Venezuela’s Economy Was Falling Apart Years Before Oil Prices Collapsed

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4 MIN READ - CO very much enjoyed this Economic overview of Venezuela from the Cautious Optimism Correspondent for Economic Affairs and other Egghead Stuff.

As Venezuela suffers from chronic inflation, shortages of food, basic consumer staples, and running water, power blackouts, shrinking oil production, empty shelves, dwindling foreign reserves, hunger, street violence, and long lines outside stores, we’ve seen an explosion in excuses from socialists and left-wing progressives blaming anything other than socialism itself. Economist Lawrence Reed discusses the constantly moving target for socialists—the definition of socialism itself—here:

https://fee.org/articles/socialism-force-or-fantasy/

But I’d like to address some of the common excuses parroted to exonerate Venezuela specifically:


1) “It wasn’t real socialism.” 

During the first few years of Hugo Chavez’s nationalizations and lootings, the same apologists claiming it’s not real socialism today were praising Chavez’s “Socialism for the 21st Century” then—as he showered the poor with seized wealth (while it lasted). Hollywood celebrities, left-wing academics, and even a Nobel Laureate incessantly lauded Venezuelan Chavismo as proof-positive that socialism works... until it didn’t. At which point it suddenly wasn’t “real socialism” anymore.

In other words, it’s socialism until it isn’t.


2) “Venezuela isn’t socialism. It’s dictatorship.” 

First, all socialism—with the exception of Karl Marx’s vision of the final stage of history: full communism, which no socialist economy has ever come close to attempting—is dictatorship by definition. Even so-called democratic socialism is a form of dictatorship since the seizing of wealth to be distributed and downward price controls must be enforced at gunpoint. Marx himself, who Chavez endlessly cited in public speeches, called the first stage of socialism the Dictatorship of the Proletariat.

https://en.wikipedia.org/wiki/Dictatorship_of_the_proletariat

But more importantly the same apologists weren’t calling Venezuela a dictatorship years ago either—because they thought it was working. Even though as soon as Hugo Chavez was swept into power he began practicing dictatorship—sending armed troops in to seize foreign energy assets, domestic steel plants, cement plants, department stores, grocery stores, farms, power stations, and more. He seized radio and television broadcasters and took control of the mass-media dissemination of information. 

The Marxian Dictatorship of the Proletariat was established to seize the means of production, and left-wingers in the Americas and Europe praised it as “democratic socialism” (not “dictatorship”) until the predictable result of economic dysfunction and collapse became too obvious to ignore. At which point the problem suddenly became “dictatorship,” not socialism. 

Just as it’s socialism until it isn’t, it’s not dictatorship until it is.


3) “Socialism would have worked, but the USA/CIA has declared economic war on Venezuela by manipulating the world price of oil downwards.”

If the U.S. government really had the power to manipulate the worldwide price of oil downwards from $100 to $26, it would never have allowed oil prices to remain high for the first fifteen years of the Socialist Party’s rule (1999-2014). And if the USA really wanted to “declare war” on the United Socialist Party of Venezuela, wouldn’t it have done so right away—instead of hesitating for fifteen years first? 

With all of Hugo Chavez’s belligerence towards the USA, calling U.S. President George W. Bush “the devil” at the United Nations in 2006, wouldn’t the White House have wanted its pound of flesh and taken revenge before Chavez died in 2013? 

Or did Barack Obama simply wake up one day in late 2014 and capriciously decide, after nearly six years in office, that now was the time to hurt Venezuelan socialists with oil price manipulation? 

For that matter, since the U.S. has been a major oil importer for the last several decades, why has it ever allowed oil prices to rise at all? After all it’s to America’s benefit to manipulate oil prices downwards all the time. The whole idea that one country—even the United States—can simply push a button and ratchet world oil prices down by 75% or more ($26/barrel at the early 2016 bottom) is ridiculous.


4) “OK maybe the USA wasn’t behind it, but the collapse of oil prices is what brought Venezuela down, not socialism.”

But one of the timeless claims going back to Karl Marx is that socialist central planners, being disinterested philosopher-kings whose thoughts only dwell on the good of society and never their own bank accounts, are more forward-looking and adept at anticipating future economic trends than short-sighted, myopic capitalists who only care about the next quarter’s profits. In other words, socialists are better planners.

Venezuela’s socialists came to power in 1999 and have yet to give it up. So in the sixteen years they were in power before oil’s decline, did they never once plan for the eventuality that oil prices could fall one day? Which begs the question: Are socialists better planners than capitalists or not? And is the failure with the price of oil, or with socialism itself which by its very nature is looking much worse at planning than capitalism?

Ironically the evil, shortsighted capitalist energy firms like ExxonMobil, Chevron, Shell, BP, Statoil, Total, etc… are even more dependent on selling oil than the entire sovereign nation of Venezuela which at least has some exports and domestic production other than energy, yet oil companies are faring much better. In fact, the large capitalist energy firms, many of whom had their Venezuelan assets seized, are still profitable (even though profits are down) while socialist Venezuela is bankrupt.


5) “OK they may not have planned as well as they should have, but socialism was really working very well in Venezuela at first. If it wasn’t for the collapse in oil prices it would definitely be a Workers Paradise today.”

Also not true, as anyone who read the news in 2006, 2007, 2008, 2009… all the way until the oil collapse began in 2014… already knows. Venezuela’s economic dysfunction began long before oil prices started their dramatic decline. Here is just a sample of news stories about long food lines, empty shelves, blackouts, and inflation going back to 2006 (more than eight years before the oil price collapse started). A whole lot more can be found simply by Googling keywords like “Venezuela,” “shortages,” “inflation,” “blackouts,” “long lines,” and be sure to enter a random pre-2014 year number like “2006” or “2008.”

