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Treasury, Federal Reserve seeks to Assure Investors and Main Street
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Over the last several weeks the White House has been introducing a huge expansion in the federal government to deal with many of the different economic challenges that the economy is facing. While many people have a wide variety of opinions one thing is clear that no matter if you are for or against this type of intervention the economy is in desperate need of economic stimulus as the unemployment rate climbs to its highest level in 25 years, the housing market is experiencing the worst financial pain since the 1930’s and there is continued contraction in the Gross Domestic Product (GDP). In spite all of this doom and gloom there are some positives that the economy will experience as a result of what is happening.
Using history as a guide, there have been several instances where the U.S. economy has faced similar kinds of situations like the one that we are in now. To be able to put an end to the downward spiral that the economy is going through requires a major commitment from the government to put an end to the economic turmoil so that the economy can resume normal economic growth. Some good historical examples of how government action or inaction has had an effect on the economy include:
1837: This was the first panic and depression that the country had ever known. Just 7 years earlier the country was growing rapidly, land was a hot item as many speculators purchased it from the federal government hoping to sell it the railroads or for it to be used as canals. The sale of this land brought in so much money that the U.S. Treasury was able to pay off the national debt by 1835. During that time President Andrew Jackson, caused the National Bank of the United States to dissolve believing that a strong central bank could hurt average Americans by having too much power over credit and the economy.
To counter this, he had the funds transferred from the National Bank to state banks. This caused the state banks to engage in foolish lending policies by loaning money to speculators for land that they purchased from the Federal Government. By early 1837, many banks had started to disappear, businesses failed and thousands of people lost their land.
Within the first two weeks of April 1837, 250 businesses in New York City had failed. As the crisis started to grow, the new President Martin Van Buren took a limited government approach meaning that he was not willing to have the government intervene in the crisis. This caused the economy to go into a depression. The result was that 343 banks had collapsed and the state banking system was badly damaged.
The depression continued until 1843 when the federal government passed low tariffs to stimulate trade. Clearly the lack of regulation of the state banks, the disappearance of the national bank, and the hands off approach of the government allowed the economy to become much worse. Had there been a strong reaction from Washington to address these issues chances are the economy would not have gone into a depression and any economic downturn would have been limited in scope.
1907: In mid 1907, the U.S. economy was starting to slow down. As October approached, a series of events took place that would shape how and when the inevitable panic would take place. First, two speculators were making an attempt to corner the copper market. Second, many banks and brokerage houses were not financially sound. In October of that year, Knickerbocker Trust (a large bank in New York City) and Westinghouse Electric both went under. This started a massive panic that caused the stock market to implode and many depositors made runs on numerous banks in an attempt to take out their money before it was too late. In response the treasury department pumped millions of dollars into the banks only to see that their efforts were not working. In an effort to restore calm, J.P. Morgan and his colleagues also pumped money into those institutions that were at risk of failing. The effort from the government and the Morgan group did provide stability over the following weeks. In the aftermath of this event, the economy went into a short but severe recession in 1908. The government also increased regulation of the banking system which included the Aldrich Vreeland Act that allowed banks to issue more bonds, this provided more liquidity and helped the credit crunch end. The Owen Glass Federal Reserve Act established the Federal Reserve Bank which created a strong central bank to regulate the economy. The creation of the federal reserve helped provide transparency and steadiness to the U.S. economy. The situation in 1907 could have easily spun out of control similar to what happened in 1837; however this time the government was willing to act and do what was needed to be done to stop the downward spiral that the economy had entered. While there was a recession in 1908, if there had not been this action by the government the economy could have easily gone into a depression.
1933: In October 1929 the famous stock market crash ushered in a depression that would last in the United States until 1933. By March of that year, the economy was at the depths of the Great Depression and it did not seem as if there was an end in sight. To stop the depression Franklin Roosevelt initiated the New Deal. The way it worked was to provide relief and recovery, It vastly increased the size of the federal government and its affects are still felt to this day. Some of the programs that were established under this plan include: The Work Progress Administration (WPA), Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission (SEC), Federal Communications Commission (FCC) and Social Security to name a few. What these programs did was to provide jobs for public projects, protect bank depositors’ money, regulate the stock exchanges, standardize the communication air waves and provide pensions for the elderly or disabled. At the time the New Deal was criticized for increasing the size of government and causing spending to go to extremely high levels. However, this politically charged idea was needed to stop the downward spiral that the economy was in. From 1933 to 1938, an economic recovery did take place. What this shows is that when the federal government steps in during times of economic crisis such as a depression they can help put a stop to the downward freefall that the economy can go into.
