Great Depression Income Tax Hikes

In my last blog, I discussed how government inaction concerning bank failures helped to turn the recession of 1929-30 into a Great Depression. This time I want to focus on how tax hikes helped that occur.

Nowadays, almost everyone recognizes that the last thing you want to do in the middle of a recession is raise taxes. However this is exactly what occurred in the 1930s and helped prolong the Great Depression.

With one or two brief exceptions, the income tax only got started in 1913. It started with a top marginal tax rate of 7%. It went much higher during WWI to fund the war, but dropped to 25% throughout the economic boom of the 20s.

In 1932, Hoover and a Democratic Congress raised the top marginal income tax from 25% to 63%, more than a double increase. In addition, the income tax was increased at all marginal rates on everyone. The idea was to increase revenues to meet the increased spending the government undertook to meet the economic crises. It didn't do that - as government revenues went down, government spending went up, and the deficit continued rising.

Roosevelt with a Democratic Congress raised the top marginal in 1936 to 79%. This meant if you were in the top income tax bracket, for every extra dollar you made, you had to pay 79 cents to the federal government. In addition, corporate tax rates as well as capital gains rates were raised in drastic measures. An investor has to consider all of these taxes, as well as taxes on the state level, which were also raised during the Great Depression, before making investments.

When the government raises top marginal to such rates, it makes investors much more reluctant to invest in economically efficient investments. Instead, they tend to spend their time and money hiring tax lawyers and accountants to find economically inefficient investment tax shelters so they don't have to pay such high taxes.

Capitalism needs investors who invest capital in economically efficient investments that create wealth, jobs, and goods for the general economy. When the government raises taxes to high rates, it discourages these kinds of investments, and an economy stagnates, eventually hurting everyone in the economy. While the government had good intentions to balance the budget, because of the increased spending to meet the needs generated by the economic downturn, I believe the extraordinary tax increases in peace time helped to turn the recession, along with other government actions or inactions I discussed in this blog, into a Great Depression and prolong it.

Great Depression Bank Failures

In my last blog, I focused on how government attempts to protect the economy from foreign competition helped turn a recession into the Great Depression. Now I want to focus on how government inaction further helped take the economy in this direction. This time I will focus on bank failures. But first I need to explain how the government got involved in this arena.

In 1913, the government established the Federal Reserve Bank to be the lender of last resort. This means that the Federal Reserve stands ready to lend a bank money in an emergency bank run when no one else would. Before this, banks banded together in associations to rescue each other in the event of a bank run. Clearinghouses, which cleared bank checks also took up this role. A bank run occurs when depositors panic all at the same time and run to the bank to withdraw their deposits. Since a bank never keeps all the deposits, and lends out most of the money, a bank run can destroy a bank unless some entity steps in early and provides enough cash to convince depositors that the bank won't close and their deposits are safe. The government took over this role in 1913 when they established the Federal Reserve system.

Now banks fail every year. However, the number of bank failures doubled in 1930, and then doubled again in 1931. On December 10, 1930, a run started on one of the largest banks, the Bank of United States in New York. The next day, December 11, 1930, it failed. The Federal Reserve, still relatively new, did not act to save it. When people heard that a bank as large as the Bank of United States failed, they feared the money in any smaller bank where they held their money could not be safe. It triggered a run on banks across the nation and more and more banks failed. As a result, the money supply across the nation fell by about a third, and the private sector lacked the money to recover from the recession. This is because in economic terms, banks create money as they turn a percentage of deposits into loans. As banks failed, not only deposits were lost, but the money created through loans were lost.

Had the Federal Reserve stepped in and saved the Bank of United States, and then other large banks, it is unlikely the panic that ensued would have happened. The Federal Reserve should have done so because it had taken over this function from the private sector. Had it done so, it could have prevented the large scale bank runs that followed and the fall in the money supply. The economy would likely have recovered on its own as usually occurs in a business cycle. However, this combined with the slowdown in worldwide trade from the increase in tariffs from the Smoot-Hawley Act (see 2/8/08 post) helped to spiral the recession down into the Great Depression.