2006 (food shortages)
https://www.ft.com/content/e0d7320e-7e39-11da-8ef9-0000779e2340

2007 (food shortages)
https://www.theguardian.com/world/2007/nov/14/venezuela.international

2008 (milk shortages)
https://www.npr.org/templates/story/story.php?storyId=91680886

2008 (power blackouts)
https://www.reuters.com/article/us-venezuela-blackout/power-blackout-in-venezuelan-capital-oil-province-idUSN0145186220080901

2009 (shortages, inflation)
http://www.mcclatchydc.com/news/nation-world/world/article24523447.html

2009 (water shortage)
https://www.reuters.com/article/us-venezuela-chavez/chavez-urges-3-minute-showers-to-conserve-water-idUSTRE59L0OU20091022

2010 (food shortages, rotting stockpiles)
http://www.economist.com/node/16326418

2010 (power blackouts)
http://www.washingtonpost.com/wp-dyn/content/article/2010/04/28/AR2010042805712.html

2013 (hyperinflation)
https://qz.com/125339/hyperinflation-is-forcing-venezuela-to-print-hundreds-of-millions-of-extra-banknotes/

2013 (food shortages)
https://www.theguardian.com/global-development/poverty-matters/2013/sep/26/venezuela-food-shortages-rich-country-cia

Lessons from the Great Depression: Wages (Part 2 of 2)

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11 MIN READ - Here is a Dispatch from the Cautious Optimism Correspondent for Economic Affairs and other Egghead stuff in his continuing series on lessons learned, unlearned and never learned from the Great Depression

CO is sure that you will find it as interesting, informative and provocative as he has.

IV. FDR TRIES RAISING WAGES AGAIN AND THE DEPRESSION OF 1937-38

With the collapse and overturning of the NIRA the Roosevelt administration became more combative with its anti-business rhetoric and the New Deal Brain Trust was replaced with more progressive, more radical, and more interventionist bureaucrats. One of FDR’s first moves to replace the failed NIRA was the passage of the National Labor Relations Act (NLRA, aka. the Wagner Act) in the summer of 1935.

Widely considered the single-most important piece of labor legislation of the 20th century, the NLRA created the National Labor Relations Board to enforce new bargaining powers granted to labor unions. Among the NLRB’s enforcements were a guarantee to collectively bargain with management, businesses were prohibited from refusing to collectively bargain, businesses were prohibited from firing, demoting, or transferring workers who attempted to unionize or collectively bargain, businesses were compelled to rehire striking workers under most conditions, and businesses were prohibited from setting promises not to unionize as a condition of employment even as unions were free to bargain for “closed shops” where employees could not be hired without joining the union.

The NLRA was also challenged in the courts, but since FDR had threatened to pack the Supreme Court with extra pro-New Deal judges in the fallout of the NIRA legal battle the high court justices became more compliant during the remainder of his presidency. In fact according to the Tenth Amendment Center, from 1937 to 1995 not a single piece of federal legislation was declared unconstitutional by the Supreme Court. A new era of acquiescence to executive power had begun. With the NLRB v. Jones & Laughlin Steel Corp case of early 1937, the Supreme Court validated the NLRA’s constitutionality and it has been enshrined in federal law ever since.

The NLRA, while not explicitly mandating wage increases, did vastly strengthen the hand of labor to not only collectively bargain, but also to strike against “unfair labor practices” without fear of losing employment when the strike was resolved since the NLRA guaranteed their reemployment. The result was a hyperbolic jump in strikes in 1937. BLS statistics from 1936 and 1937 reflect this:

Number of strikes 1936 to 1937: 2172/4740 (+118%)
Number of striking workers 1936 to 1937: 789K/1.86M (+136%)
Number of work-days lost to strikes 1936 to 1937: 13.9M/28.4M (+104%)

(sources)
https://www.bls.gov/wsp/publications/annual-summaries/pdf/review-of-strikes-in-1936.pdf
https://www.bls.gov/wsp/publications/annual-summaries/pdf/analysis-of-strikes-in-1937.pdf

Furthermore federal enforcement of labor laws was skewed in labor’s favor under the Roosevelt administration. For example, unions quickly launched “sit-in strikes” where employees not only refused to work, they also refused to leave the factory floor while physically impeding replacements and management from using company machines and equipment—all while the NLRA’s enforcement arm looked the other way.

Unable to conduct business with striking workers and physical blockage of its workfloors and factories, businesses were forced into the intended and successful consequence of the legislation: an assured hefty raising of wages for union labor over 1936 levels—yet again above the market clearing equilibrium wage.

Combined with FDR’s top marginal income tax rate hike from 63% to 79%, and the Federal Reserve’s tightening policy requiring a doubling of commercial bank reserve ratios (both in 1936), the Wagner Act’s new artificial wage floor ushered in the famous Depression of 1937-1938 or the so-called “Depression within the Depression,” the third worst downturn of the 20th century behind the Depression of 1920-21 and the Great Depression slump of 1929-1933. Unemployment predictably ballooned from an intrayear low of 11% in early 1937 to an astonishing 20% in the summer of 1938.

And the Depression of 1937-38 is undoubtedly why unemployment at the beginning of 1940 was still higher than at the end of 1930 (16% vs 11%). For the third time in less than a decade, forcing wages above the market equilibrium level not only failed to deliver the promised recovery via greater spending power, it reversed the previously improving employment trend and set the economy back into its third technical recession since 1929.

Although the Wagner Act is still with us today, the extent of the NLRA's reach changed quickly during the postwar Truman administration. Harry Truman, a moderate with no interest in upholding the most radical elements of FDR’s New Deal, wasn’t willing to look the other way from violent union abuses or “sit-in strikes.” The practices, which had been stopped during WWII industrial production, were not allowed to resume in peacetime.

And in 1947 Congress passed the Labor Management Relations Act (aka. Taft-Hartley), a law designed to return the balance-of-power between management and labor. Among its many provisions, Taft-Hartley prohibited so-called “closed union shops,” ended the prohibition of “right-to-work” laws in any state that passed them, strengthened provisions that prevented strikers from physically blocking a workplace to entry from customers, management, and replacement workers, and required a minimum number of days’ notice before unions could strike.

Although simply repealing the Wagner Act (along with the Davis-Bacon and Norris-Laguardia Acts) and never signing Taft-Hartley at all would have been a cleaner way to level the playing field, the passage of Taft-Hartley did untie employers’ hands significantly given that the NLRA was still in effect.

V. FORCING WAGES UP: THEN AND NOW

The Great Depression was easily the worst economic downturn in American history. Compared to the next worst slump, the Depression of 1893, it took nearly three times as long to return to full private employment (seventeen years vs six), the peak unemployment rate was over double (25.9% vs 12.4%: Romer), and the loss of GDP at the slump's trough was more than double (-26.3% vs -10.3%).

