Let’s look at the Great Depression. Everyone marks the Great Depression’s beginning with the collapse of the stock market in the fall of 1929. The stock market would fall by close to 90% between 1929-1932. But a major factor that people forget is that the market had some major rallies in between 1929-32, most specifically in 1930. Check out this chart of the Dow between 1928-1932.

Notice something in early 1930? The Dow rallied from about 200 up to close to 300, about a 50% increase. Not too shabby. People became bullish on the future. This was said in May of 1930: “While the crash only took place six months ago, I am convinced we have now passed through the worst — and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us,” courtery of the president of the time, Herbert Hoover.

Am I saying that the stock market will collapse again like it did in the early 30’s? Not necessarily. I just think just because the official unemployment rate is slowing (which doesn’t take into account the undermployed and the discouraged workers) and the stock market is up does not mean we are out of the woods yet. Remember, unemployment is still at 9.5% (a low figure because it doesn’t count the underemployed), oil is over $70 a barrel as the dollar falls, and we are staring at future tax increases and more governmental beaurocracy. We’re in a very fragile state, but people believe nothing worse can happen. This is a recipe for exactly what happened in the 1930’s. Remember, if we are essentially in May of 1930 right now, it is another 15 years before we are out of the woods.

History repeats itself, but never in the same way. I don’t think we’ll have a crash over the next few years, then government New Deal projects, and then a world war. Things just don’t happen like that. You can learn from history, but you can’t look at it as a pure playbook.

What I think we can learn is that people over-react in both ways to a crisis. There is a surge of pessimism and optimism. Right now, I believe the optimists are overwhelming the media, thanks largely to the rally in the stock market. This is helping to spur New Deal II type legislation, which will just drown us in inefficiency and slwo growth, much like it did in the 1930’s.

Remember people, just because the market hit its low in 1932, the economy did not itself rebound until 1945. We also had another market crash in 1937-1938 thanks to FDR’s tax hikes and the depression within a depression. Unemployment in the 30’s, even with FDR’s make-work programs, never was below 10% and averaged closer to 15%.

With epic deficits, a falling dollar, the private sector and the consumer on their knees, and new taxes looming, the five year picture does not look good. Yes, the rate of destruction is down, but beware of falling into the Hoover trap of thinking we are out of woods just yet.

Our Fed will simply not let deflation take hold. They would rather print money and create inflation then let deflation do the dirty work….and I don’t blame them. In the grand scheme of things, a horrible stagflation won’t be as bad as a pure deflation. Here’s how it will go down.

We’re going through the worst financial crisis since the Great Depression. To fix the situation, the government has decided to expand its powers greatly. It isn’t just printing money though and loosening credit. Rather, through wasteful stimulus programs, it is spending money like a drunk sailor. Our debt/GDP ratio is climbing by the day.

With the government raising our debt, the ‘crowding out’ effect begins. Why should a bank loan to a business when the bank can loan risk-free to the government? Since the government is creating so much debt,  there’s only so much the Chinese are going to lend to us at cheap rates. Ultimately, rates on government debt go up, resulting in higher interest rates for the rest of us and a continued financial crisis.

Higher interest rates, more unemployment, great depression all over again….or so we would think. The Fed has decided it wants to keep rates low and is even printing money to buy up government debt. A week ago, the Fed said it would buy $300 billion  of US Treasuries, essentially the government is now printing money to service its debt.

This money printing will lead to inflation of course. We have already seen commodity prices start to rise. As inflation kicks in, the most talked-about commodity of all, oil, will go up in price. As I write this article, oil is sitting at $54 a barrel. I forecast oil will once again hit $80-$100 a barrel before we know it.

That’s when the stupidity of Congress kicks in full gear. Congress passes some stupid windfall profits tax plus cap and trade, creating another energy crisis. Gas at the pump goes up to double digits in a year or two. We are more dependent on foreign oil than ever because Congress is doing whatever it can to essentially nationalize domestic companies. A higher trade deficit, a weaker dollar, commodities going higher, more inflation, economic slowdown.

When it’s all said and done, the misery index (which is a crude measure just adding the inflation rate and the unemployment rate) may very well hit 30.  Even during the peak of Carter-era stupidity (when they passed the windfall profits tax in 1980), the misery index reached it’s post WWII high of just above 20. I’m thinking it will go above 30 sometime in late 2010 or 2011. Yes, that’s how bad it will get.

When a country can efficiently gather and deploy resources, it thrives. When a country is inefficient, it falls. The Soviet Union collapsed because centralized planning was inefficient. A bunch of beurocrats cannot efficiently determine the prices of goods and services and allocate economic resources. It just does not work well. Centralized planning is not in of itself evil and therefore results in failure. The reason centralized planning does not work is because it is inefficient since it is too difficult for beaurocrats to allocate resources and determine prices.

Let’s also think of efficiency in terms of businesses. Suppose Sloth’s  Widgets and Henry’s Widgets both produce the same widget.  Sloth’s Widgets is very inefficient. Its boss is drunk, the workers are poorly trained and unsupervised, the business buys its inputs from the boss’s cousin, who is also an idiot and charges a high price for his inputs. In contrast, Henry’s Widgets is well-run and efficient, filled with hard-working, cost-conscious individuals. Obviously, Henry’s Widgets can produce more widgets and at a lower price. In this instance, Henry’s Widget is able to produce a widget for $5, while it costs Sloth’s Widgets $20 for the same widget. Ultimately, Sloth’s Widgets goes out of business while Henry’s Widgets thrives since Henry’s Widgets can sell widgets for as low as $6, while the minimum price for Sloth’s Widgets is $21. This is the best scenario for both society and Henry’s Widgets, though not for Sloth’s Widgets.

