Special Report: Lessons of the great Wall Street Crash
The City's travails are part of a wider financial crisis which has now spanned five years. For a historical precedent, go back 80 years - but beware the conclusions you draw from the Great Depression, argues City grandee Terry Smith
Tuesday 23 October 2012
The philosopher George Santayana said "Those who do not remember the past are condemned to repeat it." We are in the sixth year of the financial crisis which started in 2007 and experiencing problems which are reminiscent of the Great Depression with faltering economic growth, high unemployment, deflation, and a badly damaged and still shaky banking system.
It's therefore unsurprising that commentators and policy makers would look to that period for lessons on what to do and what to avoid.
However, what we need in order to learn from the Great Depression is a firm grasp of what happened then. Most commentary I hear or read is along the lines of: "The Great Depression was triggered by the Wall Street Crash, itself the result of laissez faire capitalism. The Depression was deepened as a result of the failure of governments to adopt what would come to be called Keynesian techniques to stimulate demand and by adherence to the Gold Standard. It was only when Franklin D Roosevelt took office and implemented the New Deal that America began to recover from the Depression as these Keynesian methods stimulated demand."
Sadly, this version of events owes more to myth than reality. Firstly, the idea that laissez faire free market policies were the root cause of the Crash and subsequent Depression is far removed from reality. In fact Herbert Hoover, who preceded Roosevelt as President until 1932, was criticised by FDR for "reckless and extravagant spending" and "thinking we ought to control everything in Washington", and he introduced the Smoot-Hawley Tariff in 1930 which stopped many imports. The dramatic contraction of the money supply by the Fed which began in 1929 and the rise in interest rates from 1928 helped to cause and then exacerbate the impact of the Crash. This was not simply a failure of capitalism or free markets. It had a lot of help from the government. The Hoover administration was interventionist, not laissez faire, and its interventions caused problems and made matters worse.
But surely all this changed after FDR said "We have nothing to fear but fear itself" (which was not original — it was a phrase borrowed from 19th century writer Henry Thoreau)? Roosevelt announced spending of $10bn when government revenues were $3bn a year, and government spending rose by 83 per cent between 1933 and 1936 while federal debt rose by 73 per cent.
Simultaneously many measures were implemented which were a drag on economic activity. The Social Security Act which introduced a minimum wage kept many unskilled workers out of the labour market. The Agricultural Adjustment Act produced the destruction of crops and cattle. The National Recovery Administration or NRA created a massive bureaucracy which increased the cost of doing business significantly: shortening hours and raising wages. Night work was banned. Five hundred NRA codes were introduced governing production of articles ranging from lingerie to lightning rods. So-called "cut throat" pricing was banned – a tailor was sent to jail for pressing a suit for 35 cents instead of the NRA-mandated 40 cents. How these anti-competitive and bureaucratic measures were supposed to promote activity is a mystery. The net result was industrial production dropped 25 per cent in the six months after the NRA came into effect.
Simultaneously, Roosevelt's Civil Works Administration (CWA) engaged in employment of masses in some perfectly pointless activities such as researching the history of the safety pin and using balloons to frighten birds away from public buildings. When the CWA became the Works Progress Administration similar nonsense continued such as cataloguing ways of cooking spinach. In a foretaste of our times WPA workers were also used to collect Democratic Party campaign contributions. So was born the idea of a "client" class dependent on the state who would automatically vote for the party giving the handouts. The parallel with today's loyal Labour following in the public sector in the North of England, Scotland and Wales is obvious.
Far from ending the Great Depression, such measures served to prolong it – preventing the workforce from seeking real jobs and diverting resources to politically motivated projects.
They were accompanied by a series of anti business and "soak the rich" tax provisions. The top marginal rate of income tax was raised first to 79 per cent then to 90per cent, personal tax exemption was lowered to just $600 a year, estate tax went up to 70 per cent and gift tax to 52.5 per cent. Corporate taxes were also raised with surtaxes for undistributed profits.
Unsurprisingly the economy slumped back into depression in 1938 and the stock market halved again from 1937-38, which can hardly have been the result of laissez faire capitalism. FDR acolytes claim this was due to the Supreme Court outlawing the NRA and premature attempts to cut spending and balance the budget. But it is estimated that the reduction which resulted from this was only about 1 per cent of GDP which was far too small to cause the problem – just as austerity cannot now be the cause of the UK's problems because there hasn't been any yet. Government spending has continued to rise inexorably since the Coalition took office.
By the time war broke out in 1941, unemployment was still 17 per cent. Hardly a triumph for two presidential terms of Keynesian policies.
So what did pull America out the Depression? The Second World War? America's involvement in the war was unique. It did not join the war until two years after it started, allowing America to benefit from the rearmament of the Allies as the "arsenal of democracy", to quote FDR. Even when it entered the war, it suffered none of the destruction of assets and infrastructure which the other Allies did, other than the attack on Pearl Harbour, and so had all the benefits in terms of demand from rearmament and none of the disruption suffered by other combatants.
The war was then followed by the Truman administration, which was far less anti-business than FDR's had been. This combination of factors was the cause of recovery.
We have to learn from history if we are not to repeat its mistakes, but we will learn nothing if the experiences of history are heavily edited to suit political agendas and prejudices. We need to be told the truth.
Terry Smith, chief executive of Tullett Prebon and Fundsmith
Biography: A man who speaks his mind
Terry Smith is one of the foremost City figures, a pugnacious character and successful broker.
He first came to prominence in 1992 when as a highly respected analyst at UBS he wrote a book highlighting practices used by top companies to flatter their profit figures. That book, 'Accounting for Growth', was seen to be critical of UBS clients and he was dismissed soon after its publication.
Since then he has built up two successful firms, Collins Stewart and Tullet Prebon, and also runs his own fund management company – FundSmith.
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