Not coincidentally, at that time the Great Depression was also the only depression in American history where wages and prices were prevented by government from freely adjusting. In every other prior downturn when demand fell prices and wages were allowed to fall too. Nominally wages and prices dropped, but in real terms they were generally unchanged since all other prices fell together.

As elementary microeconomics teaches us, whenever any price is forced above the free market equilibrium level, supply outpaces demand and surpluses form. In the case of the Great Depression, the surpluses were not only unsold goods that were made too expensive by NIRA cartels, but also workers who became too expensive to fully employ. Newer demand-side economics and arguments that “higher wages will create greater consumer demand, compensate for the labor surplus, and lead to faster recovery than under free market conditions“ proved to be empty promises as the nation descended into unprecedented contraction and joblessness.

The historical lessons of forcing wages and prices upwards were painful but also resoundingly clear: wage and price controls don’t work. The market must be allowed to adjust and clear, and the sooner it happens the faster the recession will end.

Which brings us to today. Even though it was 80 years ago, the failures of the demand-side policies of the 1930’s provide a valuable guide to similar debates taking place even eight years in the wake of the Great Recession. For example, the argument that $15 minimum wage, raising taxes on the rich to prevent “income inequality,” and boosting the purchasing power or middle class and working Americans through higher government stimulus spending will all lead to a faster growing economy.

The $15 minimum wage is most closely related: many of the same economic stimulus arguments from the Great Depression have been rekindled by progressive forces. Predictably conservative and free market opponents have maintained that forcibly raising the price of labor results in lower demand for labor and reduced employment, ie. the classical argument. But just like in the 1930’s, progressives have countered that raising the minimum wage above the impersonal, heartless “free market” level (actually not even the free market level, just a lower minimum wage of $7.25) won’t induce job losses or reduce hours because the increased income will stimulate economic activity through greater spending power…which in turn will lead to more hiring. So once again the theoretical battle lines have been drawn. But more telling than theoretical argument is empirical evidence. And the Great Depression has plenty to guide us.

VI. MINIMUM WAGE ON THE GRAND STAGE (not just Seattle or San Francisco)

The present day laboratory for the $15/hr minimum wage experiment has been a handful of US cities—most notably Seattle—upon which both sides of the debate have descended to find evidence favorable to their case. And while so far the results in nearly all studies have suggested that hours have been reduced, jobs have been lost (or the rate of job creation has noticeably slowed) and benefits have been cut, the metrics are far from overwhelming.

One reason is that public support for minimum wage hikes tends to coalesce only when the economy is perceived as “sufficiently recovered” to withstand its impact. Therefore minimum wage hikes have been enacted in job markets that are already improving.

Also the higher minimum wage unemploys only a small segment of the workforce—namely the least productive workers whose hourly marginal revenue productivity falls between the old minimum wage and the new one. By contrast no doctor, lawyer, computer programmer, airline pilot, professional athlete, etc… gets thrown out of work simply because the minimum wage has risen from $7.25 to $15/hour. Those professions’ hourly marginal revenue productivity was well over $15 to start with. Also, workers with so few skills that their hourly marginal revenue productivity was already lower than the previous $7.25 minimum wage were largely jobless to start with since they had long been priced out of the market. Therefore they won’t be counted as a “job loss” after a minimum wage hike either.

(It's worth mentioning these two reasons expose a common error cited by both sides of the debate—looking at the overall unemployment rate to judge the effect of minimum wage. Rather one must look at the change in unemployment only in the low-skilled sector with pre-hike wages between the old minimum wage and the new higher one)

Given the small segment of workers effected, and the countereffect of job gains in the higher wage segment due to the already improving economy, the results have been statistically small enough to sway few people particularly the $15/hr crowd. So retorts of “flaws in the study” or “the overall economy is still going well” or “ten new restaurants have opened” (never mind that 15 closed in the same period) or “the employment numbers for the metro area are good” (even though the minimum wage was only law in the anchor city such as Seattle and many jobs were transferred to the unaffected suburbs) begin to impinge the conversation. Few people’s minds are changed because the experiment is simply not large enough in scale and the laboratory is too small.

But unknown to most people there already has been an experiment, a much larger experiment, in raising wages to help workers and stimulate economic recovery. It was conducted by Herbert Hoover and Franklin Roosevelt—on the grandest stage possible: not just Seattle and San Francisco, but the entire American economy.

From 1929 to 1939 three different nationwide campaigns were launched to raise not just the minimum wage but virtually all worker wages, therefore affecting the lion's share of America's workforce as opposed to just the lowest productivity workers in the minimum wage scale. Three times in the 1930’s the federal government pushed wages up for nearly all Americans: Herbert Hoover’s “high wage policy,” then FDR’s National Industrial Recovery Act price and wage floors and then the Warner Act's ensuing higher union wages—the latter two at a time of fragile recovery when unemployment was still in the double-digits.

All three high-wage campaigns coincided with the only three major episodes of rising unemployment (see chart below noting rising joblessness in 1929-March 1933, winter 1933-summer 1934, and fall 1937-summer 1938). Plus there was no meaningful relief from the 1937-38 job slump until the European outbreak of World War II when the US military began its rapid hiring campaign in anticipation of an upcoming major conflict.

Furthermore demand-boosting policies weren’t limited just to forcing wages higher. The other two prescriptions of the trifecta—taxing the rich and redistributing the money to the working classes via increased government deficit spending—were also launched. Herbert Hoover raised the top income tax rate from 25% to 63% in 1932, and Franklin Roosevelt raised it again to 79% in 1936 and yet again to 84% in 1940. Herbert Hoover doubled real federal government spending in just four years, and Franklin Roosevelt added the entire New Deal atop it.

In this grandiose and novel witches brew of economic interventions, with all its demand-boosting policies launched simultaneously and unequivocally, the Hoover and Roosevelt administrations gave American history its greatest ever experiment in countercyclical economic policy. The result of the experiment and its conclusions couldn’t be any clearer. Was it, as progressives have argued for the last ten years, a rapid recovery from recession with unprecedented strength? No, it was America’s worst and longest economic catastrophe. With the aftermath of the demand-side policies of the 1930's so clear, can we learn from our history's blunders and avoid repeating them again?

Lessons from the Great Depression: Wages (Part 1 of 2)

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11 MIN READ - Enjoy this highly informative piece from the Cautious Optimism Correspondent for Economic affairs and other Egghead stuff on the Great Depression and Wages.

