Lehman Revisited

We are in “July 2008” again, but this time it isn’t the investment banks melting down but the Euro-zone countries led by Greece. The EU and ECB intervention can be compared to the actions of Hank Paulson and Ben Bernanke in the months leading to the collapse of Lehman: back then, you will recall, the Fed and the Treasury Department had arranged the takeover of Bear Stearns and the U.S. government was investing in “the twins” – Fannie Mae and Freddie Mac – and preparing to make them full wards of government. “If you have a bazooka in your pocket and people know it, you probably won’t have to use it,” Paulson had told the Congress. But the panic continued unabated.

Now the EU and ECB have been waving a bazooka. But now as then everyone knows it is a borrowed one: the funds the EU is prepared to marshal are based on more debt and more borrowing. Now as then there is no psychological relief from the policymakers being on the case – there is just frantic concern from market participants that the problem may be beyond repair. In short, the sovereign debt crisis in Europe is going to get a lot worse.

Taxes and Devaluation Prolonged the Great Depression

Politicians on both sides of the Atlantic should take a long hard look at an op-ed by Arthur Laffer in today’s Wall Street Journal. Laffer plots the consequences of federal and state tax hikes and protectionist increases in trade duties in the early 1930s and he takes issue with the current Federal Reserve chairman that the monetary supply was tight. “The strong correlation between soaring unemployment and falling consumer prices in the early 1930s leads Mr. Bernanke to conclude that tight money caused both.” Laffer shows this wasn’t the case: “The 1933-34 devaluation of the dollar caused the money supply to grow by over 60% from April 1933 to March 1937, and over that same period the monetary base grew by over 35% and adjusted reserves grew by about 100%. Monetary policy was about as easy as it could get,” Laffer notes.

Laffer doesn’t blame fed policy on taxes and the money supply for causing the Great Depression — he points the finger at the protectionist Smoot-Hawley tariff of June 1930 as the catalyst that got the whole process going. But he does see tax hikes and loose money supply as worsening the situation and causing the double-dip in the economy in 1937. “Huge federal and state tax increases in 1932 followed the initial decline in the economy thus doubling down on the impact of Smoot-Hawley. There were additional large tax increases in 1936 and 1937 that were the proximate cause of the economy’s relapse in 1937.” In fact, the tax hikes were eye-opening.

“The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. If there were one warning I’d give to all who will listen, it is that U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s.”

The only way out of the mess in the U.S. and U.K. is for spending cuts but they should targeted away from front-lines services such as schools and hospitals. And in the U.S. government intervention is needed on the health care front to provide affordable health insurance for all and a choice of public and private options. Not only is that a moral necessity but an economic one before the U.S. health system contributes to the bankrupting of America.