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Why does the final debt ceiling agreement look like 1938, when Republicans took over Congress after President Roosevelt ok’ed spending cuts while raising some taxes?  Because Congress may make the same mistake—a repeat of the Great Depression by cutting spending when the U.S. economy hasn’t recovered from the Great Recession.

Democrats lost 71 House seats and 8 Senate seats in the 1938 election, after Roosevelt had been persuaded by his advisors cut back on New Deal programs, which precipitated the 1937-38 second depression and gave Republicans ammunition to say the New Deal hadn’t worked.  Production, profits and wages had regained their 1929 levels by the spring of 1937. Unemployment remained high, but was considerably lower than the 25 percent rate seen in 1933.

So in June 1937, some of Roosevelt's advisors urged spending cuts to balance the budget. WPA rolls were drastically cut and PWA projects were slowed to a standstill, according to Wikipedia. The American economy took a sharp downturn in mid-1937, lasting for 13 months through most of 1938. Industrial production declined almost 30 per cent and production of durable goods fell even faster.

Does this look terribly familiar?  In other words, we might be doomed to repeat the historical mistake of listening to creditors to whom so much of the federal debt is owed by cutting spending without creating jobs, when we should be stimulating growth both to reduce the ratio of debt to GDP and help debtors repay their debts.

The new agreement doesn’t allow any revenue increases in the first stage of some $2.1-2.4 trillion in mandated spending cuts over the next 10 years.  This of course means the debt isn’t being paid down.  All of the Bush tax cuts had added $3.7 billion to the $14 trillion in debt, with tax loopholes extended for energy and agribusiness, two wars and two recessions making up most of the rest.  The spending cuts weren’t paid for then, and aren’t being paid for now, in other words.

But, had we continued the stimulus spending of 2009-10 that included the $787 Billion in ARRA stimulus, spent more of the $11 billion set aside for the HAMP mortgage modification program, and extended the homebuyer tax credits that expired last June, we might have started both a real estate recovery and longer term economic growth.

Instead, we are close to a ‘double-dip’ after just leaving the Great Recession.  The first part of the Great Depression actually ended in 1934, which lulled everyone into believing that cutting spending in 1937 would do little harm. But it just made the Depression worse, until spending from government debt that topped 122 percent of GDP during World War II ended the Great Depression!

So history is very clear on what it takes to stimulate jobs and economic growth—more spending on policies that produce growth.  That is the only way to bring down the debt level.  But one can’t borrow for the wrong things, such as tax cuts. As one pundit put it, business doesn’t care where the dollars come from—a public or private worker.   Calculated Risk has kept tabs on the possibility of a double-dip recession and second quarter numbers show the economy has almost ground to a halt.  GDP growth revisions show Q1 2011 rose just 0.4 percent and Q2 1.3 percent in the ‘advance estimate’.

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Personal Consumption Expenditures, which account for almost 70 percent of activity, have been falling for just the past 3 months for a number of reasons, including a spike in energy and food prices, and falling vehicle sales due to the Japanese Tsunami.  It is why GDP growth has slowed so drastically.  There are 4 indicators used by the National Bureau of Economic Research Business Dating Committee to determine a recession—employment, personal income less transfer payments, real GDP growth, and industrial production.  Of the 4, industrial production and GDP growth have recovered the most.

There is some hope with the July Institute of Supply Management non-manufacturing survey that showed overall service sector activity had risen 2.7 percent in 12 of its 18 industries, which account for more than 70 percent of all economic activity.  So we have not yet entered a double-dip.  But without a viable job creation program, that may still happen.  

So history as well as basic economics tells us those who want to shrink government by slashing spending without programs that also grow the economy are wrong.  What would it take to convince them otherwise?  Another Great Depression, or a Great War?

Harlan Green © 2011


Are we doomed to repeat 1938, by cutting budget, rather than spending more to create jobs?

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Comment Preferences

  •  Business cycle ended March 1933 (1+ / 0-)
    Recommended by:

    This is way more accurate

    GDP growth

    Everything was looking fine thru 1936, so lets cut the CCC and WPA by 60% in '37.

    Than this

    The first part of the Great Depression actually ended in 1934, which lulled everyone into believing that cutting spending in 1937 would do little harm.

    It wasnt that cutting spending would do little harm, it was that the spending wasnt needed.THe political pressure on FDR after the '36 elections were huge, to cut spending.

    And you didnt mention the Fed tightening policy in '37 either.

    Yes, the parallels to the recession of 37-38 are very clear, I agree with you whole heartedly.

    FDR 9-23-33, "If we cannot do this one way, we will do it another way. But do it we will.

    by Roger Fox on Sat Aug 06, 2011 at 05:04:30 PM PDT

  •  One correction (4+ / 0-)
    Recommended by:
    PhilK, jessical, Marie, outragedinSF

    This isn't 1938. It's 1931.

     Obama never made sweeping social changes like FDR did. He made tiny changes without ever addressing the fundamental problems, like Hoover did.

    "The people have only as much liberty as they have the intelligence to want & the courage to take." - Emma Goldman

    by gjohnsit on Sat Aug 06, 2011 at 05:07:16 PM PDT

    •  Yes. Unlike FDR who took over (0+ / 0-)

      in 1933, three and a half years after the crash, Obama took over half a year from the crash.  Then he gave Bernanke his opportunity to re-run the Great Depression as a better Hoover.  Between the shitload of money spent by the FED and Treasury this time, they expected the downslide to stop within a year, hold it at half what Hoover presided over, and then reverse course.  Now doesn't look as if the bottom has been reached.

  •  The Energy spike is the most worrisome thing (0+ / 0-)

    We were going fairly well until oil hit $114/barrel. That absolutely destroyed the recovery.

    It looks like every time we get any good news together oil speculators are going to kill the recovery.

    Roosevelt never had this to worry about...

    •  FDR didn't have real world experiment (0+ / 0-)

      in the power of Keynesian economics to reference either.  

      Oil speculators would lose much of their power if alternative/renewal energy projects had begun two years ago.  With the fervor that this country ramped up and responded to the Japanese and Germans after Pearl Harbor.  If the lazy ass Americans were informed that this is a national emergency and cutting oil consumption was a patriotic duty.  All we got was "drill, baby, drill" in the US v. "technology will rescue us someday, and until then our wars for oil must continue."

  •  Obama has Military Cuts available FDR did not (0+ / 0-)

    Obama could end these wars and cut the military budget in half.  FDR in 1938 did not have these potential cuts available to him.

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