The Roosevelt Recession

Attributed to Albert Einstein (probably incorrectly) is this definition of “insanity”: “doing the same thing over and over again, expecting different results.” Okay, that makes sense. But does that identical definition apply if the “thing” was not done over and over, but only once? That’s the enigma that must be resolved by economists, legislators, and in the final analysis by the nation as a whole.

The “incident” that triggered this question, a decision to balance the nation’s budget, was anything but inconsequential. The results of that controversial action taken many years ago immersed the country into a deep recession, and when that action was reversed, so was the recession. Although this occurred almost 75 years ago, there is an eerie familiarity about both the economic and legislations that existed then, and those confronting us today. This seems to be emerging as a “Been there; done that” event.

A History Lesson

First, a bit of history that preceded the “incident” mentioned above. Most of us are, at the very least, vaguely knowledgeable about the “Crash of 1929” and the subsequent “Great Depression,” the deepest one this country ever experienced.

Interestingly, according to Richard Sylla, Professor of Financial History at NYU, “Most people [including me] learned from their teachers and their history books that the 1929 stock market “Crash” was a major cause of the Great Depression. Left out of this story is that “between the lows of November 1929 and April 1930, stock indexes regained almost all the ground they lost in the October 1929 crash.” Sylla then explains, “Most likely the Great Depression began a year after the 1929 crash, when a lot of banks failed toward the end of 1930.” Those initial bank failures were followed by others in 1931, 1932 and totaled some 9,000 by 1933. Sylla’s conclusion is obvious––despite popular beliefs, the Crash of 1929 was a contributor but not the primary cause of the Great Depression.

Nevertheless, by the end of 1930 the country was in a deep recession that then deteriorated even further into the “great depression.” It is a common view among mainstream economists that Roosevelt's stimulus policies (dirty words today) within his New Deal programs precipitated the recovery. It turned out however, that the spending and stimuli were not adequate enough to bring the economy completely out of the depression. Yet, by 1937, unemployment, that had reached a peak depression high of close to 25%, had dropped to a low of 12%-14%; over that same period, Gross Domestic Product, after dropping 54%, grew at the average rate of an amazing 9%, its highest ever, even through today. That’s when things began to unravel.

The Roosevelt Recession

Few are old enough to have a clear memory of the “incident” mentioned earlier. One that in early 1937 turned what seemed to be a fairly robust recovery into what some call the “Roosevelt Recession.” What is most disturbing is that government actions taken that caused the recession are all too suggestive of current proceedings that could possibly result in similar consequences.

Robert McElvaine, author of “The Great Depression: America 1929-1941” and professor of history at Millsaps College was quoted in The New York Times saying, “The parallels to what is happening now are very strong.” He pointed out that “Then, as now, policy makers were struggling with how and when to turn off the fiscal stimulus and monetary easing that had been used to combat the initial crisis.”

History buffs will remember that based on the apparent success of the “New Deal” policies, in the 1936 presidential election, Roosevelt defeated the Republican nominee, Alf Landon, by a landslide electoral vote of 523 to 8, winning 46 out of 48 states. Obviously the voting public acknowledged that Roosevelt’s policies had been translated into a significantly improved economic climate. In fact, by the spring of 1937, production, profits, and wages had regained their 1929 levels. Despite what seemed to be a large budget deficit (for that time), even that situation had improved, benefiting from an inflow of revenues (another dirty word today) from the newly activated Social Security tax, as well as increased consumer demand that had resulted due to the last round of veterans bonus payments.

The Balanced Budget

Administration members were emboldened by these swiftly improving economic numbers, and encouraged by his Secretary of the Treasury, Henry Morgenthau, as well as by significant pressure from members of both political parties, Roosevelt, who had always been a strong advocate for a balanced budget, decided although he had not been able to keep early campaign promises to balance the budget, it was now safe to do so.

Here is how the very “progressive” Roosevelt Institute describes the results of that action: “In 1937, after five years of sustained economic growth and a steadily declining unemployment rate, the Roosevelt Administration began to worry more about possible inflation and the size of the federal deficit than the ability of the economy to sustain the recovery. As a consequence, in the fall of 1937, FDR was supported by those in his administration who advocated a reduction in federal expenditures (i.e. stimulus spending) and a balanced budget. The results — which included a massive reduction in the number of people employed by such programs as the WPA — were catastrophic. From the fall of 1937 to the summer of 1938, industrial production declined by 33 percent; wages by 35 percent; national income by 13 percent; and not surprisingly, the unemployment rate rose by roughly 5 percentage points, with an estimated 4 million workers losing their jobs.”

The Institute’s description continued, “The economic downturn caused by the decline in federal spending was commonly referred to as the “Roosevelt recession,” and to counter it, FDR asked Congress in April of 1938 to support a substantial increase in federal spending and lending.” By then Roosevelt had reluctantly abandoned his efforts to balance the budget. He initiated a $5 billion spending program [that number sounds rather quaint but it is the equivalent of $75 billion today] in the spring of 1938 in an effort to increase mass purchasing power. Although the New Deal had in fact engaged in deficit spending since 1933, the conversion to Keynesian economics had now become official. The report explains further, “Equally important, the lessons drawn from the 1937-38 recession convinced FDR that deficit spending and monetary expansion were critical to economic recovery.”

While Roosevelt’s action to stimulate the economy with more spending worked, and consequently was, and is the rationale for the 1938 recovery as expressed by “Progressives,” the situation was actually more complex. Conservatives attribute the recovery of 1938 to another major factor.

According to Milton Friedman, the Nobel Prize winning conservative economist, it was the Fed’s action in 1936 to combat what was perceived as an inflation threat that precipitated the recession. Increasing the banks’ reserve requirement tightened credit and that caused a contraction in the money supply. This move, together with the sharp cuts in federal spending, led to a plunging stock market and a further increase in unemployment.

Conservatives credit the 1938 recovery to the fact that the Federal Reserve completely backed off from its stringent bank reserve policy by decreasing the discount rate to one percent, thereby loosening the money supply for further investment. It seems logical to assume that the arguments forwarded by both the Progressives and the Conservatives have validity in which case then it was probably a combination of Roosevelt’s renewed spending policies and the Fed’s money loosening that put the economy back on track.

Is the history of the Roosevelt recession and the Recovery of 1938 that relevant to the current balanced budget imbroglio, perturbation, turmoil, upheaval (you name it), that a mirror image exists, that it’s beginning to look like 1937 all over again? While Roosevelt’s spending cuts are similar to our current efforts to cut the budget deficit, the Federal Reserve is certainly not contracting the money supply as it did in 1937, it is expanding it. Inflation, that seemed to be creeping up in 1937, is not (yet) a severe problem.

So, if we view only the cutbacks in spending in both eras as the constant, will that alone serve as the catalyst to foment a recession today as it did in 1937? If you believe in Keynesian economics, the answer is yes. If you are in the economists’ conservative camp, the answer is no. The reality is that considering the current dysfunctional climate in Washington, any type of effort to initiate even a short term Roosevelt-like spending increase is most unlikely, and cutbacks will prevail. As a result we will definitely get an answer to that question––perhaps all too soon.

To paraphrase Albert Einstein, “Will it be insanity if we did the same thing once and expect a different result when we do it again?” We will soon get an answer to that as well.