Episodes of soaring unemployment correspond perfectly with government wage floor programs

The most crucial yet mostly forgotten job-killing government policies of the 1930's manipulated prices and wages. Although Herbert Hoover and Franklin Roosevelt’s hefty tax increases and profligate spending had extensive effects on unemployment, wage policy more directly influenced the fate of American workers. Federal intervention induced downward wage rigidity and precipitated unemployment levels never seen in American history then or ever since. This article examines those policies in detail.

I. NOVEMBER 1929: HOOVER ACTS DECISIVELY ON WAGES

The first major policy act of the Herbert Hoover administration after the October 1929 stock market crash was to convene a meeting of American business leaders to coordinate his novel wage policy. On November 21st, 1929 dozens of executives from an array of industries arrived at the White House to hear Hoover’s plan to mitigate any upcoming depression and hasten recovery. Among the delegates present were Henry Ford, Alfred Sloan (General Motors), Pierre Dupont, Julius Rosenwald (Sears), Owen Young (RCA), Walter Teagle (Standard Oil), William Butterworth (Deere Company) and many more.

Hoover’s pitch? In past depressions American business had always dealt with dwindling sales by selfishly cutting worker pay. But this, according to Hoover, was a mistake—precisely the opposite of what they should do. Instead American business should make a short-term sacrifice by keeping wages high for, as Hoover believed, higher wages were the wellspring of economic prosperity. In his own words:

“The very essence of great production is high wages and low prices, because it depends upon a widening range of consumption only to be obtained from the purchasing power of high real wages and increasing standards of living."

-Commerce Secretary Herbert Hoover speech on labor relations: May 12, 1926 (source: Hoover Memoirs Volume 2)

“I have instituted ... systematic ... cooperation with business ... that wages and therefore earning power shall not be reduced and that a special effort shall be made to expand construction ... a very large degree of individual suffering and unemployment has been prevented.”

-President Hoover address to Congress: December 3, 1929

Of course the labor market quickly learned that the reality is precisely the opposite. Greater production—the outgrowth of business investment in labor saving capital tools and machines that increase productivity per worker—is the true source of higher wages, not the other way around. Simply pushing up wages doesn’t create economic prosperity. Productivity gains leading to lower unit production costs and greater purchasing power per dollar earned does.

Nevertheless, Hoover sold his “new economic science” to American business with the added encouragement of patriotic exhortation—urging them to do their duty as Americans to keep wages high for the sake of the nation and to think of the [macro] economy before themselves. And that in the long run they would be rewarded as a high-wage policy would blunt the pains of the depression and translate into a healthier business environment.

American business leaders were duly inspired and vowed to maintain wage rates—all under the watchful eye of the Commerce Department. Henry Ford, in a brave moment of enthusiasm, emphatically pledged to raise wages. Hoover and his business cohorts appeared united before the press as the President announced that their coordinated plan of attack would hasten the arrival of prosperity. And in a separate meeting with railroad executives Hoover extracted the same pledge.

II. HARD LESSONS IN DEFLATION AND PRICE FLOORS

The consequences of Hoover’s high-wage policy, predictable for anyone who understands elemental microeconomics, did not bode well for the American employment picture. Not only do price floors, when set above market equilibrium prices, create unsold surpluses (“unsold” or unemployed labor), but America also suffered from the famous deflation of 1929-1933 which further exacerbated the impact.

The U.S. economy suffered three major banking panics (1930, 1931, and the largest by far in early 1933) during Hoover’s term, due to a combination of factors including restrictive unit banking regulations, the shocking suspension of gold convertibility by the Bank of England in 1931, and most importantly the Federal Reserve’s policy of refusing to carry out its lender of last resort role for banks suffering from temporary liquidity shortfalls—especially banks perceived as having loaned to fuel stock market speculation in the late 1920’s.

From 1929 to early 1933 the broadest US money supply measure fell by nearly a third, and prices fell by nearly as much. A purchase that required one dollar in October 1929 only cost 93 cents in December of 1930, 84 cents by the end of 1931, 75 cents by the end of 1932, and 72 cents by the final banking panic in the spring of 1933 (source: BEA). Therefore, maintaining a wage of one-dollar per hour from October 1929 at one dollar in the spring of 1933 was the equivalent of paying $1.39 in real terms.

As deflation set in across the country, nominal business sales/revenues fell accordingly. But due to their pledge to maintain wage rates, American business—at least American big business—kept worker pay inflexible and therefore wages actually rose in real terms. All labor employed by industrial America was getting a 39% pay raise!

British economist John Maynard Keynes, who was well aware of the effect of price and wage floors, toured America in 1931 praising the high-wage policy both publicly and in his reports to British Labour Prime Minister Ramsay MacDonald. According to Keynes, high wages would spur greater demand/spending power and rapidly end the slump. Clearly they were of the same mindset as Hoover who, even on the 1932 campaign trail, boasted:

“For the first time in the history of depression, dividends, profits, and the cost of living, have been reduced before wages have suffered. . . . They were maintained until the cost of living had decreased and the profits had practically vanished. They are now the highest real wages in the world.”

But the reality on the financial books of American business painted a different picture. Companies could not endure revenues falling eventually by 28% due to deflation alone, plus business weakness due to depression, while wages remained constant. Losses quickly set in and widened every year as nominal prices fell further.

Corporations bravely tried to hold out, but the only way to maintain 1929 nominal wages in light of falling revenues was job cuts. Workers were steadily fired—first, the least productive but eventually even key personnel—and by the end of 1931 the unemployment rate was already 15.8%. By 1932 businesses started to defect from the plan entirely and began quietly lowering wages, but not enough abandoned ship before the notorious banking panic of 1933 which marked the nadir of the depression. At its early 1933 peak, the unemployment rate reached 25.9%.

III. FDR RAISES PRICES BUT RETURNS TO WAGE FLOORS

By the beginning of the Roosevelt administration American businesses had abandoned rigidly high wages and were entirely focused on survival mode. With the introduction of Federal Deposit Insurance, closing of insolvent banks over the Bank Holiday, and to a lesser extent the end of the dollar’s gold convertibility, the US money supply and prices stabilized. More importantly bank customers began to redeposit their cash in the financial system, encouraged by FDIC guarantees that their money would be reimbursed should their bank fail, and prices began to rise. 

