Five Ways to Wreck a Recovery

By Amity Shlaes
Monday, August 18, 2008

Perverse monetary policy was the greatest cause of the Great Depression. But five non-monetary missteps were important in making the Depression great, and the same missteps damaged the global economy as well. While many are thinking about the Depression, few seem concerned about replicating these Foolish Five today:

· Giving in to protectionism. In Herbert Hoover's time, Sen. Reed Smoot and Rep. W.C. Hawley proposed a tariff that was to raise effective duties by as much as half. More than a thousand economists signed an open letter warning that the duties would "raise the cost of living and injure the great majority of our citizens."

But Hoover's Republican Party didn't much care. In its 1928 platform, the GOP had pledged to "reaffirm our belief in the protective tariff." Ambivalent, Hoover signed the bill. An irate Canada and many other nations retaliated. At a time when the United States was begging for foreign markets, it lost them. The selfish signal discouraged an already unstable Europe.

Today, international trade claims a sizable share of our economy. Bilateral free-trade agreements with Colombia or Panama are good insurance -- cheap steps that might prevent an expensive loss, that of the Western Hemisphere to Venezuela's Hugo Chávez.

Yet again, one party -- the Democrats, this time -- is cavalier. House Speaker Nancy Pelosi is blocking passage of these bilateral agreements. And another ambivalent politician -- Sen. Barack Obama -- has sent mixed messages to Canada about just how much he wants to roll back the North American Free Trade Agreement.

· Blaming the messenger. Punishing the stock market for the 1929 crash was popular in Washington in the early 1930s. Lawmakers attacked the practice of short selling; Senate Banking Committee counsel Ferdinand Pecora hauled J.P. Morgan and other Wall Streeters in for hearings. By 1934, Congress was creating the Securities and Exchange Commission. The Roosevelt administration also prosecuted business leaders, including former Treasury secretary Andrew Mellon and utilities magnate Samuel Insull. The new regulatory culture cut crime and protected investors. But the arbitrary nature of the assault petrified Wall Streeters.

Today, too, a "Blame the Street" mood prevails. SEC Chairman Chris Cox has criticized "naked shorts," an attack with a legitimate anti-fraud component. But targeting short-selling also generates uncertainty. The investigations of Bear Stearns and Freddie Mac are just the beginning; more prosecutions are likely. Like the Sarbanes-Oxley Act, which followed Enron's accounting meltdown, this cleanup will send companies and jobs abroad.

· Increasing taxes in a downturn. Hoover more than doubled income tax rates, taking the top marginal rate to 63 percent from 25 percent. FDR hiked the top rate to 90 percent. Perhaps worse, Roosevelt's Treasury crafted taxes to punish business, including an undistributed profits tax and an excess profits tax, that ultimately sucked cash from a capital-starved economy.

Today, Democrats are planning tax increases that make Bill Clinton's hike look mild. The proposals start with lifting the cap on Social Security payroll taxes -- an effective increase in the top marginal tax rate of 6.2 percent, or for some 12.4 percent, all by itself. Add in the promised repeal of the Bush tax cuts and you have an additional 4.6 percent increase. Effective top rates approach 50 percent. There are also proposed increases for dividends and capital gains. Taken together, these will make the U.S. economy sluggish and more like that of Europe.

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