Lessons from the Century, Economics 101
ECONOMICS 101
LESSONS FROM THE CENTURY
As the curtain came down on the 20th century, the U.S economy found itself in the 17th year of the longest consecutive period of prosperity of the past 100 years. This according to the Cambridge, Mass. Based National Bureau of Economic Research, the nation’s principal arbiter of business cycle trends and turning points.
Since 1982, the technology-driven U.S. economy has created more than 41 million new jobs, leading to a 4.1 percent current unemployment rate with broad inflation measures barely registering above 1 percent. Record-setting high inflation and interests rates held over from the 1970’s have evaporated during the past two decades. Household net worth of American families has increased by roughly $30 trillion, as the stock market gained 13-fold during the 1990’s. No wonder 50 percent of American households now own shares for retirement and other purposes, amounting to more than 80 million stockholders. It is the greatest example of democratic capitalism in world history.
Unfortunately, not all of the major 20th century economic cycles have been so blessed. Between 1929 and 1940, for example, economic growth averaged less than 1 percent annually, while unemployment averaged 20 percent. The stock market lost nearly 1 percent per year during the 1930’s and between September 3, 1929 and July 8, 1932 the market value of the nation’s greatest corporations declined an incredible 89 percent.
During the 1970’s, America experienced the twin evils of high inflation and rising unemployment. Real living standards declined steadily, productivity lapsed, profit quality deteriorated, and the American spirit collapsed. Between 1968 and 1982, stock market investors lost about 60 percent of the inflation adjusted value of their portfolios in the post war bear market.
This economic decay was a sharp reversal from the post war prosperity of the 50’s and 60’s. The longest bull market in the 20th century occurred between 1949 and 1968. Real economic growth averaged better than 4 percent yearly during this period, while both inflation and unemployment were consistently low. By the mid-1960’s a less than 2 percent inflation rate was coupled with below 4 percent unemployment.
Then also, there were the prosperous 1920’s, a return to economic normalcy following the disruption of World War I. The Harding-Coolidge-Mellon policies of tax, spending and debt reduction produced average real economic growth of 6 percent per year, while price indexes registered mild deflation. Unemployment was scarce during the rise of the Model-T Ford, the telephone and radio. Between 1922 and 1929, the third ranking bull market of the century threw off average annual returns of 20 percent after inflation.
Now, as we peer into the 21st century, the question for economist is what have we learned from the 20th century? Why do some long cycles prosper while others blunder?
The answer is economic freedom. The freedom to work, produce, invest, take risks, invent and innovate with minimal government obstacles. But the road to economic freedom in the 20th century was all too often blocked by circuitous twists and turns based on liberal Keynesian planning business theories and an all too frequent intellectual distrust of entrepreneurship and business.
Those cycles with freedom enhancing incentives, especially low tax rates, international trade tariff rates and inflation (which is a tax on money) promoted high economic returns for both capital investment and worker effort. The 1920’s, the 1950’s, and 60’s, and the 1980’s and 90’s had enviable records of prosperity. But those periods of high government activism, such as the 1930’s, and 40’s (abstracting the war effort), and the mid-1960’s to early 1980’s, fell far short of the prosperity mark.
I can put it no better than one of the greatest economist of our time, Arthur Laffer, who defines the precondition for optimal economic performance as the absence of four major prosperity killers:
1. High inflation and interests rates.
2. Confiscatory tax-rates.
3. Government over-regulation, especially wage and price controls.
4. Protectionist trade tariffs.
At the turn of the last century, however, avant-garde economist got us off on the wrong foot by embracing government interventionism and rejecting market capitalism. This was mainly in response to the depression of 1893-1897. Early century social thinkers and journalistic muckrakers lost sight of the spectacular post Civil War economic growth and rise of living standards, and instead focused on the redistribution of income. So economic reformers implemented the income tax, undertook rabid trust-busting, created the Federal Reserve System, child labor laws, workmen’s compensation and numerous regulatory agencies. The social safety net was born.
Government activism accelerated during the collapse of the 1930’s. President Herbert Hoover and Franklin Roosevelt turned a mild recession into a deep and long depression. Hoover, who I rate as the single worst economic president of the 20th century, signed the Smoot-Hawley protectionist tariff, and then raised the top personal tax rate to 65 percent from 25 percent. Both the external and the internal tax increases blocked commerce, triggered a debt-deflation spiral and halted business investment. Hoover’s exhortation to business leaders to set higher wage rates resulted in an upward unemployment wave. Even his public spending on emergency construction, farm assistance and the Reconstruction Finance Corporation was too little too late.
