2013 looks a lot like 1937 in four fear­some ways

The Pak Banker - - Front Page - Amity Shlaes

WILL 2013 be 1937? This is the ques­tion many an­a­lysts are pos­ing as the stock mar­ket has dropped af­ter the U.S. elec­tion. On Nov. 16, they noted that in­dus­trial pro­duc­tion, a cru­cial fig­ure, dropped as well. In this case, "1937" means a mar­ket drop sim­i­lar to the one af­ter the re-elec­tion of an­other Demo­cratic pres­i­dent, Franklin D. Roo­sevelt, in 1936.

The drop wasn't im­me­di­ate in that case; it came in the first full year af­ter the elec­tion. In­dus­trial pro­duc­tion plum­meted by 34.5 per­cent. The Dow Jones In­dus­trial Av­er­age dropped by half, from al­most 200 in early 1937 to less than 100 at the end of March 1938.

It's hard to imag­ine stock in­dexes drop­ping by half to­day, or un­em­ploy­ment ris­ing past 15 per­cent, as they did in the "de­pres­sion within the De­pres­sion." But the par­al­lels are vis­i­ble enough to be worth trac­ing. They have to do with the dan­ger of big gov­ern­ment, and can be cap­tured in a few cat­e­gories. Pre-elec­tion spree that sets records. In the old days, fed­eral spend­ing amounted to about 19 per­cent or 19.5 per­cent of gross do­mes­tic prod­uct. That ra­tio was so re­li­able that economists took it as a given, the Amer­i­can nor­mal, from which di­ver­gence was un­nat­u­ral and tem­po­rary. By the old 19 per­cent rule, fed­eral spend­ing would have dropped back once the worst of the 2008 eco­nomic cri­sis passed.

That didn't hap­pen. In­stead the fed­eral gov­ern­ment con­tin­ued to spend. Most im­por­tant, even in 2012, when the cri­sis was long past, the gov­ern­ment went on a spree, spend­ing the equiv­a­lent of 24.3 per­cent of the econ­omy, more than the 24.1 per­cent for the year ear­lier.

In 1936, a sim­i­lar bar­rier was breached. Up un­til 1936, fed­eral spend­ing flowed at smaller lev­els than the spend­ing by states and towns com­bined, with wartime be­ing the ex­cep­tion. Roo­sevelt slowly ratch­eted up the out­lays, and in 1936, Wash­ing­ton spent more than the states and towns. This shift was dizzy­ing for a coun­try based on the prin­ci­ple of fed­er­al­ism, of strong states.

-- Bath of cold wa­ter af­ter­ward. Af­ter this year's elec­tion, Pres­i­dent Barack Obama made it clear that bud­get­ing was his pri­or­ity: "I'm ready and will­ing to make big com­mit­ments to make sure that we're lock­ing in the kind of deficit re­duc­tions that sta­bi­lize our deficit, start bring­ing it down, start bring­ing down our debt. I'm con­fi­dent we can do it." Roo­sevelt too opened his sec­ond term on a sober bud­get- cut­ting note. The pres­i­dent, wrote jour­nal­ist Anne O'Hare McCormick in 1937, was like "the Dutch house­holder who care­fully totes up his ac­counts ev­ery month and who is re­ally an­noyed now that he is bent on bal­anc­ing the bud­get, that Congress can't stop spend­ing." Fear­some at­tack on the sta­tus quo. In his first news con­fer­ence on Nov. 14, Obama went out of his way to make clear his tax in­creases would fall on the rich: "What I'm con­cerned about is not find­ing our­selves in a sit­u­a­tion where the wealthy aren't pay­ing more or aren't pay­ing as much as they should."

Roo­sevelt was also fe­ro­cious, telling the old guard: "I should like to have it said of my first ad­min­is­tra­tion that in it the forces of self­ish­ness and of lust for power met their match. I should like to have it said of my sec­ond ad­min­is­tra­tion that in it these forces met their mas­ter."

When Roo­sevelt fol­lowed through in 1937, both with high taxes and his ef­fort to pack the Supreme Court with more pro­gres­sives, mar­kets shiv­ered.

-- Fall­out from first-term leg­is­la­tion. 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. Roo­sevelt's equiv­a­lents were three­fold: So­cial Se­cu­rity, the Wag­ner Act and a new Fed­eral Re­serve law, the Bank­ing Act of 1935, all passed well be­fore the elec­tion. The last law gave the Fed a new tool, the easy abil­ity to or­der changes in re­serve re­quire­ments for banks.

In all three cases, the full ef­fects of the laws weren't felt un­til af­ter the elec­tion. It was only in 1937 that Amer­i­cans had to pay into So­cial Se­cu­rity, di­vert­ing cash from the econ­omy. And it was only in 1937 that John L. Lewis, the la­bor leader, pushed his hard­est for wage in­creases and strikes, forc­ing com­pa­nies to pay higher wages than they could af­ford. In 1936 and 1937, the Fed in­creased re­serve re­quire­ments, ef­fec­tively dou­bling them. The con­se­quence of these laws was re­duced avail­able cash, in­creased un­cer­tainty and lower busi­ness con­fi­dence. The ob­vi­ous ques­tion is why an an­nounce­ment by Obama or Roo­sevelt to cut back just af­ter the elec­tion doesn't re­as­sure those who dis­like gov­ern­ment ex­pan­sion. The an­swer is that the mar­kets, which ob­serve a gi­ant march for­ward and then a step back­ward, don't be­lieve the step back is per­ma­nent.

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