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Some Inconvenient Facts About Fiscal Austerity

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Andrew Mellon's infamous advice to Hoover is as good now as it was in 1932: "Liquidate labor, liquidate stocks, liquidate the farmer, and liquidate real estate."

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Daniel Patrick Moynihan once said that policy advocates are entitled to their own opinions, but not their own facts. A possible corollary in the context of the present rip-roaring debate about the macroeconomic impact of our dawning age of fiscal consolidation and austerity is that Nobel Laureates, especially, aren't allowed to make up their own history. So Professor Joseph Stiglitz please get out your copy of "Historical Statistics of the United States" and, after perusal of the GNP and government finance tables, consider retracting your preposterous statement on CNBC this morning that Federal spending cutbacks caused the Great Depression. Perhaps you might copy Professor Krugman while you're at it.

In 1929 the nation's GNP was $104 billion and by 1932 it had plunged to $59 billion. But there isn't a snowball's chance that changes in Federal spending had anything to do with this huge 43% decline in national output. In the first place, Federal spending in 1929 was just $3.1 billion, or a mere 3% of GNP. It took another 80 years to erect today's leviathan state at 26% of GDP. More importantly, Federal spending wasn't reduced as the economy tumbled into depression during the next three years but, in fact, it grew by 50% to $4.6 billion in 1932. To be sure, there was a debate about whether the resulting shift in Federal finances from a sizable surplus in 1929 to a deficit in 1932 would help or hinder recovery. Yet the plain fact is that Federal finances in these fiscally antediluvian times were a rounding error in the national economy's scheme of things.

By contrast, the statistical source of the $45 billion decline of GNP during the descent into the Great Depression is readily evident, as is the likely train of causation. Between 1929 and 1932, private fixed investment plummeted by an astonishing 94% while durables consumption dropped by 61% and exports by 65%. In dollar terms, the sum of these three components, which had been $33 billion in 1929, dwindled to only $7 billion by 1932. Now that's a depression-scale collapse! Furthermore, this means that nearly three-fifths of the decline in GNP over 1929-1932 was accounted for by private fixed investment, exports, and durables-consumption spending.

This isn't coincidental because these three components were the epicenter of the unsustainable 1920s boom that had been spawned by the Fed's easy-money policies. Exports collapsed in part because of foreign retaliation after the passage of Smoot-Hawley in June 1930, but mainly because America's original experiment in vendor finance of exports failed miserably after the 1929 stock market collapse. During the preceding Wall Street boom, massive issuance of foreign bonds by governments from Peru to Poland and Germany -- that era's equivalent of sub-prime borrowers -- had artificially financed a huge build-up in US exports to countries which otherwise couldn't pay their bills (like China's vendor-financed exports to the US and Europe in the present era). But when the underwriting boom on Wall Street abruptly ended in 1929 (and the price of most of the foreign bonds soon fell to cents on the dollar), export orders in Pittsburg, Detroit, and Kansas City dried up shortly thereafter. Thus, not for the first time did an outbreak of capital market speculation stimulated by central bank largess ultimately result in a devastating liquidation of jobs and production on Main Street.
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