What these historical examples show is that while massive intervention by the government is not necessary all the time. There are instances when speculation can run amok, meaning that when you have times of excessive speculation going on it can lead to extreme cycles of booms and busts. Doing nothing will cause the bust cycles to continue eroding consumer confidence and can affect the overall wealth of literally millions of people. This is why it is so important for the federal government to use its massive resources to restore confidence in the economy and the financial markets. Secondly, the changes during times of economic upheaval bring new laws as well as regulations meaning that the amounts of greed and speculation have to be controlled to prevent the economy from overheating in the future. This was indeed the case with the New Deal, the effects of this increase in regulation leads to steady economic growth that the country experienced for almost 80 years.
When you do a comparison of the economic plan that President Obama has in store, it is clear that there are many similarities to what was done with the New Deal and the massive amount of the stimulus package from the Federal Reserve is similar to what happened during the economic crisis of 1907. So far the White House has proposed several different items to stimulate the economy including:
- An $8,000.00 credit for first time home buyers.
- An investment fund of both private capital and money from the federal government to take the bad mortgages off the books of different banks transferring them to a fund that can slowly divest itself of the assets over time.
- A massive public works program that Obama claims can create 5 million new jobs.
- Money for the state as well as local governments.
- Doing bailouts for some of those industries that have become vital to the functioning of the economy.
- A tax cut for those individuals who make less than $250,000.00 a year.
The debate on this plan is coming in at a furious pace with many opponents arguing that the President’s plan is nothing more than a massive increase in the size of the federal bureaucracy which could lead to inefficient social programs, trample on the civil rights of everyone and cause the national debt to balloon leading to higher interest rates down the road. Furthermore they argue that the way to stimulate the economy is to give the money back to the people in the form of tax cuts similar to what happened in the 1980’s and 2003. The opponents of Obama’s plan are comparing it to what happened in Japan during the 1990’s citing that it will do little if anything to stimulate economic growth.
While proponents argue that when the economy falls into a downward spiral the only way to prevent a major financial meltdown is for the government to become actively involved in forcing those corporations who were a part of the excess to do the right thing and to prevent the economy from slipping further into the economic abyss. These people often site how the New Deal during the 1930’s put an end to the Great Depression and lead the country out of the economic turmoil that it was in.
The big question here is who is right?
Using history as an example one thing is clear, that while opponents of the President’s economic package are correct to a certain extent. The reality is that during times of extreme economic distress it is imperative for the federal government to act quickly, swiftly and creatively to put an end to the current economic upheaval that the country has fallen into. As history has shown, during these kinds of economic conditions, taking a hands-off approach to the economy as far as the government is concerned will only cause the economic crisis to become worse. This was indeed the case that took place in 1837 when the federal government did nothing causing a depression that would last for six years. In contrast when you compare it to similar situations which took place in 1907 and 1933, one thing is clear thanks to the strong reaction from the federal government during these periods of economic crisis it helped put an end to the economic situations that the country was in. In addition the new regulations which came about because of this government action lead to some of the strongest periods of economic growth in the county’s history. Even though the size of the federal government will increase dramatically under the President’s plan, given the current economic circumstances, what else can be done?
A common argument which you will hear from many opponents is that those companies or industries that are not strong enough should go into bankruptcy and reorganize to come out stronger. While this sounds nice in theory, the reality is that during times of economic distress when you let major industries fail it will only fuel the downward spiral of job losses, lack of consumer confidence and you will have a situation where many industries simply will not be able to emerge from bankruptcy stronger, instead they will go into liquidation. Another key point that these opponents make is that these massive bailouts and spending plans are the same things that Japan did in the 1990’s. But what they are not telling you is that in Japan during that time period the government never fully enacted their plans, only saying that if the current economic situation did not turn itself around within two years then they would react. The differences with the President’s plan, is that this cannot wait, something must be done now before the economy sinks deeper into economic turmoil.
Regardless, if you are for or against the President’s economic stimulus plan one thing is clear doing nothing to resolve the current economic crisis is simply not an option. As history has shown, the action or inaction from the federal government will play a major role in stopping the downward spiral that the economy has fallen into. While no one knows what the future will bring, the actions taken by the government to restore confidence in the economy and the financial markets will work, it’s only just a matter of time.
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