It has become fashionable to compare our present economic crisis to the Great Depression, especially by partisan opponents of the Bush Administration. The comparison may turn out to be apt, though not for the reasons that these critics believe.
In both the early 1930s and today, the Republican president responded to a severe financial shock with extraordinary interventions into the marketplace. That’s right, the “do-nothing” Herbert Hoover was no proponent of free markets, despite what you learned in history class. Hoover thought the proper response to an economic downturn was to spend massively on public works, and to support crop prices and wage rates. (See Andrew Wilson’s recent Wall Street Journal op ed.) Another similarity between the 1930s and the present, is that the unpopular Republican was replaced by a charismatic Democratic leader, who was unafraid to double-down on his predecessor’s interference with markets.
So far Barack Obama has not pledged the top-down central planning that characterized the New Deal, but he will be sworn in with the banking sector already partially nationalized, and a very weak economy on his hands. Given his promises to unions, his pledges to “fix” health care and education, his desire to wean the country from cheap energy, not to mention his casual dismissal of private property rights, a Newer Deal is entirely possible.
If a true economic disaster occurs, it will probably unfold along these lines: The economy sinks deeper into recession, causing home prices to tank even more. This translates into hundreds of billions in losses for the Treasury, which—thanks to its seizure of Fannie and Freddie, as well as the $700 billion bailout—has exposed itself to the fortunes of the real estate market. When combined with another major “stimulus” package, as well as a shrinking tax base, the government faces a budget deficit exceeding $1 trillion. Note that the September CBO estimate [pdf] already had the FY 2009 deficit pegged at $438 billion, and that figure doesn’t reflect the bailout or another possible round of rebate checks.
Besides record-breaking deficits, we might also enjoy double-digit price inflation by the summer. In an attempt to end the “credit crunch,” Fed Chairman Bernanke has recently allowed the monetary base to grow at a truly jaw-dropping pace, as the Fed’s own chart makes crystal clear.