The normal growth of technology and 
productive capacity was so stunted that our industry was 
not as well prepared as it should have been in 1942 to 
produce the armaments needed for victory.

Facetiously, Keynes joked that if the government paid 
workers to dig ditches and refill them, the entirely 
wasteful spending would nevertheless stimulate the 
economy.  It was not a joke!  WW II became a huge 
Keynesian ditch with four years of enormously wasteful 
spending, but also with full employment.  Result: 
returning war veterans and war-workers and farmers 
exchanged “Victory”; bonds for cars and homes,
turned old farms into new suburbs, and created the baby 
boom.

Wartime deficit spending finally ended the Great 
Depression and began 35 years of growth without serious 
inflation.  Deficit spending worked!  That is historic 
fact, not textbook theory!

In his Labor Day, 2010, NY Times column,
Nobel laureate Dr. Paul Krugman describes the political
strife and the results of deficit spending during WW II.

How did they do it? International Economic Law Professor 
Timothy A. Canova of the Chapman University of Law in 
Orange, California, describes the strategy of Marriner 
Eccles, the Fed chair in the 1930s and 1940s, here. (A 
hat tip to The American Prospect blog.) Eccles guided
FDR out of 25% unemployment and through WW II to a
flourishing post-war economy.

This was a period when government spending and the DR were 
almost twice today's and the federal deficit was over 
three times today's. This is exactly the strategy we need 
today.
What If ?
And if all that wartime deficit spending could instead 
have been used to upgrade our infrastructure, we would 
have gained an immense national wealth while ending the 
Great Depression!

Just imagine that, with the same expenditure, FDR had 
built, during the four-year period 1934-1937, interstate
highways and modern railroads, airports and seaports, 
water and sewer systems, levees and dams, and laboratories
and arsenals.
 
And imagine also that, during the same period, 16,000,000
youth were paid to learn trades, engineering, and science
at free schools and universities instead of being paid to
go to war.  What would have been the result?

The Great Depression would have ended in 1934. By 1938, 
the DR would have been the same as it was at the end of 
the war.  Consumers would have had as much savings, enough
to buy cars and homes and turn old farms into new suburbs.
We would have been better set for war and many of our 
dead heroes would have survived and returned to a far 
richer nation.

Only the blind stupidity of the deficit hawks kept much of
that dream from being real.
The  Success of Post-ww II Stimulus
Absolutely none of the huge debt accumulated during the 
Great Depression and WW II was ever reduced because 
stimulus spending did not stop on VJ (Victory over 
Japan)-Day.  Instead, rural America was modernized and our
South was air-conditioned by spending for the Veteran 
Education Bill, the Veterans Housing Bill, the Marshall 
Plan, rearmament, wars in Korea and Vietnam, proxy wars in 
a dozen small countries, NASA, and the Interstate Highway 
System.

We grew out of our WW II debt and were enriched by 35 
years of mostly hot and cold war-related stimulus 
spending. Another wasteful - but stimulating - Keynesian 
ditch!
Proceed to:
Lecture 14. RECENT DEBT HISTORY
Thanks for your interest.
  Marvin Sussman, retired engineer

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