Banks were able to begin normal lending operations again, free of worries that depositors would start a run that required them to boost reserves and curtail lending. And the high-wage commitment was all but gone. Wages and prices were, for the moment, flexible again and free to adjust to changes in supply and demand.

The recovery beginning in March of 1933 was staggering. Jason E. Taylor, Professor of Economics at Central Michigan University and a Great Depression specialist, calculates that from March to August of 1933 GDP and employment rose so quickly that at that continued rate the USA would have returned to 1929 levels of activity by the end of the year. And by early 1934 the US economy would be at levels that implied no Great Depression had ever occurred and that the USA had grown steadily at a 3% clip from late 1929 onward. There has been no five months of growth like March-August 1933 in American history.

But the new administration wasn’t ready to give up manipulating wage-rates upwards yet.

In a grand pattern of boom-and-bust the rally came to an abrupt halt in August of 1933 and promptly reversed course. In just four months during the fall of 1933, manufacturing retreated by a third and US GDP fell by over 5%, more than during the 2007-09 Great Recession. But instead of contracting 5% across a 19 month period as it did from December 2007 to June 2009, the 1933 contraction was compressed into just four harrowing months.

Ironically, since the downturn didn’t last six months—the official definition of a recession—it’s not recorded in any history books as the Recession of 1933, yet in that brief time the economy contracted more severely than during the 2007-09 Great Recession. And unemployment rose accordingly—up five percentage points in just five months.

What caused this giant U-turn in America’s economic fortunes? The frenzy of FDR’s famous “First 100 Days” of legislation was long over by the winter, so what other external factor or policy initiative could have caused such a negative reversal in the job market?

Taylor places blame squarely on the passage of the National Industrial Recovery Act (NIRA or NRA). Signed in June of 1933 but slow to ramp up, the NIRA is most famous for suspending antitrust laws and forcing big business to cartelize, collude, and artificially set prices above the market level. This misguided and patently absurd program had the effect of creating price floors for American goods and the result—much like unemployed labor—was a pileup of unsold merchandise. Faced with rising inventories due to falling demand, businesses cut back on production as well as jobs.

But what the NIRA is less famous for is the reintroduction of wage floors for workers—only this time coerced instead of sold via patriotic appeals by the Hoover White House. The NIRA authorized the “Presidential Reemployment Agreement” (PRA) which was enacted on August 1, 1933.

The PRA officially called for reducing hours to share labor across more workers—so-called “worksharing” agreements—but it also bullied businesses for a minimum pay rate of $15/week for workers in any city of greater than 500,000 people within a broad array of industries—20% above the average pay rate at the time and well above the equivalent minimum wage introduced in 1938 especially when considering the PRA’s reduced work hours provision and inflation adjustments for the 1933-1938 period. Smaller cities fared little better as the PRA called for a $14 to $14.50/week minimum wage for any city larger than 2,500 people. A new minimum wage had been created that went far above the level of the least skilled workers and encroached into salary levels in the nation’s factories.

Although the minimum wage was not technically mandatory, FDR offered businesses that agreed the right to display the NIRA “Blue Eagle” emblem on their storefronts, publicly encouraged Americans to shop at Blue Eagle businesses, and more importantly called for a nationwide boycott against businesses that didn’t display the emblem. The coercive message was clear and American business overwhelmingly complied out of fear of reprisals.

(for the full text of the PRA mandates go to http://www.presidency.ucsb.edu/ws/index.php?pid=14492)

Once again, corporate managers were faced with expectations—indeed coercion this time—to pay many skilled and industrial workers above the market equilibrium rate—at a time when unemployment, while falling, was still at 17% and 18%. Wages on average were artificially boosted 20% overnight in contrast to the Hoover high-wage agreement where real wages rose a higher 39% but over a much longer period of 40 months.

Higher skilled manufacturing jobs weren’t as heavily affected, since their market wage tended to be above the PRA floor. But lower skill manufacturing jobs such as textiles and clothing saw wage increases of even greater than the 20% average. Suddenly millions of American workers became unemployable moneylosers for their employers.

FDR extended the PRA wage mandates again in January of 1934, but by 1934 legal challenges to the NIRA and PRA began to pile up. The National Recovery Administration went through several restructurings and lost its effectiveness. Many businesses soon calculated the higher operating costs were not worth the marginal gains in customers, especially as public support for the NIRA’s Blue Eagle campaign waned. Eventually the entire NIRA was ruled unconstitutional and overturned by the Supreme Court in 1935, but enforcement of the NIRA, uncertainty surrounding its legality, and a general lack of enthusiasm by the public had already set in by mid-1934.

“By the end of 1934, NRA leaders had practically abandoned the progressive interventionist policy which motivated the Act's passage, and were supporting free-market philosophies—contributing to the collapse of almost all industry codes.”

-from Wikipedia https://en.wikipedia.org/wiki/National_Industrial_Recovery_Act_of_1933#Criticism

Professor Taylor once again points to the NIRA—only this time via its demise—as the catalyst for a second recovery in the job market. By mid-1934 unemployment began a rapid decline coincident with the largest wage policy change at the time—the beginning of the unraveling of the NIRA. For the second time in two years government control over wage-rates was abandoned, allowing prices to adjust freely and the market for goods and labor to clear. Twice now a rapid recovery in employment was underway.

Stay tuned next month for Part 2 of this Great Depression installment on wages.

ps. For more information on Professor Taylor’s NIRA and PRA work analyzing late 1933 job losses, listen to his Mercatus Center interview here:

https://www.mercatus.org/podcast/2016/08/08/macro-musings-18-jason-taylor-great-depression-world-war-ii-and-big-push

…or read his more detailed research paper here:

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.568.244&rep=rep1&type=pdf

Robert Wenzel: An Austrian Speaks to and Criticizes the New York Federal Reserve

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3 MIN READ - From the Desk of the Cautious Optimism Correspondent For Economic Affairs and other Egghead Stuff

With Jerome “Jay” Powell, President Trump’s nominee to chair the Federal Reserve, having cleared Senate Banking Committee testimony and expected to pass the full Senate confirmation vote it looks as though monetary policy won’t change very much with his term starting in early February. Powell is expected to continue his predecessor Janet Yellen’s easy money policy of very low interest rates, gradual hikes in the Fed Funds rate (expected at one quarter-point, three times a year) and a slow unwinding of the Fed’s massive $4+ trillion balance sheet. 