The bank situation, as well as the money supply began to get better by 1934 after the bank holiday imposed by President Roosevelt in 1933. However, by that time, most of the damage to the banking system and to the money supply had been done and helped to turn the recession of 1929-30 into the Great Depression.

Great Depression Start?

How did the Great Depression start? Most of us learned in school or elsewhere that the stock market crashed one day in 1929, rich investors whose fortunes went into free fall started jumping out of buildings. and as a result the economy tanked in short order - thus kicking off the Great Depression. This proved the free market either did not work, or could not be counted on, or inevitably led to such a disaster sooner or later. The truth is not only more complicated, it starkly different.

The stock market did lose 90% of its value in the Great Depression. However, this did not happen in one day. The Dow went from a high of 381 on Sept. 3, 1929 down to a low of 41 on July 2, 1932 - a span of almost 3 years. A lot happened between then. In fact on June 30, 1930, almost a year after Black Tuesday, the Dow stood at 244 - almost the same level it stood on October 1, 1928 when it stood at 240.

The stock market slide began on October 24, 1929, less well known as Black Thursday. The Dow initially fell 33 points. 11 investors committed suicide. However, large banks intervened, and the Dow only lost 6 points that day.

The following Monday and "Black Tuesday", the Dow fell from 298 down to 230, a 68 point drop known as the Great Crash. By Nov. 13, the Dow had hit a low of 198. However, by April of 1930, the Dow was back up to 291, wiping out the losses back up to the level before Black Tuesday.

During the ups and downs, Congress debated enacting a tariff increase to give American products an advantage in American markets. At first, the tariff was to be limited to farm products. However, on October 24, 1929, Black Thursday, it became clear the tariff would be expanded to many products beyond agriculture. The debate went on, back and forth till June 14, 1930 when President Hoover announced he would sign the Smoot-Hawley tarriff law whereupon the Dow began its steady descent to 41 two years later without recovery.

Economists had begged Hoover to veto Smoot-Hawley. They foresaw that such a protectionist measure would surely only lead to retaliatory protectionist tariffs by other trading partners, which is precisely what happened. Once Smoot-Hawley became law, our trading partners soon followed in retaliation by raising their tariff rates on a host of products they wanted to protect within their borders. World-wide trading came almost to a standstill, greatly contributing to a world-wide depression. Investors, seeing this was coming, began to leave the stock market as well as other types of investments. This in part turned what started as a recession into a full-blown depression, though other causes contributed which I will explore in future blogs.

The great economic expansion of the 1920s had to come to an end at some point as the economy went beyond its own capacity. However, it appears that government action helped to turn what should have been a healthy recessionary correction into a full-blown depression. The stock market anticipated the economic downturn, and then panicked as it became clear that the government would, and then did, take action that while intended to protect the American economy, wound up slowing down world-wide trade which precipitated a world-wide depression.

Out of the Silent Planet

In a previous post, I wrote about the friendship between C.S. Lewis and J.R.R. Tolkien. (Oct. 20, 08.) In 1936, they flipped a coin at Magdalen College. They had decided they themselves had to write the quality adult fairy tales they so wanted to read. Heads and Tolkien would write a time travel and Lewis a space travel. Tails and they would switch. The coin turned up heads. Tolkien eventually wrote The Lord of the Rings trilogy as the time travel tale. Lewis wrote Out of the Silent Planet as the first part of his space travel trilogy.

Up till the 1930s, the most famous science fiction book was H.G. Wells' 1898 book, War of the Worlds. Wells presented extremely scary alien Martians out to invade and take over planet earth, and terminate any human life that got in their way. Orson Wells produced a radio drama broadcast on October 30, 1938, the day before Halloween. The broadcast on the Mercury Theatre on the Air literally scared people to death. Though the broadcast was clearly identified as a radio broadcast four times during the hour long broadcast, people listening believed it was a real event because of the news bulletins in documentary style that Wells innovated as part of the radio play. You can listen to the broadcast at a website devoted to Mercury Theatre broadcasts. http://www.mercurytheatre.info/

In sharp contrast, the aliens in Lewis' Out of the Silent Planet are good, caring, and even altruistic. The book was published in 1938, the same year as the as the War of the Worlds radio drama broadcast. The aliens are also Martian. However, they do not come to earth. Instead, earthlings go out of Earth (the silent planet - called Thulcandra on Mars) and go to Mars (called Malacandra on Mars). Earth is the silent planet because no one has heard from it since its Oyarsa, its spiritual ruler (Satan) led it in rebellion against the "old one" - the creator, a fate Malacandra has not undergone. This explains why the Malacandrans are essentially good - they have not undergone the fall. In contrast, the earthlings come to conquer Malacandra, with the exception of Ransom, the protagonist in the book.

