The Dow has closed about 350 points as I write this, and if the 777 point drop on Monday is “blamed” on the House rejecting the Pelosi Bailout Bill, then we have to blame this drop on the Senate passing their version of a Bailout last night. Fair is fair. When you factor in the Dow gain on Tuesday, the two net drops are close to one another. The excuses are starting to fly, and the blame is beginning to be slung about, and everybody is starting to feel sort of…depressed.

Which brings me to my topic.

The D-word has passed the lips of many people over the last couple of weeks. That was unthinkable even a month or two ago, and would have had the speaker labelled as a kook and marginalized as an alarmist. But now, we routinely hear people warning that another Depression-not-recession is looming and can only be staved off by swift, decisive action by the Government.

Take a deep breath for a moment, let the panic subside, and let’s consider what exactly causes a Depression and how we can avoid one before it happens, or get out of one after it starts. That is, after all, what we are talking about. It is what everyone wants. And it should be a part of any discussion of the crisis we are facing.

Now, discussions of economics and economic theory have a tendency to make people’s eyes glaze over, so I am going to keep this direct, specific and cut through some of the tech-speak. This is a basic pocketbook issue for all of us, and I firmly believe that you don’t have to have a doctoral degree to understand it. A lot of it is common sense, but there is not a lot of common sense demonstrated in politics and economics usually. As a sort of guide and outline for discussion–and as a fairly impartial assessment of current thinking–I am going to be quoting passages from the Wikipedia article on the Great Depression. It isn’t perfect, but it is in this case quite useful.

So, from the Wikipedia article on The Great Depression:

“Recession cycles are thought to be a normal part of living in a world of inexact balances between supply and demand. What turns a usually mild and short recession or “ordinary” business cycle into a great depression is a subject of debate and concern. Scholars have not agreed on the exact causes and their relative importance.”

We begin, therefore, with an admission that there is no consensus of opinion among economic and financial experts on exactly what causes a Depression. Which of course means that there is no consensus of opinion on how to prevent one, or what to do to get us out of one. And that raises big questions about the need for speed this past week in passing legislation most Senators and House members didn’t have a chance to read, and wouldn’t have understood even if they had read it since it was long on money and short on explanations. And things get even more amusing, confusing and worrisome after the jump…Also from Wikipedia:

“In early 1930, credit was ample and available at low rates, but people were reluctant to add new debt by borrowing. By May 1930, auto sales had declined to below the levels of 1928. Prices in general began to decline, but wages held steady in 1930, then began to drop in 1931. Conditions were worst in farming areas, where commodity prices plunged, and in mining and logging areas, where unemployment was high and there were few other jobs. The decline in the American economy was the factor that pulled down most other countries at first, then internal weaknesses or strengths in each country made conditions worse or better. Frantic attempts to shore up the economies of individual nations through protectionist policies, like the 1930 U.S. Smoot-Hawley Tariff Act and retaliatory tariffs in other countries, exacerbated the collapse in global trade. By late in 1930, a steady decline set in which reached bottom by March 1933.”

At first glance, and allowing for differences caused by the passage of time, this sounds an awful lot like what we are facing at the moment. So is it any wonder that Ben Bernanke, who has studied the Great Depression to death, is behaving as if the sky is falling?

We should all be concerned. Nobody wants another Great Depression (except possibly and cynically certain members of a certain political party who might advance their careers and their socio-political agenda through a depression in the same way they tried to gain a political advantage by causing America to lose a war…but I digress.)

The question really isn’t if we “want” to avoid another Depression, the question is “how” can we avoid another Great Depression. And there are basically three schools of thought on that question.

First, the Classical Economics viewpoint–and for the technically minded, I’m lumping monetarist views and neo-classical supply-demand economics in here too. This approach says that the Great Depression was caused by a contraction of the money supply. The Stock Market crash of 1929 would have been just another recession if it hadn’t been for a lot of bank failures happening at the same time that reduced the availability of credit and the drying up of capital.

