Why unemployment persists: Part III

History regularly reveals government spending no cure for government-created messes

By Geoffrey Lawrence
  • Wednesday, August 17, 2011

The evidence is in: Washington's economic nostrums are repeating the job-destroying errors of the 1930s.

Parts one and two of this series showed the perverse impact artificial credit expansion has upon any society's capital structure, with the resulting damage to employment: Artificial credit temporarily suppresses interest rates, deforming entrepreneurial investment in both quantity and quality, while stimulating the rise of unviable "bubble" industries. Short-lived inflationary booms are then followed by economic recession or stagnation and systemic labor unemployment.

This was the pattern of the 1920s, 1970s and 2000s.

When governments intervene during the recessions that follow artificial booms, attempting to prop up bubbles they themselves produced through credit manipulations, they prevent the reallocation of capital resources that markets would otherwise achieve. In this way, policymakers — despite their professed desire to keep workers "on the job" — prolong the very crises they bemoan.

In the 1930s, federal policy attempted to keep workers "on the job" by coercively transferring real wealth from American families to politically strong business cartels and federal agencies operating nationwide make-work programs. Thus, the New Deal policies of the 1930s robbed private families to throw good money after bad, because policymakers, at the time, could not recognize that a decade of Federal Reserve money creation had produced a misaligned capital structure and bubble industries that required liquidation — not further subsidization. As a result, society's productive resources became increasingly locked up in nonproductive sectors, prolonging the pain inflicted by the Great Depression.

In fact, in an authoritative 2003 econometric analysis examining the impact of the New Deal, University of California, Los Angeles economists Harold Cole and Lee Ohanian determined that New Deal policies — which were intended to alleviate economic hardship — were themselves responsible for prolonging the Great Depression for seven years. During her academic career, even Christina Romer, former chair of President Obama's Council of Economic Advisors, concluded that fiscal stimulus policies designed to generate employment on public works projects were ineffective at curtailing Depression-era unemployment.

So conclusive is the evidence that government spending exacerbated the Great Depression by preventing the necessary liquidation of poorly invested capital that the motives behind the New Deal's engineers are increasingly called into question. Did economists of the time simply fail to understand that the expansion of artificial credit had prompted pervasive distortions in investment patterns, leading to recession? Did they not understand that government policies that blocked the liquidation of these investments and propped up failing industries would only lengthen the Depression?

Leading intellectuals of the time understood these dynamics quite clearly. From Ludwig von Mises to Lionel Robbins, noted economists, who had correctly foreseen the coming of the Great Depression years in advance and correctly diagnosed its causes, advised that New Deal policies would only worsen the crisis. Indeed, it was not until after the most aggressive New Deal policies already had been implemented that their primary source of intellectual justification — John Maynard Keynes' General Theory of Employment, Interest and Money — began to be written in 1935.

Modern legend obscures the fact that the unprecedented expansion of government embarked upon by federal policymakers during the famed first 100 days of Franklin Delano Roosevelt's presidency ran explicitly against the advice of the period's most noted economists. Prominent national journalists of the time were well aware of this discord, however. Garet Garrett, H.L. Mencken and Albert Jay Nock all routinely characterized the New Deal's central purpose as no attempt to solve the nation's economic ills, but rather a simply self-aggrandizing means of concentrating power.

Garrett — though not trained as an economist — even authored a widely popular book in 1932 that accurately depicted the Depression as an inevitable result of poor investments spurred by artificial credit expansion. Written for a lay audience, "A Bubble That Broke the World" reflected the strength of the consensus that existed among academic economists opposing the New Deal.

The conclusions of these economists have not lost their validity in the succeeding years. Quite the opposite is true. While politicians have seized upon Keynes' flawed justifications for more and more government spending, reality has repeatedly borne out the warnings of Mises, Hayek, Robbins and others. Each of the Keynesian revivals in American policymaking since the New Deal, including the economic policy agendas pursued during the Nixon-Carter and Bush-Obama eras, have resulted in economic catastrophe.

Now more than ever, the lesson should be clear: Undistorted markets are far more capable of providing for the needs of humanity than government meddling.

Geoffrey Lawrence is deputy director of policy at the Nevada Policy Research Institute. For more, visit http://npri.org.

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