Monday, December 31, 2012

Hang On We're Heading Over the Fiscal Cliff

As usual, listening to the Washington Beltway crowd and their friends in the Mainstream Media one can easily conclude that the American economy is headed for a major crash as the economy careens over the January 1, 2013 Fiscal Cliff.

Despite Chicken Little scaremongering by the chattering classes, most people seem to be taking the cliff fairly calmly.  The stock market has declined a bit as it usually does when faced with uncertainty and potentially bad news but the nation has remained calm.

The so called Fiscal Cliff is basically a fiscal tightening or anti-stimulus that involves cuts in Federal spending and increases in taxes.  This is the opposite of a Keynesian obsession with throwing money at the economy.

Following the end of World War II we hit a major fiscal cliff in 1946 and beginning of 1947.  Then as now, Keynes and his followers were certain that going over the fiscal cliff would result in an economic crash and renewed economic depression. 

According to popular myth, World War II brought us out of the Depression.  Granted, everyone not drafted into the military had a job and factories, mines and farms were at full production throughout the war.  Government spending on materials needed to fight the war amounted to a huge economic stimulus which had the economy operating at maximum capacity.

While the statistics looked good, consumer production was minimal leaving workers with little on which to spend their earnings. Everyone had a job but only limited quantities of bare necessities were available for purchase by consumers.

It was in this immediate post war period that President Truman in a speech uttered words to the effect that war is hell but peace could be worse, alluding to the Keynesian belief that, without the continued stimulus of massive government spending, the economy would quickly collapse.

The dropping of the atomic bombs on Hiroshima (August 6, 1945) and Nagasaki (August 9, 1945) coupled with the Soviet Union joining the war against Japan on August 8, 1945 quickly brought the war to an end on August 15, 1945.

Not only did the war end much sooner than expected, but, under pressure from the people who were sick the austerity that marked the Depression and World War II, the U.S. government immediately began demobilizing the troops (which represented about 18% of the labor force), canceling contracts for military material and lifting wartime regulations and restrictions on consumer production.
In the1946 mid-term Congressional elections the Republicans retook the House of Representatives defeating 54 Democrats and 1 left wing Progressive Party member to obtain a majority of 246 seats against the Democrat's 188.  In the Senate the Republicans picked up eleven seats from the Democrats plus defeating the left leaning Progressive Republican Robert LaFollette the primary and keeping the seat for a 51 to 45 Republican majority in the Senate.

While Democrats and believers in Keynesian economic theories fanned fears that there would be a major Depression in 1946, it never materialized as the private sector, freed of many of the New Deal regulations and controls quickly switched from war production to civilian production. 

Federal spending fell from $84 Billion in 1945 to less than $30 Billion in 1946.  The sharp drop in spending  enabled the Federal Government to both quickly begin paying down the war debt. The deep cuts in spending also resulted in a small Federal budget surplus in 1947.

Both the Depression of the 1930s and the current massive economic downturn under President Obama have resulted from the ill conceived stimulus spending and massive increase in unnecessary regulations. 

Going of the Fiscal Cliff may not be that bad and could result in the economy quickly turning around and recovering early in 2013.

Click the links below for more on the feared Depression of 1946:

Stimulus by Spending Cuts:  Lessons from 1946 - Cato Institute Policy Report

Cheer Up!  The Cliff Doesn't Look So Grim - Barrons December 31, 2012 issue 


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