This situation was made worse by too much debt caused by cheap, over-available credit that was fueling the economy. When the economy faltered and debt began to be unsuccessfully called in, it triggered the collapse of banks. That led to panic and runs on banks, which led to a cascade of bank failures.

Sound familiar? It should. It is Ben Bernanke’s personal nightmare, and the biggest question that should be asked of him is why with his theoretical monetarist stance and his broad knowledge of the Great Depression, he did not spend every moment since becoming Fed Chair shouting warnings and insisting that something be done. And while Bernanke is right on many of his fears about the situation we are in, he is wrong in his approach to solving those problems. Theoretically a monetarist, for some schizophrenic reason he has been trying to use Keynesian solutions at odds with many of his theoretical beliefs. But more on that below.

So, to anyone who believes Classical Economics–and there are not many of them in positions of authority or power any more–our current crisis is a repeat of many of the problems that led to the Great Depression of the ’30’s. Or, in the words of Yogi Berra, it is “deja vu all over again.” The solution now, as the solution would have been then, is to provide liquidity to the banks through the Fed (as has been done on an ongoing basis) and prevent a cascade of bank failures (increase the FDIC limit, make targeted bail-outs, not wholesale ones, and let sound financial institutions buy up unsound ones.)

To round out the Classical theory, add into this mix overproduction caused by the spread of electricity and better industrial machinery in the first decades of the twentieth century, a downturn in employment as fewer workers were needed to produce greater numbers of products, and underconsumption since unemployed workers don’t buy that many products and you have the Classical causes of the Great Depression. But the Classical theory is not the only one around, as I mentioned.

The second school of thought on what caused the Great Depression is Structural Economics, principally Keynesian economics. Keynesians like to focus on the idea that the Great Depression resulted from a large-scale crisis of confidence. Depressions can be avoided by bolstering confidence. You can do that in part by slapping more regulations on the financial system–because an unbridled market is a robber baron market as everyone knows, and people have confidence in Big Government and know that Big Business is inherently bad.

Ahem.

Secondary causes of the Great Depression for Keynesians were underconsumption because of high unemployment and overinvestment (an economic bubble). Toss into the mix malfeasance by bankers and capitalists and incompetence by government officials who didn’t enforce enough regulations, and you have their recipe for the Great Depression.

Ben Bernanke, while theoretical a monetarian, has been doing things as Fed Chair that are mainly Keynesian in his attempts to manage and fix national economics (macroeconomics).

(An aside to the esoterically minded: I know, I know, Bernanke is supposed to be primarily a monetarist, but a case can be made that monetarism is just a special case of Keynesian theory for reasons we don’t need to go into now, and most people don’t give a hoot about these distinctions in label anyway. They simply look at what a person says and what a person does.

if you want to read a very good analysis of Bernanke’s approach to managing the economy, here is a link to a Forbes article from 2006 that is very enlightening.

Keynes was a very big advocate of socializing investments, and Bernanke and Paulson have been travelling that path a lot lately. With that, I could basically rest my case that Bernanke is channelling Keynes in this situation. However, if you have any lingering doubts, remember that Bernanke is the one who said, “We have the keys to the printing press, and we are not afraid to use them.” which is not the statement of a monetarist and may go down in history as a line as famous and fatuous as the one falsely attributed to Marie Antoinette: “Let them eat cake.”)

Heads are going to roll over the mishandling of this crisis at some point or another.

But back to the second main view of what caused the Great Depression. For Keynesians, it is all a confidence game, and one way to instill confidence is to pump large amounts of money into the system and let everyone know the government is on the job and nothing can possibly go wrong. (Another word for “pumping up” of course, is inflation, but we aren’t going to mention that, are we?)

