Econ 101: Depression as a result of Intervention

Like every other scarce good, the interest rate in an unhindered market is governed by the law of supply and demand. When people have a large amount of fluid currency to spend and lend, they put it in banks, the banks have a lot of it, and, in order to under-bid other banks, they charge less interest to Investors.

In an unhindered market, then, the Investor borrow money from a bank, build factories and hire worker and make widgets. They put the widgets up for sale. The people have a large amount of fluid currency to spend and lend, and so they can buy the widgets. The Investor makes his money back, he pays the workers their wages, he repays the loan, and so when the people go back to the bank to get their money, there it is.

In a distorted market, the Fearless Leader’s well-intentioned meddling causes malinvestment. The people do not have much money to spend and lend. They put less money in the bank. When Investors come to borrow money, they bid against each other, and this drives up the interest rate, the price of borrowing money, so that only the Investor with the best prospects for repaying the loan can wisely afford to risk taking out a loan at a high credit rate. Other investors hold their money, or invest in safe projects. Few factories or none are built; not many widgets are made; but that is okay, because the people do not have much spare money to lend and spend to buy the widgets.

Then along comes the Fearless Leader on his White Horse. The Leader on the White Horse threatens the banks with the sword, telling them that they cannot charge an interest rate above some arbitrary rate.

The businessmen and investors now can borrow money more cheaply than the natural rate of interest. Now, the people have little money to lend andspend, by hypothesis, for otherwise the interest rate would be low. The interest rate is high, but the Fearless Leader lowers it. This means that the investors cannot bid against each other to secure the loans they want and need. An investor with a risky project, if he gets his foot in the bank door first, take out the loan at the lower-than-natural rate of interest, and the safer investor is not in a position to offer to pay more and out-bid him, because his action has been declared illegal by the Fearless Leader.

Lo and behold, a season of what looks like boom appears. The risky investors build factories and hire workers with the loan money. Happy days are here again, and flapper dance on the tops of model-T Fords, drinking wine from slippers. But remember, by hypothesis, this is a season where the people have relatively little fluid cash to lend and spend. The risky investor puts his widgets for sale on the market, but the bidding is sluggish. The price drops, and the widgets cannot be sold. Remember, again, that by hypothesis, this is a riskier venture than the safe investment. So the factory does not make its money back; the risky investor declares bankruptcy, and cannot pay his wage-earners, and he cannot pay back the bank.

The wage-earners are out of a job at that factory, and when they go to the bank to look at their savings, lo and behold, that is the exact same capital the bank lent to the risky investor.

Now, even if the risky investor knows that the interest rate is artificially low, because some other risky investor with an even less-likely project will cut ahead of him in line and take the loans at the low rate if he does not, even if an investor knows that a bust is coming, he is put in a position where it is economically wise, in the short term, to borrow the money and make the bad investment any way.

The symptom of a depression is the universality of the malinvestments. Not just one or two bad stocks drop on Wall Street, but almost all the stocks. Not just one or two foolish banks make bad loans and go bankrupt, but almost all the banks. Not just one or two workingmen find their jobs dried up, but thousand and tens of thousands.

A universal effect argues a universal cause. No one business, no one bank, has so much influence over the market that merely one bad investment or a string of bad investments can create a depression. A depression is caused by widespread, that is by SYSTEMATIC, mal-investment.

There are other indirect ways the government can interfere with the natural interest rate, aside from the Fearless Leader on a White Horse making a decree. The Federal Reserve Board is a permanent body whose business it is to interfere with the credit cycle, and the Federal Deposit Insurance Corporation is something that encourages bad investments by underwriting inefficient or risk-taking banks. The taxpayer underwrites the FDIC ultimately.

The way to get out of a depression is by liquidated bad investments and investing in good, low-risk businesses. This requires firing workers from the bad companies and having the low-risk companies hire them. This works best in an environment of low taxes and stable laws. Uncertainty about the laws causes investors to be more cautious than otherwise.

What FDR did was

(1) Discourage businesses from firing workers. ‘Share the work’ where two or three idle men did one man’s job, became the order of the day.

(2) Raised taxes to unprecedented levels.

(3)  Seize the gold supplies from the people and inflate the currency.

Inflating currency robs creditors and gives value to debtors. Imagine if Wimpy borrowed a dollar from you to buy a hamburger on Monday, promising to pay you back on Wednesday. On Tuesday, Fearless Leader prints up one hundred one dollar bills and floods them into the market. Your dollar is now worth fifty cents; a hamburger now costs two dollars. Wimpy pays you back a dollar bill, but in reality he borrowed a hamburger from you and paid you back half a hamburger. The difference in value, half a burger, just went from you to him. This is what is known as Keynesian economics: basically Keynes persuaded FDR to screw the workingman, on the theory that they would not notice the value of their burger-buying dollar was dropping.

In the long run, inflationary policies lead to capital decumulation, which interferes with the credit cycle in its own way. But Keynes responded to this objection by the quip that we should not worry about the long run, “because in the long run, we are all dead.”

A more feckless and irresponsible attitude toward matters of state cannot be imagined. Mr. Keynes is indeed dead, but we now live with an inflation rate as a permanent part of our economy, a permanent drain. I am suffering from the short-sighted folly of Keynes, and I am not dead.

FDR not only did NOT solve the Depression, his government’s reckless and abominable policies turned a minor market down-turn into a decades-long permanent feature of American life. If there is a Dante’s Inferno reserved just for people who sin against the laws of economics, FDR is buried upside-down in it, with his feet on fire.

What about the war?

There are those who say that World War Two solved the Depression. Humbug.

I offer you the following thought experiment: the next time there is a recession, have the government seize control of the same percentage of factories that in WWII were used to make ordinance. Take all the ordinance out into a field somewhere, and blow them up. Then draft as many able-bodied young men out of the work force as were drafted during WWII. Kill and maim the appropriate percentage of workers as battlefield casualties killed and maimed. Keep these workers fed at taxpayers expense with crapped K-rations, under the miserable conditions of trench warfare for four to five years.  Have your overseas trade partners bombed and blitzed, and reduce their cities to rubble, so that they have no good to trade, and nothing to buy anything with. The have the tax-payer bear the massive expense of the Marshall Plan.

Better yet, to make the thought-experiment simpler, merely add up the dollar value of the workers taken out of the market place to go soldier, the dollar value of the bombed cities in Europe, the dollar value of the loss to the civilian of gas rationing, and the cessation of all civilian industry to wartime purposes. Let us say this dollar value is, say, one third to one half of GDP.

But all that money into a big pit in the Mojave Desert, and ignite an atom bomb over it, reducing the money to ash, and making the ash radioactive. There. That is the economic recovery effect of World War Two on the American Economy.