Stanford economist John B. Taylor, who proposed placing the Fed on a rules-based interest rate policy and ending discretionary overreach, drew eleventh hour praise from Trump for a possible nomination nod, but in the end the president embraced the status quo of easier money.

So now that we know no major change is coming to the Federal Reserve for at least four years, maybe we should take a look at what’s been wrong historically with the central bank for decades—that’s also not about to change. Austrian economist Robert Wenzel did precisely that a few years ago… at a speech within the Fed itself! 

(to read Wenzel's wonderful speech go to...

https://mises.org/library/new-york-fed-leave-building)

Wenzel was invited to speak at the New York Fed by accident, his inviting host unaware of Wenzel’s anti-Fed positions, but by the time the mistake was realized it was too late and Wenzel was allowed to make his appearance. Wenzel’s policy criticisms were many and quite entertaining (perhaps not for the employees who attended) and included:

-Mathematical methodology: Treating the literally billions of daily economic decisions made by American consumers and businesses like variables and constants that can be plugged into a scientific equation, as if the capricious and constantly-changing preferences of consumers share the predictability of mathematical constants in physics or astronomy.

-Dogma that demand is the primary driver of economic activity/growth and not production.

-The inability of Fed economists to differentiate between “price and wage stickiness,” which they consider a market phenomenon, and government-induced price stickiness such as unemployment benefits, pro-union legislation, and historically the wage-rigidity policies enacted by both the Hoover and Roosevelt administrations during the Great Depression.

-Obsession with maintaining stable or rising prices and apoplithorismosphobia (aka. deflationphobia). If, according to Fed policymakers, deflation creates depressions, how on earth did the American economy grow at its fastest rates ever during the Gilded Age when prices were falling on average one percent per year? How do the computer, cell phone, and flatscreen TV industries not only survive, but actually thrive when both their nominal and inflation-adjusted prices plummet year after year?

-Spawning asset bubbles, financial crises, and major business cycles with a misguided monetary policy that creates vast amounts of credit from thin air, unbacked by voluntary saving (ie. deferred consumption) from the public.

Wenzel also had some interesting notes on the Q&A at the end of his speech. In fairness, many of the attendees were good sports about the critique although many of their questions revealed they had absolutely no knowledge whatsoever of economic theories outside the mainstream Keynesian and Monetarist schools that dominate today’s academic and policy landscapes.

Lessons from the Great Depression: Government Stimulus Spending Made Things A Lot Worse

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10 MIN READ - An important in depth analysis from the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff

Real federal spending nearly doubles 1929-1933

This month we focus on the historical lesson of government spending (more or less?) during an economic slump—the correlative to last month’s discussion on Herbert Hoover’s destructive 1932 tax hike (from a top marginal rate of 25% to 63%) and FDR’s nearly equally detrimental 1936 increase from 63% to 79% and new “undistributed profits” tax.

Mainstream Great Depression histories and the economics columns of America’s major newspapers have been mostly silent on Hoover’s massive revenue measures that sent the economy plunging to its worst levels in American history the following year—opting instead to criticize his laissez-faire approach. But what have they said about spending?

I. ECONOMIC FAIRY TALES: HERBERT HOOVER WAS A BUDGET-SLASHING AUSTERIAN

Well Herbert Hoover’s 1929-1933 spending policy is one subject the press and academia were certainly not silent on. During the Great Recession the New York Times, Washington Post, Boston Globe, the Guardian, Atlantic, and other more liberal outlets like Salon, Slate, Vox, Huffington Post, etc… were virtually unanimous in their endless bemoaning of government austerity—primarily in Europe—and repeatedly cited their own “lessons” from the Great Depression: that Herbert Hoover slashed federal spending at a time when the economy needed expansionary stimulus in the form of enlarged budgets and fiscal deficits. The examples are virtually endless, but here are just a few to illustrate:

“The nation will be reeling from the actions of 50 Herbert Hoovers — state governors who are slashing spending in a time of recession” 

-Paul Krugman, “Fifty Herbert Hoovers,” New York Times, Dec 28, 2008

“Virtually all the deterioration in the US debt position from 1929 to 1939 took place under the tight-fisted Hoover rather than under FDR… …the Hoover experience also provides a nice illustration of self-defeating austerity… …It’s too bad that people who don’t understand any of that seem to have the upper hand in policy.”

-Paul Krugman, “Debt Depression,” New York Times, July 20, 2010

“World Leaders Heed Herbert Hoover, Opt for Belt-Tightening Over Economic Stimulus”

-CBS News, June 7, 2010

“[Nobel Laureate economist Joseph] Stiglitz believes the world is in danger of repeating U.S. President Herbert Hoover's mistakes in 1929 of slashing spending. ‘There is ample evidence on this,’ Stiglitz said. ‘We call these Hooverite policies (government austerity measures) in honor of Herbert Hoover.’”

-CNN, “Depression, Double-Dip, and Deficits: Economists Speak Out,” July 9, 2010

“But one of the most basic principles of economics is that when an economy is anemic, governments should use deficit spending as a fiscal stimulus, even though that means an increase in debt. If Senator Rubio believes that the response to a weak economy is to slash spending, he is embracing the approach that Herbert Hoover discredited 80 years ago.”

-Nicholas Kristof, “Why Pay Congress?”, New York Times, April 6, 2011

“That‘s a bad thing. Hoover is a political epithet in bad economic times because his response to the depression—was to, first do nothing and then do stuff that made it worse. The country needed massive federal spending to stimulate demand and keep people working. Hoover? Cut spending… …I‘m Herbert Hoover. I can‘t do anything helpful. How about I hurt the economy some more instead because of my dumb, moralistic, ideologically-driven, ignorant, short-term, self-serving bad ideas? I‘ll take this depression and make it not just good but great. That‘s the ticket, the Great Depression.”

-Rachel Maddow, “The Rachel Maddow Show,” December 12, 2008

Regarding the Maddow quote: to anyone who knows anything about government spending under the Hoover administration, you can only shake your head in disbelief at the awesome ignorance of such a self-righteous commentary. OK I know, Rachel Maddow is no economist. She’s not even a good economics commentator. But she did at least get the part right about Herbert Hoover turning a recession that started in 1929 into the Great Depression.

But for the opposite reason. Herbert Hoover was actually a runaway spender. As you’ll see it’s not even up for debate.