Elwin Ransom bears an uncanny resemblance to Tolkien. He is a philologist and a fellow at Cambridge College. Elwin means elf-friend. Ransom thrills at meeting the Malacandrans, after overcoming his initial fear, and learning their language. Just as Tolkien developed a language for The Lord of the Rings trilogy, Lewis develops a language for his space trilogy. Ransom loathes his fellow earthlings who treat the Malacandrans as native children ripe for colonizing, though he eventually identifies with them enough to choose to make the return trip to Earth with them.

While traveling between planets, Ransom finds that instead of space being a cold, empty void, he feels invigorated and that it is full of light and energy. The side of the spacecraft facing the sun is in fact very warm. I find this interesting because scientists today think of space being full of dark matter instead of void space.

In this book, Lewis fully explored his imagination, his faith, and his desire to challenge modernity, and took us along for the magnificent journey of discovery.

How Does an Economy Turnaround?

How does an economy turnaround? That is the big question in Washington D.C. and around the country. Some say it is infrastructure spending while others say it is tax cuts. Usually the entire debate is focused around what will stimulate the economy enough to lift it out of the recession we are in. Of course this assumes the government must do something to turn the economy around, and that without government action, the economy would simply continue in a downward spiral. At least that is how a lot of the discussion goes.

Of course the flip side of the question is how does an economy go into a recession in the first place? If the question is asked at all, the answer usually finds a nefarious actor to blame. During the recent political campaigns, the candidates usually blamed greedy Wall Street types. Many blamed the former President and his political party - usually ignoring that the other political party controlled the Congress since 2007 - which actually sets the federal budget and makes law. It sort of begs the question whether a nefarious actor has to be found to blame at all for the variations of the economy. Do those nefarious actors get credit when the economy does well? Usually not. Besides, different parts of the political spectrum have their own nefarious actors to blame, lambast, and ridicule. It usually only adds to the acrimony in politics rather than help to solve any problems.

Another way to look at recessions, recovery from recessions, as well as expansions of the economy is the business cycle. Just as there are cycles for many things, including the seasons, there is a business cycle for an economy. In general, economies tend to expand for a certain time, peak, then start to contract, bottom, and start recovering. Sometimes the cycles are longer and sometimes they are shorter. Usually when economies are expanding, they reach a point when they have outpaced the capacity of that economy to continue expanding, and the economy has to contract. It usually contracts until the forces in that economy are in a state to expand again, which is usually called a recovery. Hopefully, the economy continues to rise overall from one cycle to the next. The business cycle usually occurs without any action from the government. This means the government does not have to do anything for an economy to recover. It usually happens all on its own.

Of course politicians do not like to say this. They are elected to do something, especially when an economy takes a downturn. They like to indulge in big talk about how they are going to take action to turn the economy around, even though it will likely do so all on its own. I think the government can help in an economic downturn, as long as the actions it undertakes helps the recovery that usually already occurs all on its own. The government can also help those hurt by the downturn, since the churches, charitable organization, communities and families who usually help are also hurting. This is similar to the field of medicine where the best cures work with the natural ability of the body to heal itself. What I worry about is that action by the government can work against the natural ability of the economy to recover from a downturn and thereby extend the downturn -possibly even turning a recession into a depression, which is simply an extended recession.

A lot of scholars are reexamining the Great Depression to determine if this happened. They are examining actions by the government under both President Hoover and President Roosevelt to determine whether government action extended the Recession of 1929-1930 into the Great Depression which did not end until the start of World War II. I think this is a worthwhile study that is very relevant to our current situation. I will discuss their research and conclusions in a following post, perhaps the next one, though I have wanted to do one about Out of the Silent Planet for a while.

