Poke through the ashes of the 1929 stock market collapse and FDR's New Deal response and the winner of today's raging political debate becomes manifest. Two fundamental problems caused the crash and two fundamental solutions prevented a recurrence.
The fog of war has nothing on the fog of economic debate. Obama's slogan should not be "it's the economy, stupid" , but "it's the economics, smart ass". Since no two economists seem to agree on anything, I offer this non-expert primer on some fundamental economic principles, and some fundamental economic history lessons.
First economic principle: Economics is not fundamentally about money, but about predicting human behavior. The best evidence for future human behavior is past human behavior.
First economic history lesson: The 1929 stock market crash. Stock prices became unhinged from their underlying value for two reasons. Stockbrokers and banks could lend the investor 95% of the cost of buying the stock and the company issuing the stock did not have to disclose to the investing public the material facts about the company's financial condition. Investing turned the stock market into the nation's gambling casino. Imagine being invited to Vegas where the casino would lend you 95% of every bet you placed. Note well: the 1929 investor was not betting that the company's stock price would rise because the company's profits would rise but because another investor (gambler) believed the stock price would rise even higher, and cash the first investor out at a profit (the "greater fool " theory).
Second economic principle: Unregulated financial markets do not respond to altruiusm or how an investment enriches or impoverishes others or might strangle other parts of the economy. Unregulaterd financial markets respond primarily to fear and greed. Fear and greed are not, in the financial world, evil things but rather necessary for the proper functioning of a captialist economy, because they make people get up in the morning and do what needs to be done.(I'm from Minnesota, in case you can't tell).
Second economics history lesson: The New Deal fix for future stock market investong and trading. Simple. One, you have to have real skin in the game if you want to buy stock, at least 50 cents cash for every dollar invested. Two, the company issuing the stock had to tell you and every one else its true financial condition, with updates at least every 90 days.
Third economics principle: Rich investors, in the aggragate, are every bit as stupid and greedy as the small investors who were wiped out by gambling on the 1929 stock market.
Third economics history lesson: The government exempted the rich investor from the New Deal rules about margins and disclosue. In the Bush years, the rich investors returmed to borrowing 95% of the cost of their investments, and to extremne secrecy about the investmentrs they sold.
Only they didn't call it investing in the stock market, they called it investing in hedge funds, private equity funds, derivatives, collateralized mortgage obligations, etc. Anyway, the result was the same as 1929.
Fourth economic principle: A crash in the financial markets does not necessarily lead to a recession.
Fourth economics history lesson: In the '30s, the Federal Reserve exacerbated the depression by restricting cash and credit, the New Deal offset this to some exent by guaranteeing bank deposits.
Final solution: If the government guarantees the soundnes of the financial system and removes the bad financial products and bad financial players from the market, and requires full discloure about investments and investors, the economy can stabilize.