II. THE NEW YORK TIMES VS. ECONOMIC HISTORY, HERBERT HOOVER: PROFLIGATE SPENDTHRIFT

Which leads us away from the New York Times, CBS, CNN, and Rachel Maddow back to economic reality on planet Earth. Since Krugman, Stiglitz, Kristof, or Maddow have for good reason never produced any actual 1930’s budget numbers to back up their assertions, let's discuss the important details that they never will:

1) In response to the 1929 stock market crash, Herbert Hoover launched the largest peacetime percentage expansion of federal spending in American history—then or ever since. From Calvin Coolidge’s last budget (FY29) to Hoover’s last budget (FY33), federal spending rose 47% from $3.127 billion to $4.598 billion (source: whitehouse.gov historical budget tables—although any 1930’s budget source will confirm the same).

https://www.usgovernmentspending.com/spending_chart_1929_1933USk_20s2li111mcn_F0f

https://www.whitehouse.gov/sites/whitehouse.gov/files/omb/budget/fy2018/hist01z1.xls

2) But that’s just the beginning. During the same 1929-1933 period rapid deflation boosted the dollar’s purchasing power due to the failure of nearly 10,000 commercial banks and credit contraction by highly stressed surviving banks. The money supply fell by nearly a third as did prices. So an inflation-adjusted dollar spent in 1933 was worth almost 1.5 times its 1929 value. Adjusting Hoover’s FY33 budget for deflation, spending swelled by 93.5% in real terms. In fact, calculating the hike from the nadir of the monetary contraction in the late spring of 1933 federal spending rose briefly by over 100%. Yes, you read that correctly. Herbert Hoover nearly doubled real government spending. Not quite the “draconian cuts” you may have read about?

https://www.usgovernmentspending.com/spending_chart_1929_1933USk_19s2li111lcn_F0f_Recent_Federal_Spending_In_Percent_GDP

3) As if it couldn’t get any worse, as a percent of GDP federal spending rose from 3.64% to 8.92%--due to a combination of real spending hikes and the shrinking economy. So as a share of the economy, Herbert Hoover ballooned federal spending by 145% or to about 2.5 times its original size.

https://www.usgovernmentspending.com/spending_chart_1929_1933USp_19s2li111lcn_F0f_Recent_Federal_Spending_In_Percent_GDP

On a side note Keynesian economists argue “You can’t measure federal spending as a percent of GDP because the economy was collapsing from 1929-1933 which distorts the calculation. It’s an unfair metric.” To which there are at least two valid responses: First, even ignoring government spending as a share of GDP, real spending itself nearly doubled which is already high enough to kill the “austerity” myth. But second, Keynesians always argue huge boosts in government spending are precisely what prevent recessions/depressions from getting worse in the first place. So if Herbert Hoover oversaw the largest peacetime spending expansion in American history, why was the economy even collapsing? Shouldn’t his near-doubling of real government spending have saved America, or at least prevented the calamity of the Great Depression instead of delivering… well, the Great Depression?

Or is it just possible that there's something wrong with their theory, and that all this profligate government spending is precisely what made things worse? The data sure fits the alternate theory a lot better than theirs.

Incidentally, if we account for all levels of government and include state and local spending—the hike as a share of GDP, while still enormous, wasn’t quite as dramatic: up “only” 98%. But other than some aid to state and local governments, Herbert Hoover had much less of an effect on their budgets than Washington’s. And of course the main target of the media’s Great Recession criticism was Hoover’s austerity, not the states'. But the evidence that total government spending at all levels by 1933 had doubled up to 22% of GDP also establishes that government spending was by no means insignificant by then, and was in fact a record at the time. By contrast, during America’s second worst depression, the Depression of 1893, total spending at all levels of government tallied at only 7-8% of GDP. And not coincidentally the Depression of 1893 ended in less than half the time as the Great Depression.

https://www.usgovernmentspending.com/spending_chart_1929_1933USp_11s0li111lcn_F0t_US_Government_Spending_As_Percent_Of_GDP

4) When confronted with the folly of austerity claims—a rare occasion in and of itself—Keynesian economists will sometimes focus on a single year: FY33 where federal spending dipped slightly from the previous year—from $4.659 billion to $4.598 billion, a decline of 1.3%.

But to call a 1.3% cut “draconian” or characterize it as “slashing spending” is not only an anemic argument, it once again ignores the impact of deflation. One dollar in 1932 was worth $1.11 in 1933, so in 1932 dollars the FY33 budget was not $4.598 billion but instead $5.104 billion, yet another hike—this time up 9.6% in real terms. Pointing to FY33 as the year of tragic austerity is just a fool’s errand.

5) One more legend of Hooverian austerity is his Treasury Secretary Andrew Mellon’s advice in the early days of the downturn to “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate…” which Hoover has recounted in his memoirs (available online at the Hoover Institution). Paul Krugman has also resurrected the quote in his April 2011 column “The Mellon Doctrine”—the insinuation being that Mellon’s quote is proof that Hoover stood by and allowed the economy to collapse in the mistaken belief that liquidation and adjustment were the proper policy response.

Well if only Hoover had really believed that. Americans might have been spared a lot of pain and suffering! The problem is two paragraphs later in the same memoirs Hoover describes his reaction to Mellon—which unsurprisingly Krugman, Delong, Stiglitz and others have chosen not to tell their readers about:

“Secretary Mellon was not hard-hearted. In fact he was generous and sympathetic with all suffering. He felt there would be less suffering if his course were pursued… ...But other members of the Administration, also having economic responsibilities—Under Secretary of the Treasury Mills, Governor Young of the Reserve Board, Secretary of Commerce Lamont and Secretary of Agriculture Hyde—believed with me that we should use the powers of government to cushion the situation… …The record will show that we went into action within ten days and were steadily organizing each week and month thereafter to meet the changing tides— mostly for the worse. In this earlier stage we determined that the Federal government should use all of its powers.”

-Hoover memoirs, p. 31

6) Finally the last demand-side line of defense usually goes something like “Well, Hoover tried but his spending programs weren’t big enough” and the standard corollary of “The Great Depression would have been worse were it not for his half-measures.” Of course every time the Keynesian prescription has all-too-often failed (think Obama’s $800 billion 2009 ARARA stimulus, bloated European budgets in the initial post-2008 crisis years, and multiple Japanese stimulus packages) the “not big enough” card is dusted off and played, almost as if on an automated script.