Infrastructure Spending

Many currently advocate spending on infrastructure projects in order to recover our economy from the Recession it is in, and to prevent it from getting worse. Traditionally, States and local governments fund most infrastructure projects. I favor such spending by State and local government, often financed by government bonds. However, from a historical perspective, Federal infrastructure spending has not recovered an economy from an economic downturn. The Great Depression provides a classic example of this.

As the Recession started around 1930, the government under President Hoover, started spending more on infrastructure programs such as the Hoover Dam, among others. By 1932, government spending increased by 50%, a huge increase. However, this increased spending did not turn around the Recession, which then became the Great Depression.

When Franklin Roosevelt became President in 1933, he launched many infrastructure projects under various new federal programs. He increased federal spending even higher in an attempt to bring unemployment under control. Even with all that spending, unemployment never fell below around 15% until 1941, well into World War II - a rate we today would find an unacceptable tragedy.

1929 - 3.3% 1930 - 8.9% 1931 - 15.9% 1932 - 23.6% 1933 - 24.9% 1934 - 21.7% 1935 - 20.1% 1936 - 17.0% 1937 - 14.3% 1938 - 19.0% 1939 - 17.2% 1940 - 14.6% 1941 - 9.9% 1942 - 4.7%

There are other examples in history, including Japan in the 1990s which launched massive infrastructure spending to turn around its economy, only to wind up with massive yearly deficits, and an economic doldrum that was called The Lost Decade. There are several reasons why massive infrastructure spending does not turn an economy around. One of them is the lag time for infrastructure projects to get going, and to put money in the economy. The Congressional Budget Office yesterday published a preliminary report about the proposed infrastructure spending, and noted that most of it won't be spent and get into the economy before a recovery is already underway. We should be cautious before generating deep deficit spending using this approach to try to turn the economy around.

The Great Depression Again?

Lately, some compare our current recession to the Great Depression. Ben Bernanke, the Federal Reserve Chairman, and a student of the Great Depression, addressed this at the Austin Chamber of Commerce. He said there was no comparison between our economy and The Great Depression - where unemployment peaked at 25%, the GDP lost about one-third, about 50% of homes foreclosed, around 1 out of 3 banks failed, and the stock market lost about 90% of its value. In contrast current unemployment is at 7.2%, the GDP lost 0.5% in the 3rd Quarter, the stock market has lost about 40% of its value, and the foreclosure rate is around 1 percent. Even if unemployment becomes worse in the coming months, and GDP loss grows, it is unlikely we will reach Great Depression levels.

Others say it is the worst recession since The Great Depression. However, since the Great Depression, we have had 11 recessions according to the National Bureau of Economic Research (NBER). The worst unemployment during those recessions was a peak of 10.8% during the 1981-82 Recession. The worst quarter GDP loss was a 10.8% loss during the 1957-58 Recession. At the current moment, we are still over 3% away from the peak worst unemployment, and 10.3 % away from the worst GDP quarter loss. (See update.)

Yet others say our recession could become the worst one since the Great Depression. We don't know that yet, and it is speculation at this point to so predict. Those who do so mostly want to justify an extremely large government spending program to address the situation they claim. This doesn't mean we are not facing a serious situation, but overexageration of how bad it is does not help, and can make the situation worse as consumers hold back on spending and investors hold back on investing.

What is true is that we are in the worst financial crises since the Great Depression. We are still in the midst of a collapse of housing bubble, which has far reaching effects in our financial institutions, resulting in their collapse. In the Great Depression, the relatively new Federal Reserve failed to take action to save collapse of major financial institutions, which led to a run on many banks. The resulting decrease in the money supply helped to turn an initial recession into a great depression.

This time, both the Fed and the Treasury, with the help of TARP, have flooded financial institutions with money to keep them solvent and liquid. This should keep the recession from turning into a depression as in 1930, though more has to be done, which is why the 2nd part of TARP was approved. However, the current recession is not yet the worst recession since the Great Depression. Saying it is so just to justify large government spending programs is not true, at least not yet. Basing a large government spending program on this basis is less than honest. Those doing so most likely favor large government spending programs anyway. The problem is the proposals so far will increase the deficit to about a staggering $2 trillion dollars for this fiscal year, making any past deficit look almost trivial in comparison.

