Monday, September 18, 2017

The 1950’s Weren’t America’s Most Prosperous Decade: It’s Not Even Close

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4 MIN READ - From the desk of the Cautious Optimism Correspondent for Economic Affairs and other Egghead stuff

In the recent crusade against “income inequality” it has become fashionable to cite the 1950’s as America’s greatest decade of economic growth—and then credit it almost exclusively to the period’s 91% top marginal income tax rate (the idea being that soaking the rich somehow promotes growth). 

In distant second place is crediting Dwight D Eisenhower’s push for the Interstate Highway System as a giant Keynesian government stimulus thus championing the virtues of large federal spending programs. 

In either case, the correlation of big-government interventions with an affluent decade is used to justify steeper taxes and higher government spending today with the promise of reliving the riches of the fifties.

But even though a multitude of deductions allowed nearly everyone to avoid paying the 91% rate, the larger fallacy in both arguments is that the 1950’s simply weren’t America’s greatest growth decade.

For one, the USA experienced two recessions during Happy Days (1953-54 and 1957-58) with two more bookending the decade (one bottoming in October 1949 with America just beginning a recovery in 1950, and another recession beginning in April 1960. Source: NBER). So the slightly longer 10-1/2 year period October 1949-April 1960 encompassed part or all of four recessions.

Second, based on real GDP growth the 1950’s decade barely ranks in America’s top five. Although no government figures exist before the 1930’s, academic estimates show without a doubt that America’s greatest decades of growth were during the post-Civil War era of the late 1800’s—when by the way there was no giant government spending program on interstate highways and federal peacetime spending was typically only 2-4% of GDP. 

And ironically by the income inequality crusader’s logic, the growth of the Gilded Age must have been fueled by the top marginal tax rate of zero since, with the brief exception of the Civil War, the federal income tax didn’t even exist until the passage of the 16th Amendment in 1913. So will the income inequality warriors now call for abolition of the income tax?

Statistics can be boring, but in this case a little slogging tells quite the compelling story. Using FRED/BEA figures for 1950-1960 and Johnston/Williamson numbers from for the 19th century we can compare the 1880’s, the decade when America emerged as the world’s largest economy, and the 1950’s real GDP and per-capita GDP growth rates:

Real GDP: 1950-1960. +42.3% ($2.184T to $3.108T, 2009 dollars)
Real GDP: 1880-1890. +66.7% ($207B to $345B, 2009 dollars)

Real per-capita GDP: 1950-1960. +20.1% ($14.4K to $17.3K, 2009 dollars)
Real per-capita GDP: 1880-1890. +32.6% ($4,123 to $5,467, 2009 dollars)

Real GDP sources: 
As you can see, it isn’t even close.

1850-1860 and 1870-1880 (even with the Depression of 1873) also outperform the golden 1950’s in both categories.

Real GDP gains for the Gilded Age decades were +65.5% and +70.8% respectively ($53.6B to $88.7B and $121.3B to $207.2B, 2009 dollars).

And real per-capita GDP gains were +22.2% and +35.7% respectively ($2,303 to $2,815 and $3,039 to $4,123, 2009 dollars).

Even the destitute 1980’s—when we’re told the great riches of the postwar era were squashed under heartless Ronald Reagan’s iron boot when he cut the top marginal rate from 70% to 28%—outperforms the 1950’s on a per-capita basis. 

Although real GDP grew by a slightly lower 38.9% ($6.45T to $8.96T, 2009 dollars), slower population growth translates to a superior real per-capita increase of 26.3% ($28.5K to $36.0K, 2009 dollars).

Third and finally, what growth came out of the 1950’s isn’t explained by 91% high tax rates, wealth redistribution or the Interstate Highway System at all, but rather by the very unsexy, boring, and little-understood international monetary arrangement of the time. 

Under the postwar Bretton-Woods agreement the US dollar served as the world’s anchor-reserve currency due to its peg to America’s vast gold reserves, and other member nations’ currencies were convertible to US dollars at fixed exchange rates. However, America’s low money stock-to gold reserves ratio in the first 15-20 years of Bretton Woods undervalued the dollar via its trading partners’ currencies—the exact opposite phenomenon of the overvalued British pound during the interwar gold-exchange standard. 

Unlike Britain, which during the 1920’s suffered from chronic trade deficits and gold outflows due to its overvalued currency, the US experienced an export boom during the 1950’s and most of the 1960’s due to the undervalued dollar.

With the exception of the US having already been a developed economy during the 1950’s, strong American exports were driven much the same way China’s deliberately undervalued yuan—pegged at fixed exchange rates to the US dollar by the People’s Bank of China—has stimulated its current export boom. 

But the party came to an end in the late 1960’s when aggressive money creation by the Federal Reserve to finance deficits for Lyndon Johnson’s Great Society and the Vietnam War reversed the dollar’s undervalued status to overvalued. America’s trade surpluses turned to chronic trade deficits and the late 1960’s Fed-induced stock market bubble popped, leading America into the stagflation era of the 1970’s.

Sometimes sound answers to economic questions can be a little bit complicated, but Bretton-Woods and an undervalued dollar aren’t quite the progressive soundbite the “91% tax rates made us wealthy” forces are looking for. And certainly neither is “zero tax rates drove America’s truly most prosperous decades.”

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