Incorrect Economic Historian Is Incorrect

Thomas Masterson | November 20, 2012

Amity Shlaes, whose main claim to fame is an allegedly new history of the Great Depression, thinks we may be in trouble as a result of the election. Looking beyond her alarmingly alliterative title (“2013 Looks to be a Lot Like 1937 in Four Fearsome Ways!”  Oooh! Scary!) she has some valid points. Of course she is talking about the stock market not the real economy, which produces the jobs and the economic benefits most people rely on for a living. And, unfortunately, she doesn’t realize where she is right.

But first, what are the four fearsome factors that will drive us to doom? First, a federal spending spree before the election. Shlaes uses “the old 19% rule” as a benchmark to argue that because federal government spending in 2012 “when the crisis was long past” was 24.3% of GDP, clearly the Obama administration was spending up a storm. To argue that the crisis is long past, one must be willing to ignore the employment crisis that still hasn’t left us, but let’s give her this one. Whether this is a problem given current economic conditions is another story. If it’s the debt implications you’re worried about, it is worth noting that revenues as a percentage of GDP are also quite low historically speaking, just over 15% for the last few years (see CBO’s historical budget data).

Shlaes’ second fear factor is a bath of cold water afterwards. Roosevelt restored budget balance in 1937 and since that very topic (and who David Petraeus was or was not sleeping with) is all people are talking about in Washington these days it seems likely we’ll get spending cuts and tax increases in the next budget. The “depression within the Depression” was the result of exactly this fiscal restraint. This is where Shlaes is quite right, though she doesn’t actually come out and say this: whether the President and Congress jump off the fiscal cliff together, which would reduce spending across the board, or avoid it by cutting spending on everything but defense instead, we are in for poor economic performance indeed.

Shlaes’ third scary thing is the fearsome attack on the status quo. In 1937, this meant raising the top marginal rate from 56% (where it had been raised by Hoover in 1932 from 25%) to 62% (this actually passed in 1936) and the undistributed profits tax. This, and Roosevelt’s attempts to pack the Supreme Court meant that (stock) markets “shivered.” Note that this year, Obama is talking about raising the top rate to, um, 39.6%, which is where it was before the Bush tax cuts. Remember how much markets were “shivering” in the 1990s? Me neither.


The fourth fearsome way that Obama is just like Roosevelt is all that legislation that was passed. For Roosevelt it was Social Security, the Wagner Act, the Banking Act, etc.  I must quote Shlaes at length here:

Obama signed his health-care act in 2010, postponing much of its enforcement until 2013, after the election. Now that the effects of the act are so proximate, markets are wondering whether they or investors can handle the changes demanded.

Got that? Two things stand out hilariously here. First, the implication that Obama wanted to delay implementation of the Affordable Care Act until after the election as some master political strategy to win re-election. But didn’t he win by giving “gifts” like free health care to the unwashed masses? Not Shlaes’ argument, of course, but what exactly is Shlaes’ argument here? That Obama knew that the health care plan would be unpopular once it took effect and so spoil his chances of re-election? Unlikely. Fascinatingly, Shlaes says that “markets” are wondering things. How, one wonders, can markets wonder? And if indeed they can, how does Shlaes know what they are wondering? She leaves us, um, wondering.

There was a huge recession in 1937-1938. It was caused by a combination of fiscal and monetary restraint (the Fed increased reserve requirements). The scale of the fiscal restraint we get remains to be seen. The bigger it is, the worse will be the outcome for employment in the coming years. The fact that Ben Bernanke, a more clear-sighted scholar of the Great Depression than Amity Shlaes, and the Fed are not moving to monetary restraint means that at least that part of the equation will remain on the positive side. Other than Shlaes’ warnings that markets are shivering and wondering, we have nothing here to make us believe that the Affordable Care Act will bring the economy crashing down (nor that Social Security did, although the phasing in of the payroll tax did have a negative impact). I do hope that markets, when they are done wondering, will see more clearly than Shlaes.

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