The Scientific Method

Modern Science is based on the scientific method. Basically hypothesis are tested in experiments. Observations of the results are recorded and then compared with the hypothesis. The results and conclusions have to be repeatable. In other words, the same experiment should return the same results and conclusions by any other scientist conducting the same experiment any where and any time, as long as all the other conditions are the same.

However, the scientific method has to be seriously questioned under the many worlds theory with parallel universes - which I discussed in my November 13 post. This is because you could have one result in one universe, and an entirely different result in another universe. This is similar to the suicide scenario theorized among scientists who explain parallel universes. In one universe, the person with the gun lives, while in another universe, he commits suicide. This can be translated into many other situations, including whether a couple goes out and gets married, etc. This theoretical possibility means no scientist could rely on their observations of the results of an experiment, because in a parallel universe, the result could be entirely contradictory. The theoretical ramification could be the complete collapse of modern science. This all results from the quandary in quantum mechanics, of no one being sure of where the particles actually are in a predictable manner. It creates a great deal of uncertainty. Many scientists deeply immersed in quantum mechanics say that all we can do is have a probable result to scientific experiments, and a probability of what might happen in the future under the same situation

This is best illustrated in a thought experiment by Erwin Schrodinger in a thought experiment known as "Schrödinger's cat" It goes like this: A cat is penned up in a steel chamber along with a radioactive substance such as uranium, a Geiger counter attached to a quick-release hammer, and a flask of poison gas, hydrocyanic acid. At the heart of it all is a quantum event. Every now and then, completely randomly, there's a chance of a uranium atom decaying and emitting radiation. This radiation is enough to trigger the counter that sets off the hammer that breaks the vial that poisons the cat. But if none of the uranium atoms decay over the duration of the experiment, the cat will live. According to the Copenhagen Interpretation, until the experiment is observed by peering inside, the entire contents of the box exist in two possible states. Each uranium atom both has and has not decayed. And still further, the poisonous gas has both killed and not killed the cat. And this is the paradox: a single cat that is both dead and alive at the same time.

This simple thought experiment showed the contradictions in quantum mechanics that led Everet to his many worlds theory, where the cat is alive in one universe - and dead in another. However, whether in the the many worlds universe, or the quantum mechanics world, uncertainty enters, and the scientific method suffers, and leaves modern science weakened. This leaves science vulnerable to the whims or the politics of the ruling elite to manipulate to obtain their goals, of whatever color, in an easier fashion because of the respect usually carried with modern science.

In contrast, Chistrianity gives a firm foundation to modern science which I hope to discuss in the next posting or so.

The Ultimate Real Parrallel Universe

There is an increasing amount of interest in Parallel Universes, especially in the field of science, and specifically, theoretical physics. As I mentioned in my last post (11/13), a lot of this is due to the uncertainty principal advanced in quantum mechanics. The History Channel had a recent episode of The Universe called "Parallel Universe." In it, physicist talked about 4 levels of theoretical Parallel Universes based on 11 different dimensions of reality. The webpage for the show is: http://www.history.com/shows.do?action=detail&episodeId=373152 You can watch parts of the episode on You Tube at: http://www.youtube.com/watch?v=2_vpEyE6rug

However, there is a very real and ultimate parallel universe that most of us know as the spiritual world. I believe this dimension provides the basis for why we want to find a parallel universe. All cultures acknowledge this spiritual reality. Modern science rejects it, but only because science is a means of knowledge limited by the requirements of the scientific method, which clearly does not apply to such a realm. However, it is fascinating to watch scientists explore and theorize about parallel universes we have as yet no physical evidence for.

The spiritual world preceded the physical world, and in a sense is more real, as well as more enduring. It is limitless, yet it is immediately next to us, all around us, and within us. People sense this all the time, and long to understand it. On the other hand, since people do not understand it that well, they tend to be wary and cautious of the spiritual realm.

There is a great deal of activity all the time in the spiritual world. It affects us in all kinds of ways every moment of the day. There are campaigns, battles, interventions, messages, and endless activity. We only catch a glimpse of it. Sometimes, it dawns on us that we are in the midst of such activity, often when there are things going on around us that we do not understand. Most often, we are oblivious to this activity.

