Update Recession Comparisons

On my January 18 post, I made some comparisons of our current recessions, since there was a lot of talk that this was the worst recession since the Great Depression. Some figures have changed, so I decided to update the post.

At that time, the latest GDP figures we had from the 3rd Quarter stood at a 0.5% loss. Since then, we have the revised 4th Quarter GDP numbers at an annualized 6.2% loss - still 4.6 percentage points less than the 1957-58 peak quater loss of 10.8%, but near the 6.4% peak quater loss in the 1981-1982 recession.

At that time, the latest national unemployment rate was at 7.2% for December. Since then, the national unemployment in January went up to 7.6% - still 3.2 percentage points less than the unemployment peak of 10.8% during the 1981-1982 recession.

At this point, I can't agree it is the worst recession since the Great Depression, but I will keep track of the numbers.

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.