Will history repeat with recovery withering away as it did in ’36?

Updated Sep. 2, 2010 at 3:35 p.m.

Will history repeat with recovery withering away as it did in ’36?

On The Web

Site Search

By MICHAEL MUNGER, Duke University

Editor’s note: Dr. Michael Munger, is director of the Philosophy, Politics, and Economics Program at Duke University. This is one of a three part package about the state of the U.S. economy.

DURHAM, N.C. - To paraphrase Ronald Reagan, it's 1936 again in America.

A nascent recovery in 1936 died aborning, and the economy and the public mood slipped back into deep depression.

Economic historians tell two different stories about 1936. One is that the government mistakenly switched from stimulus spending to deficit management, but they did it too soon. The government spending that had been propping up growth was abruptly ended, and unemployment rose and investment fell.

The other story is that the constant starts and stops, and uncertainty over investment returns and taxes, spooked investors and consumers, and everyone started hoarding cash to wait until things got better.

Those two stories are not mutually exclusive, of course. BOTH could be true. And the same thing appears to be happening today. Still, there are some differences, and those are worth talking about.

First, it does appear some of the props under employment and growth have been the result of stimulus spending. John Maynard Keynes argued that GDP is the sum of consumer spending, investment, and government expenditures.

For the past two years now, the main "growth" has been in the government spending part of that equation. Backing off on those supports makes the whole structure shaky. New housing was subsidized, so everyone who might buy a house has bought one. Car purchases were subsidized, so anyone who might buy, did. So none of the "growth" was real, but was simply displaced consumption that would have happened anyway, paid for at much greater expense by taxpayers. Just like in 1936.

Second, it is worth remembering the initiatives on the table in 1936. Companies were holding onto to "too much" cash, whatever that means. So the government threatened a "retained earnings tax," wiping out private investment.

There were new initiatives on safety, work hours, and increased pay, all of which dramatically raised the cost of new hires.

This drove employment down significantly. Further, there was uncertainty about what new "experimental" policies the administration might try.

We find ourselves in very much the same position now. Politicians love uncertainty, because it makes them feel needed.

But markets hate uncertainty. The Bush administration used uncertainty about terrorism and war to its advantage for years, and propped up housing markets using artificial loan guarantees and down-payment subsidies. The Obama administration is using the same strategy, with only slight variations in theme. No one knows what changes will take place in health care, in tax policy, and in regulatory regime over the next year.

The election looming in November brings its own uncertainty: will the Democrats lose control of the House (better than even money), or the Senate (a long shot)?

It's 1936 again in America. By 1937, unemployment was back up to nearly 18%, and economy had collapsed. What will the U.S. economy look like a year from now?

For overview of this package, read here.

For analysis from N.C. State’s Michael Walden, read here.

For analysis from East Carolina’s James Kleckley view, read here.

Get the latest news alerts: Follow LTW at Twitter.