Literature explores this realm, including Milton's Lost Paradise, or Dante's Divine Comedy. Some would assign this concept to the realm of fairy tales. But Tolkien, who rescued fairy tales from the nursery room, pointed out that the spiritual realm is the ultimate basis for stories from the realm of Faire. culminating in the ultimate, joyous story of the Gospel. As you read through his Lord of the Rings Trilogy, his adult fairy tale, there are glimpses of the spiritual world throughout.

The Bible gives us accurate information about the spiritual realm and its relation to the physical world and our lives. In particular, the final Book of Revelations, opens up for us in apocalyptic language, an understanding of what, from our perspective, is going on behind the scenes in the spiritual realm. It deserves serious consideration from the most rational minds, especially in a time when science is urging us to seriously consider parallel universes.

Quantum Mechanics & Parallel Universes

Quantum mechanics physics essentially states in very simple terms that on the atomic, and especially the sub-atomic level, nothing is predictable, and everything seems completely random. (At least for specific positions - it can predict "probability distributions" where a group of particles will probably be distributed.) In part this is because such extremely tiny matter sometimes behave as particles and sometimes as a wave. Einstein rejected this conclusion of complete randomness by famously saying "God does not play dice with the universe."

Einstein strove for the latter half of his life to find a unified theory that would explain this anamoly. However, he did not reach this goal before he died. Others continue in this work, but still have not reached this goal, though string theory (and now membrane theory) is thought to possibly provide an answer. As he strove on, Einstein was seen as increasingly irrevelant as quantum mechanics was used in many applications such as electronics and the transistor. My own feeling is that there are matters here that we do not yet understand, but will in time. Many matters in science remained unresolved for long periods of time in history before an answer was found, and I tend to believe eventually one will be found that will explain what now seems to us as uncertainty and randomness at the atomic and subatomic level.

However, in the meantime, many physicists and thinkers believed everything is essentially uncertain because of the implications of quantum mechanics. Along comes Hugh Everett III, a bright physicist student at Princeton in 1957, who wrote a dissertation, "The Many Worlds Interpretation of Quantum Mechanics." Basically, Hugh Everett proposed that the problem was in assuming only one observer, and that a solution would be to think of parallel universes at each point when a particle was there and then was not. If taken to its extreme, this could mean at every instant, a new parrallel universe is spun off, doing exactly the opposite. At first, Hugh Everett was isolated in the scientific community. Over time, his theory gained ground, at first with people who loved the concept of parallel universes, and then much later in the scientific community. However, the initial rejection devastated Hugh Everett, and he died in 1982 of a heart attack, still mostly unrecognized.

Hugh Everett had a son, Mark Oliver Everett, and bought him a toy set drums when he was 6. Eventually, Mark became the lead singer for the Eels, an alternative rock band whose music was featured in the Shrek soundtrack. Mark felt distanced from his father, and only started finding out about his father recently. That search is documented in a recent Nova program, "Parallel Worlds, Parallel Lives." The website for the show is at: http://www.pbs.org/wgbh/nova/manyworlds/. The show not only explores Mark Everett's search to find out more about his father, but explores and explains his father's ideas.

Star Trek, created by Gene Roddenbury, did a famous show that explored the whole concept of a parallel universe, "Mirror, Mirror," which aired on October 6, 1967 as Episode 4 of Season 2. In it, the major characters of the show have evil counterparts in a parallel universe. Kirk, Uhura, Scotty, and McCoy accidentally swap with these counterparts, and all sorts of confusions begin. Many other writers have explored parallel universes in other settings, and C. S. Lewis uses them in the "Chronicle of Narnia."

For a Christian the uncertainty posed by quantum mechanics does not need be troubling. God created an orderly universe with certain predictible laws. This premise is the foundation for modern science in the West. Discovering God's laws in science was the impetus for scientists in the West to test theory with observations and experiments to discover how the universe God created worked. I believe eventually, though I don't know how long it will take, we will come to understand how what now seems to us to be random and unpredictable at the atomic and subatomic level actually works.