We're going back to our Austrian roots...It's Time for a History Lesson
A Brief History of Booms and Busts in 20th and 21st Century United States
The Federal Reserve set the stage for The Great Depression beginning around 1920s when it began a series of credit expansions, each resulting in bouts of inflation. The largest credit expansion occurred around 1927, and created unsustainable speculative bubbles in the stock market and in land, setting the stage for The Great Depression with a prior recession. President Hoover exacerbated the recession through a series of fiscal policies such as the subsidization of agriculture, pushing banks to offer riskier mortgage loans in order to increase housing availability, artificially inflating union worker wages, and putting tariffs on international trade. In 1929, the country fell into a depression.
FDR took office, and repeated the same policies of Hoover, but with a new twist. He increased welfare and public works programs (“The New Deal”), essentially prolonging the depression through government stimulus. Instead of attempting to pay back the borrowed money from previous expenditures, the country went deeper into debt. Around 1934, the Federal Reserve made the decision to reflate the economy through an expansion in the supply of credit. This increased bank reserve balances, and decreased interest rates to an arterially low level. Before WWI, economic growth was not organic, or fueled by an increase in production. It was fueled by an increase in credit.
In the 1940s, the United States involvement in WWI and WWII created economic growth as the U.S. expanded its manufacturing sector to produce equipment and machinery for the war. While the rest of the world was decimated after WWII, the United States remained the sole leader in manufacturer, and their economy intact. Unlike Europe, the U.S. was not used as a battleground. The United States replaced Great Britain as the dominant power, and with it, the dollar become the world’s reserve currency through the Bretton Woods Conference. The U.S. had the qualifications: a strong manufacturing-based economy, and a strong currency. The dollar was backed by gold. In contrast with the abdication of economic responsibility in the 1920s and 1930s, the U.S. now served as the model economy.
The United States in the 1950s, as a result, was marked by the highest savings rate of the century. The U.S. economy was at the height of manufacturer, providing itself and flooding the world with the highest quality consumer goods produced at the cheapest price. The wages it paid its workers were the highest in the world. Americans possessed a newfound wealth of automobiles, dishwashers, radios, and televisions.
The 1960s were characterized by President Johnson’s “Great Society” and “guns and butter” policies. Johnson financed a war in Vietnam, a war on poverty, and NASA space shuttle flights to the moon through deficit spending. Johnson simply borrowed without attempting to pay it back, and instead had the Federal Reserve intervene with an expansion of the money supply.
Also during the 1960s, due to low interest rate and easy money policies by the Federal Reserve, asset prices were pushed upwards unnaturally. The “Nifty Fifty” index reflected the most popular stocks at the time of a roaring bull market. Of course, the exuberance came to an end when the adverse effects of Johnson’s foolish policies were realized.
In 1970, countries began to panic when they realized that there wasn’t enough gold to back up all of the dollars being printed to finance the Vietnam War and social programs. Led by France, the countries demanded the United States government to allow them to redeem their U.S. dollars for gold. When the U.S. began to pay some countries back the money the U.S. had borrowed from them, President Nixon panicked when he saw that the reserve of gold was nearly drained. As a result, he closed the gold window in 1971. The U.S. lost its gold standard, and become a purely fiat standard as a consequence of President Johnson’s irresponsible policies a decade beforehand.
Following the closing of the gold window, the dollar fell, oil prices skyrocketed as oil was priced in dollars, and a raging bear market replaced the bull. Most of the Nifty Fifty stocks collapsed, and the U.S. economy underwent a period of painful stagflation, characterized by high unemployment and high interest rates.
In the 1980s, the Federal Reserve yet again reflated the U.S. economy with an expansion in the money supply. On the foreign front, Japan, Germany, and Italy rebuilt their economies and began competing with the U.S. for manufacturer producers. Their products were more cheaply produced, as cheaper labor was found in China, India, and Vietnam.
Unable to keep up with competition due to a weaker economy, the U.S. began a transition from a manufacturing-based economy to a service-based economy. At the same time that it decreased capital production, the U.S. increased pay for social programs and subsidies, and increased its military expenditure, even after the Soviet Union collapsed and the U.S. was no longer fighting the cold war. Domestically, low interest rates set the stage for another bull market.
The 1990s were characterized by a false impression of a healthy U.S. economy. On the surface, there was an economic boom, but in reality, people were discouraged by low rates of return from bonds and cash, and incentivized to buy into the stock market. As a result, the stock market began to reach unsustainable levels. The new fad this time was technology companies. In 2001, the bubble popped, only to be replaced seamlessly by another one in the housing sector.
In the 1990s, Clinton expanded programs, further increasing the subsidization of houses. This continued into the 2000s. Low interest rates, and low savings rates nudged people into buying houses they couldn’t afford. The appeal for buying houses was due to the appeal of high appreciation. This bid up housing prices domestically into unsustainable levels. As interest rates began inching up, people failed to take notice.
In 2008, the United States experienced a painful housing crisis that equaled the magnanimity of the Great Depression. The shock was felt all throughout the nation. However, this crisis was different from The Great Depression. This time, the United States did not have a strong manufacturing sector and a high savings rate to fall back on. Instead, the United States had to rely on an artificial recovery. The Federal Reserve bought treasury bonds from the U.S. government, and sold those bonds to foreign governments, such as China. In exchange, the Chinese and others gave the U.S. their products. Essentially, dollars represented claims on goods, and were not backed by actual goods. The United States instead imported consumer goods, not capital goods, through borrowing. This was severely in contrast with the United States at the turn of the 20th century. Back then, the United States borrowed from Europe to finance capital goods, such as factories, which produced a return on capital. The same cannot be said today.