But America experienced major depressions in 1837, 1873, 1893, 1907, and 1920, the first four in particular with major financial/banking panics. Not only were federal stimulus spending programs “not big enough” then either, they were completely nonexistent since demand-side economic policies hadn’t been invented yet. In fact, the federal government’s standard response prior to 1929 was to cut the budget during slumps to compensate for falling tax revenues.

According to the Paul Krugmans of the world, those downturns should have deteriorated into “Greater Great Depressions,” lasting entire generations. But the opposite happened: the slumps were over in a year or two and full employment was restored in anywhere from two years (Depression of 1907 and 1920) to at most seven (Depressions of 1873 and 1893), instead of the eleven years required after 1929, or more accurately sixteen years if you exclude World War II when the US military conscripted 12 million men, sent them overseas, and counted them as “employed.”

It’s also worth noting that early 1930’s federal spending increases were not on liberal bête noires like military budgets, but rather for standard New Deal type programs: The Resolution Finance Corporation to bail out railroads, politically connected banks and businesses. Compensation to state governments for falling tax revenues. The Federal Farm Board to buy up crops in an attempt to prop up produce and livestock prices, and eventually pay farmers directly to stop growing food. Public works programs building roads, bridges, parks, buildings and large jobs projects such as Mount Rushmore and the Hoover Dam. So no one can argue Hoover’s budgets weren’t “demand boosting” in the longstanding conventional sense.

III. WHERE RECORD TAX AND SPENDING HIKES GOT US (AND WILL STILL GET US NEXT RECESSION)

But back to what we now know is, to borrow a line from economist Lawrence Reed, one of the Great Myths of the Great Depression: that Herbert Hoover was a tight-fisted budget cutter. The countless claims in America’s newspapers and among academics that Hoover was a small government austerian is an openly categorical falsehood. Herbert Hoover launched tax hikes and spending increases that, measured as percentage gains, were and still remain records for American peacetime. The top tax rate rose by 150%, real federal spending rose by nearly 100%, and federal spending as a percent of GDP rose by nearly 150%.

And given the prescriptions liberal economists, journalists, and policymakers have been pushing since 2009—more taxes on the rich and more government spending—well, Hoover has already generously given us all the greatest experiment in American history of that very same prescription; by ballooning the federal budget and soaking the rich. Was the result an energetic recovery achieving full employment in record time? No, it was the Great Depression; delivering peak unemployment rates double that of the nearest slump (also the Depression of 1893) and lasting two-and-a-half times longer than the next longest downturn (tie: Depression of 1873, Depression of 1893, and 2008 Great Recession—as measured by number of years to return to full employment).

So what’s our Great Depression’s great lesson for this month? More government spending makes recessions longer and worse (for a modern-day example, see Japan’s nearly three decades of government stimulus spending). Multiple articles have been written about the Hoover myth and the real lessons of early 1930’s fiscal policy, but they have been confined mostly to conservative and libertarian outlets such as the Mises Institute, CATO, and Mercatus Center. Most of America simply isn’t aware that Hoover the tightfisted miser is a complete myth, because if you watch or read mainstream media you’d probably never know either.

MiG Pilot Defector Viktor Belenko Visits a Virginia Grocery Store

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2 MIN READ - From the desk of the Cautious Optimism Correspondent for Economic Affairs and other Egghead stuff; following up from last post on the world of Marxism.

PVO Lieutenant Viktor Belenko before his spectacular defection to Japan

And not to limit our history lessons to the Chairman of the Supreme Soviet Presidium and Politburo party bosses, everyday Soviet MiG-25 pilot-defector Viktor Belenko had his own observations about the suburban Virginia supermarket he visited with his CIA handlers.

"Thirty or forty different varieties; milk, butter, eggs, more than he had ever seen in any one place; the meat counter, at least twenty meters long, with virtually every kind of meat in the world-wrapped so you could take it in your hand, examine, and choose or not; labeled and graded as to quality. A date stamped on the package to warn when it would begin to spoil!..."

“…Never had Belenko been in a closed market selling meat or produce that did not smell of spoilage, of unwashed bins and counters, of decaying, unswept remnants of food. Never had he been in a market offering anything desirable that was not crowded inside, with lines waiting outside. Always he had been told that the masses of exploited [U.S. citizens] lived in the shadow of hunger and that pockets of near starvation were widespread, and he had seen photographs that seemed to demonstrate that.”

“If this were a real store, a woman in less than an hour could buy enough food in just this one place to feed a whole family for two weeks. But where are the people, the crowds, the lines? Ah, that proves it. This is not a real store, The people can't afford it. If they could, everybody would be here. It's a showplace of the Dark Forces. But what do they do with all the meat, fruit and vegetables, milk, and everything else that they can't keep here all the time? They must take it away for themselves every few nights and replace it.”

(to read more of this amusing story, click and download the PDF link)
http://www.uen.org/Lessonplan/downloadFile.cgi?file=1271-6-23581-viktor_belenko.pdf&filename=viktor_belenko.pdf

A Houston Randall’s Grocery Store Convinces Boris Yeltsin to Leave the Soviet Communist Party

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1 MIN READ - An offering from the Cautious Optimism Correspondent for Economic Affairs (and other Egghead stuff).

Before we say goodbye to the November 100th anniversary of the communist Bolshevik Revolution, CO has decided to take a slightly different path from recounting the deaths, suffering, and famine under the early Lenin regime and nightmarish Stalin dictatorship. Instead we ask "How were things going in the Soviet Union near its end--after the Communist Party had spent over 70 years ironing out the details of the Workers’ Paradise utopia?"

Boris Yeltsin certainly formed his own opinions about how the Soviet economic model was performing in 1989—right after he visited NASA’s Johnson Space Center in Houston. But it wasn’t the American space age technology that impelled him to leave the CPSU but an impromptu visit to the nearby Randall’s supermarket afterwards.

The frozen Jell-O pudding pops in the ice cream aisle woke Yeltsin up to hard truths about communism and economic central planning—lessons that thousands of Marxist and communist university professors in the USA and Europe still haven’t grasped today.

Read the Houston Chronicle story at...

http://blog.chron.com/thetexican/2014/04/when-boris-yeltsin-went-grocery-shopping-in-clear-lake/

Great photo slide show to boot!