The economics of Herbert Hoover

What is amazing today are the number of supposedly competent economists of the Chicago school who are, deliberately or not, echoing the economic theories that dominated the Presidency of Herbert Hoover in support of the Republican Party. Here is one of them, for example, talking about the interventions to prop up the banking system:

The government's interventions may prevent the reallocation of stagnant capital to more productive ends. Hence, rising unemployment.

This is the Mises/Hayeck view that was in vogue during the Presidency of Herbert Hoover, most vociferously advocated by Hoover's Secretary of the Treasury Andrew Mellon. Mr. Mellon had only one formula: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” He was but reflecting the view of Hayeck and other scholars of the Depression of 1873, who held that depressions were caused by the misallocation of capital to parts of the economy that did not need so many resources, and that the correct action was to liquidate that over-invested portion of the economy and re-allocate those resources to places where they were needed.

But the problem today is not the reallocation of stagnant capital. This is not 1873 and we do not have 70% of the U.S. economy building railroads only to finish building the railroads and suddenly having all these capital assets with nothing for them to do. The U.S. economy today is dominated by services, not by industry, and we do not have the problem of having surplus steel foundaries and hundreds of thousands of laid-off railroad construction workers caused by the fact that we spent the late 1860's and early 1870's rebuilding the railroad network of the South and finishing off several cross-continent rail lines. Today's problem is a mismatch between demand and supply caused by a reduced propensity to spend (and lend) caused by people viewing the future value of their money as being greater than the present value of their money for whatever reason, thus causing the so-called "paradox of thrift" where saving more money (because it is presumed to be more valuable to them in the future when the economy turns up in the case of banks, or when they become unemployed in the case of consumers) causes reduced demand and thus reduced economic output.

In other words, we're in KeynesLand, not Herbert Hoover-land. If the problem was stagnant capital, the Republicans channeling Herbert Hoover would be absolutely correct. However, that is not the problem, the problem is a collapse of demand across the board -- i.e., rather than the problem being that the economy is demanding goods not currently being manufactured (because those resources had been diverted towards railroad construction) such as in 1873, the problem is that demand for *all* goods has collapsed, across all industries. In short, there's no place to divert stagnant capital *to* even if existed, because there is no part of the economy currently experiencing more demand than it is capable of supplying, unless you are talking about the demand for soup at soup kitchens.

In short, Republicans are channeling Herbert Hoover, and are as right today as Herbert Hoover was in 1930. I.e., if you'd been talking about the Depression of 1873 they likely would have been correct, but this is not 1873 and applying the lessons of 1873 to today is as completely and utterly inappropriate today as it was in 1930.

-- Badtux the Economics Penguin