Let’s say though that Sloth’s Widgets owner is good friends with the governor. The governor manages to somehow heavily subsidize Sloth’s Widgets. For every widget Sloth’s Widgets makes, the governor will give them $19. Sloth’s can now sell widgets for as low as $2. They get a $19 subsidy, a $2 sale price, which covers the $20 production cost. They can now undercut Henry’s Widgets and put them out of business.

Customers think “ooh, the price of widgets went down.” Of course, this is not truly the case. While the price charged for widgets went down, it was simply because the government subsidized them, meaning more tax dollars will have to be raised. So while people are paying $2 for each widget, they are also paying an extra $19 in taxes for the widgets produced. All in all, society is made poorer because Sloth’s Widgets is making the widgets instead of Henry’s.

The moral of the story is that we want the most efficient producers to make the products. If the price of widgets go down, but we have to end up paying more in taxes, we as society lose out. We all have less money to pay for other items and create other goods.

Obama’s budget is an attack on inefficiency in this indirect way. By borrowing heavily, he promises higher taxes on businesses, large and small. He tries to guise this as class warfare, to make everyone think they’re just soaking some rich fat cat, but the truth behind it is that Obama is simply soaking businesses for money and deploying it through government spending. Whether its the increase tax on small businesses (those evil people making $200k+), closing corporate loopholes, attacking the health care industry, cap and trade, they are all taxes on private businesses aimed to fund massive government spending.

The result of this is less money in the hands of private businesses, more in the hands of government. There’s plenty of precedent to show that countries where the government is a higher proportion of the economy are ultimately poorer societies. You don’t need to look at the extreme examples of the Soviety Union or Cuba. Just look at our neighbors in Western Europe or Japan, where taxes are higher and the government plays a larger role in the economy. In those countries, GDP per capita is at least 20% less than ours, meaning the average person is at least 20% poorer than in the United States.

After Obama and the Democrats are done raising taxes and increasing government spending, our taxes may be higher than Western Europe/Japan and government spending may be even higher. All things being equal, the inefficiencies of government spending means society as a whole ultimately suffers, and we will all be at least 20% poorer than we once were.

Myth: The Great Depression has been our country’s only depression.

Fact: Our country has had several depressions, the Great Depression was simply the longest and the worst. There is no exact definition of what is a ‘depression’ versus a recession. Most of these depressions were referred to as ‘panics.’ Notably was the Panic of 1893, which lasted from 1893-1898. During this time, unemployment is estimated to have been well over 10% at points. Remember though, this depression lasted only five years. The Great Depression lasted over a decade and was only cured by World War II.

Myth: Herbert Hoover was ‘hands off’ on the economy, which led to the Great Depression

Fact: Quite the opposite. Hoover’s tinkering with the economy helped precipitate the Depression. Long before he was ever President, he actively denounced free market, laissez faire thinking. Hoover did initiate some public works projects (similar to the New Deal), though not nearly in the same scope as FDR since he did not want Americans to be too dependent on the government (Hoover believed such actions should be voluntary). Hoover’s policy disasters included interventions in the labor market and foreign trade.

To combat unemployment,  President Hoover initiated the Mexican Repatriation program. The goal of this program was to remove Hispanics from America because they were viewed to be taking American jobs. Hoover’s Mexican Repatriation program led to the deportation of 400,000-500,000 Hispanic Americans. Their migration was both forced and voluntary and ran through 1937. All this had the effect of simply increasing the cost of labor, decreasing the demand base, and thus hurting the ability of companies to be efficient and make profits, leading to more unemployment and a greater downward spiral. While no one is pushing for a Mexican Repatriation today, there are plenty who are pushing to cut off H1B visas, which would have a similar economic effect of the Mexican Repatriation program.

Hoover’s foreign trade antics are notorious. Most notably was his passage of the Smoot-Hawley Tariff. This tariff led to retaliations by other foreign countries and foreign trade plummeted. This had the effect of sinking global productivity and efficiency in an already tenuous environment. Luckily, most of the world has learned the lesson from this tariff, though people who want NAFTA repealed apparently have not. Think what having to pay $40 to buy a t-shirt or $150 to buy a pair of shoes would do in this already sagging economy.  That is the effect of tariffs.

Myth: FDR’s New Deal Got Us Out Of The Depression

Fact: The New Deal, if anything, simply prolonged the Depression. First, let’s use some basic logic. The Great Depression was not over until America entered WWII, almost nine years after FDR took office. Unemployment during the New Deal averaged over 17%, even with the increase in government jobs.

Most of the New Deal projects were wasteful government spending. This ultimately had the effect of raising the country’s debt, resulting in higher business taxes. The higher business taxes and regulation stunted economic growth in the private sector. Essentially, FDR’s New Deal sacrificed businesses for government. As we have learned countless times through history, whether it is the Soviet  Union, Cuba, or the post office, governmental central planning does not produce prosperity nearless as well as private free enterprise.

Even FDR’s treasury secretary admitted the New Deal was a colossal failure. In 1939, he wrote: ” “We are spending more than we have ever spent before and it does not work. . . . We have never made good on our promises. . . . I say after eight years of this Administration we have just as much unemployment as when we started. . . . And an enormous debt to boot!”” What was an enormous debt then is a pittance now. The debt/GDP as a result of the New Deal never went above 50%. Obama’s policies may take us well over 120%, possibly as high as 200%.