- The Washington Times - Sunday, November 16, 2008




“The greatest financial crisis since the Great Depression.” So frequently the sobriquet of today’s financial crisis, it begs the question: Do we face a repetition? To that the answer is unquestionably “No.” We can be so certain because, as uncertain as we may be about what we face, we can at least be sure we are approaching it from the right direction.

Today’s response is not simply better than that to the Great Depression, it is exactly the opposite. Yet dangers still exist. Among the most serious are “neo-Keynesians” seeking to advance as economics ideological policies that could hinder America’s growth for decades.

As bad as the current financial crisis is - and it is and will likely worsen - it is a long way from the Great Depression of the 1930s. Then, housing starts and the stock market fell by 90 percent, unemployment reached 25 percent, the economy fell by a third, and consumer spending fell by almost a fifth. As of now, unemployment is just 6.1 percent and the economy just recorded its first negative growth quarter (minus 0.3 percent).

Of course, even the Great Depression did not start that way. How do we know this crisis will not follow the same precipitous course?

In its time, the Great Depression defied understanding. As economies globally ground to a halt, an explanation to the inexplicable was demanded. The English economist John Maynard Keynes seemed to fill the vacuum. Keynes’ critique saw this as no mere cyclical failing, but a systemic one: markets themselves were dysfunctional and, in contrast to classical economic theory, unable to correct themselves. Only government intervention through fiscal policy could restart them.

For Keynes’ followers, government’s crisis intervention became constant manipulation through fiscal policy - increasing during economic downturns and reversing course during upturns - which could counter and smooth the economic cycle. Continual tinkerers, Keynesians would dominate economic thinking for decades following World War II.

In contrast to the lessons taken from it, the real explanation for it would not come for more than two decades after the Depression ended. It came in Milton Friedman’s 1963 book, “A Monetary History of the United States, 1867-1960.” Refuting then prevailing Keynesian thought, Friedman showed monetary policy, not fiscal, was paramount and government action had not only not cured the Depression but caused it.

Specifically, Friedman showed government constriction of the money supply caused the Great Depression. As Friedman biographer, Lanny Ebenstein, points out, the U.S. Federal Reserve decreased the money supply 2.6 percent by the fall of 1930, 7 percent from 1930-31, 17 percent from 1931-32, and 12 percent from 1932-33. “Unprecedented annual consecutive declines … constituted the Great Contraction and were the primary source of the simultaneous deterioration of the U.S. economy.”

Had the Federal Reserve been doctors, they would have violated the Hypocratic oath to first do no harm. Essentially cutting off their patient’s oxygen, they then expected him to breathe! By drastically and continually decreasing the money supply, they took the worst possible approach at the worst possible time, exacerbating an economic downturn into the modern age’s worst economic calamity.

Bad as it was, the Depression’s policy aftermath was arguably worse. The Keynesian paradigm held sway for a generation after World War II. In doing so, it held growth below its potential. From 1947-82, America suffered eight recessions and inflation above 4 percent in 19 of those years.

Only upon Keynesians’ final foundering on the 1970s’ stagflation was the door opened to Friedman’s prescription of controlling the growth of the money supply. Through it stepped Federal Reserve Chairman Paul Volcker and President Reagan. The payoff has been superlative: from 1983-2007, the nation has experienced only two recessions - one following the Bush I tax increases and the other technical following Sept. 11, 2001 - and only five years in which inflation has exceeded 4 percent.

Questions may be raised over the response to the current financial crisis, but at least it is directionally correct. Yet like the Great Depression, the potential for misdiagnosis again exists. The opportunity to unlearn the negative lessons of government economic manipulation is readily at hand. And there are undoubtedly “neo-Keynesians” who, for a variety of noneconomic reasons, see such a course as attractive.

Such an errant course would be even more serious now than the earlier one. In contrast to our post-World War II position, America can no longer absorb the Keynesian cost. America emerged from World War II as the world’s sole economic superpower. With former rivals defeated or devastated, our economy easily outperformed any and all, essentially rebuilding the industrialized world.

Such dominance no longer exists. Today’s competitors exist not only in the developed but the developing world. We must choose our economic paradigms carefully. And we must be equally on-guard against those seeking to change them for ideological, not economic, reasons.

J.T. Young served in the Treasury Department and the Office of Management and Budget in 2001-04 and as a congressional staff member 1987-2000.



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