Franklin Roosevelt deserves credit for his sunny disposition and optimistic vision of America. A later optimist, Ronald Reagan, voted for FDR four times. But most of FDR’s industrial policies had an adverse effect on production and employment by mandating excessive wage rates that made labor overly expensive relative to capital. Hence, both were largely unemployed. Later on, both Roosevelt and Truman were quick to use wage and price controls when it served their political purpose. Also, FDR’s industrial policies included highly punitive tax rates, thereby violating even Keynes’ pump-priming notions. Roosevelt took the top personal tax rate to 90 percent, where it stayed until the Kennedy tax cut of 1964.
FDR significantly raised the corporate income tax, the estate tax, and the capital gains tax. What’s more, he imposed special surtaxes on undistributed corporate income (undivided profits tax). The result of these punitive tax measures was a paralyzing influence on enterprise and investment. These tax hikes, along with Roosevelt’s later extremism in the implementation of various industrial, anti-trust and labor policies, (what the eminent economist Joseph Schumpeter called “anti-capitalist attitudes”) smothered all manner of innovative risk-taking in the 1930’s. Business felt threatened by New Deal attitudes and administrators. Technological innovation was practically non-existent.
A generation later, President Dwight Eisenhower created a pro-business administration where the entrepreneur once again achieved a position of esteem. Though Ike did not lower the punitive 90 percent tax rate, he enhanced the post-war movement toward expanded free trade and dollar gold exchange stability. Near-zero inflation and trade liberalization exerted tax-cuts effects throughout the economy, and economic growth responded.
President Kennedy was less congenial to business (remember his assault on Big Steel), but he did launch broad-based tax reduction that ultimately brought the top personal tax rate down to 70 percent. Between Kennedy and Reagan administrations, however, U.S economic fortunes declined steadily. Johnson, Nixon, Ford and Carter combined for a murderers row of economic malfeasance. This was the high tide of Keynesian fine-tuning, with disastrous economic consequences. As well, Soviet adventurism increased and America’s place in the world declined. Of this group, Nixon exerted the most powerful negative influences on the economy.
After Hoover, I rate him the second worst economic president of the 20th century. He was responsible for double-digit inflation by de-linking the dollar from gold and pressuring his Fed chairman, Arthur Burns, to unleash excessive money supply growth in order to win the 1972 re-election. Interacting with unindexed personal tax brackets, this inflation caused a massive tax-hike effect that undermined economic activity.
Just as bad, the supposedly conservative Nixon unveiled a massive wage and price control program, including interest, dividends, profits and energy, that obstructed markets and thwarted the efficient allocation and distribution of resources. One way or another, wage and price controls remained in place until Reagan abolished them in the early 1980’s. Nixon was also the king spender on entitlements and other social programs. Lyndon Johnson’s Great Society programs were launched in the late 60’s, but were funded by Nixon in the early 1970’s. And it was Nixon’s overspending on Social Security cost-of-living adjustments and numerous welfare plans that laid the foundation for the chronic budget deficits in the 1980’s and 1990’s (until recently, where rapid economic growth finally solved the problem, a vision predicted by supply-siders nearly twenty years ago).
President Reagan broke through the stagflation of the 70’s with a two-track recovery approach. Lower marginal tax rates (the top personal rate was reduced to 28 percent from 70 percent) restored economic incentives and a strong dollar broke the back of inflation. Columbia Professor Robert Mundell, a co-author of these policy approaches and the 20th century’s last Nobel recipient for economics, recently told an interviewer that “Reagan’s marginal tax rate reduction and deregulation cleaned out the economic barn. The benefits of these policies continued spilling over into the 1990’s.”
Future historians are likely to rank Reagan and Roosevelt as the dominant presidential influences of the 20th century in both economic and foreign affairs. It is interesting to compare and contrast these two great leaders. Reagan’s optimism was under-girded by a set of free market policies that returned the entrepreneur to the center of the economy. Roosevelt’s optimism was backed by a set of government planning policies that pushed business free enterprise outside the center of influence. Reagan’s economic approach worked; FDR’s did not.
And the U.S. growth revival of the 1980’s was a key factor in the downfall of the Berlin Wall and the end of Soviet Communism. The socialist model was incapable of delivering the goods. The Soviets recognized that they were out-manned militarily and economically by the U.S. So they folded.
As a question for future historians, did the continuous 1930’s depression in the U.S. mislead our adversaries in Germany and Japan into thinking they could defeat America?
In the end, Reagan’s pursuit of sound money, low tax rates, deregulation and free trade is really the great 20th century economic growth lesson that should become the 21st century vision. Reagan’s policies opened the door to entrepreneurial opportunity, technological advance and the new Internet economy.
If these policies are continued into the 21st century, then the United States will succeed in producing not only an even faster prosperity rate, but the economic model of free market capitalist entrepreneurship will forever replace discredited socialist state planning, to the benefit of future generations world wide.
This is the “ New Era”.
As always, thank you for your business.
Sincerely,
F. E. Mowery
Fritz Mowery, President
Mowery Capital Management
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