One reason for the stock market’s negative response to the Trump administration’s stimulus announcements earlier this week is that the market has seen this play before. Handing out billions of dollars in checks to individuals, as the White House wishes to do, replicates past responses to market downturns. Those measures, regardless of the party that promulgated them, were largely Keynesian, referring, of course, to the British economist John Maynard Keynes. A Keynesian reaction to a sudden downturn is to try to shock markets into moving back upward, whether through a monetary stimulus—lower interest rates or more liquidity—or a fiscal stimulus, such as tax breaks or those $2,000 checks that the Trump administration is suggesting (also intended as simple economic aid, to help people make ends meet during the crisis). The stimulus is nearly always targeted and temporary: one group gets the money at the expense of others. Supplying liquidity is normally part of the Keynesian mix. The typical Keynesian response also conveys a heavy political message: blame business, and acknowledge that in a crisis, more government action is always better.
But as markets are all too aware, more government hasn’t always triggered an instant or strong recovery. The proximate example is the prolonged two-president, two-party rescue in response to the 2008 financial crisis. In the summer of 2007, as clouds began to gather, the key interest rate—the federal funds rate—stood at 5.25 percent. Over the next 16 months, as the storm raged, the Federal Open Market Committee lowered interest rates to nearly zero. Both the Bush and Obama administrations led bailouts of individual companies—AIG, and, in a real sense, Goldman Sachs. When George W. Bush left office, he passed the baton to Barack Obama, who continued the interventions. Bush, a free marketeer, justified auto-company subsidies with a line that sounds similar to Treasury Secretary Steven Mnuchin’s pronouncements this week: “I didn’t want there to be 21 percent unemployment. I didn’t want history to look back at me and say, ‘Bush could have done something but chose not to do it.’” Both presidents, likewise, backed and implemented some form of cash give-back, whether through tax breaks or the suspension of Social Security taxes, to many groups of citizens.
And yet the recovery from 2008 arrived relatively slowly. It took years for the Dow Jones Industrial Average to return to its pre-crash level. It was nearly a decade before joblessness dropped from a high of 10 percent to a reasonable level of 5 percent. And so, the crash of that period wasn’t merely a recession; it is known now as “the Great Recession.”
The Great Depression, the big brother of the Great Recession, also saw a grand display of Keynesian remedies. Indeed, the Crash of 1929 was the first U.S. crisis to see a government response led by targeted action and stimuli. Herbert Hoover, the Republican president, established the Reconstruction Finance Corporation to supply liquidity. Hoover also increased the income tax dramatically, imposing an unexpected burden on companies that were already struggling. He put upward pressure on wages through the Davis-Bacon Act, which had the effect of requiring government contractors to pay at the top end of the scale. Those high wages made employers pause before rehiring. Hoover berated the markets and vilified short sellers.
As the Depression continued, Franklin Roosevelt, who succeeded Hoover, operated with an even heavier hand, not only increasing taxes more dramatically but also micromanaging the industrial economy through the National Recovery Act. In addition, Roosevelt sustained the upward pressure on wages through minimum-wage rules and a tough union law, the 1935 Wagner Act. His New Deal program randomly punished whole areas of the economy, particularly the emerging utilities industry, a sector so promising that it could have pulled the nation out of the downturn.
As history shows, recoveries are like people: they make choices. In every year of the Depression, the recovery chose, on a different pretext, to stay away. But underlying the annual decision was a simple sentiment: government was intervening too much. As Benjamin Anderson, the chief economist at Chase, concluded, the Depression worsened when it became clear that the government, “far from retiring from the role of God,” decided that it “must play God yet more vigorously.”
Examples to the contrary exist, too. As a recession neared and took hold in 1920 and 1921, for example, the Federal Reserve tightened money, actually doubling the interest rate. The federal government also reacted to the downturn by cutting the federal budget, the equivalent of fiscal tightening. And the government moved to lift burdens on businesses with a commitment to lower tax rates permanently. The changes made in the early and mid-1920s signaled to the U.S. and world markets that the nation was determined to make the market competitive. As James Grant, the Manhattan Institute’s 2015 Hayek Book Prize winner, has noted, the Depression of the early 1920s saw unemployment of over 10 percent—sometimes closer to 20 percent. Yet it passed so fast that it became known as “The Forgotten Depression.”
The stock market of 2020 may not recall the details of what happened under Woodrow Wilson or Warren Harding, but it does reveal how Keynesian policy has exhausted itself. After all, how much lower than zero can you cut interest rates? And how much more can you do than send citizens checks of $2,000? The White House should embrace some pre-Keynesian steps, making it clear that American markets are open for business. Most obvious would be creating individual retirement accounts for Americans and placing cash in them on the condition that they invest the money. That way, they would at least have the consolation of knowing that they own shares likely to go up in the future. A massive intervention that makes shareholders of Americans in this way would both reassure citizens and reset the public mentality.
It’s also important for the U.S. to signal to world markets that the nation’s markets are worth a quick investment. The easiest way is to lower the capital-gains tax—permanently. A dramatic cut in investment costs would help get the stock market moving upward.
If there’s a silver lining to the dark cloud that’s shadowing the country, it’s that such ideas, considered loopy by the commentariat as recently as last week, will now win serious consideration. Socialism may be under discussion, in some quarters; but truly free-market policy can now be as well.
Photo by Spencer Platt/Getty Images