Bad thoughts aside, if this approach is followed and confidence is maintained, then the shee…ah, people, will keep on buying things, keep on investing their money, and everything will be hunky-dory on Main Street, whatever that means. So, demand will keep up with supply on a microeconomic level and There Will Be No Great Depression. This is the “in” thing among economists at the moment–a double standard of Keynes theories for “big” or macroeconomics, and neo-classical theory for “small” or microeconomics.

“Small” by the way, means how you and I do economics. Managing a household, keeping to a budget, making personal and family savings and investment decisions, figuring out what not to buy when gasoline prices go through the roof because refineries and pipelines shut down temporarily due to a hurricane, etc., etc., etc.

Wouldn’t it be nice if you and I could switch over to Keynesian economics to manage our households whenever we felt a “crisis of confidence” in our ability to buy what we want to have? All we’d have to do is go into the family room or our office, crank up the computer and the laserjet printer, print out a few dozen sheets of colorful paper money, cut them out neatly and carefully, and go buy whatever we wanted to buy.

Or, we could just write as many checks as we wanted to on our bank account and run an ever-increasing deficit that the bank would be obliged to allow. Don’t worry about it. Just keep that negative checking account balance rising from month to month as we buy anything we want to buy, from emergency expenditures to get the car repaired or pay for that leg we broke on our last ski trip, as well as the luxury ski trip to Vail where we broke our leg.

Maybe our kids will pay off our checking account deficit. Or their kids. But who cares. Don’t worry. Be happy.

A moment’s thought will be enough to show you why the Fed, and the government…and the bank, of course, do not think that Keynesian microeconomics are a good idea for you and I to use in our everyday lives. No, Keynesianism is reserved for governments since only they know enough and are responsible enough to use it wisely and with careful, measured discretion.

I’ll pause here a moment until you stop laughing or swearing, as the case may be.

Ready to go on? Good.

The third current school of thought on why depressions happen is Marxism. I’m going to ignore Marxism in this discussion, since even though many on Capital Hill may be closet Marxists, for the most part they are not insane enough to advocate it as an economic theory the U.S. should be basing decisions on.

At least, not yet.

Besides, the Marxist argument is that basically depressions happen because capitalists are evil and exploit the masses, separating those who produce from the just rewards of their labors, and a pox on the whole system anyway. Not a lot there that is useful or works in real life.

Instead of discussing Marxism, I want to talk about one additional theory of how the Great Depression happened. It is a theory that all fiscal conservative–and all Republicans–should be thinking about right now. Because if this theory is correct, then actions by the Senate yesterday and probable actions by the House tomorrow will inevitably insure that happy days are indeed here once again.

“The severity of the Wall Street crash, he argued, was not due to the unrestrained license of a freebooting capitalist system, but to government insistence on keeping a boom going artificially by pumping in inflationary credit. The slide in stocks continued, and the real economy went into freefall, not because government interfered too little, but because it interfered too much.”

This statement is from the forward to the Fifth Edition of a book I heartily recommend to everyone, called America’s Great Depression by Murray N. Rothbard. It is available freely online as a PDF file from the Mises Institute.

The Mises Institute espouses economic beliefs that fall under the Austrian School label, and they are rather libertarian in philosophy. I am not going to go into their background any farther, but if you have an interest google “Ludwig von Mises” or check wikipedia.

The Austrian economic school of thought believes that the primary cause of the Great Depression was the expansion of the money supply during the 1920s by the Federal Reserve. That expansion led to an unsustainable credit-driven boom, or bubble, in the U.S. economy that burst with disastrous consequences for our country and for the entire world.

Asset prices (the price of stocks and bonds) and the price of capital goods went up and up until they were tremendously over-valued. By the time the Fed tried to get control in 1928 by raising interest rates in an attempt to tighten things up, it was too late and a depression was inevitable. Interference in the economy by the government didn’t work since the system was overbalanced and needed correction, and attempts to prop up the economy after the crash of 1929 made things worse. The death blow came through Congressional action instituting protectionism and tariffs, and an ill-advised raising of tax rates in an effort to redistribute wealth.

According to the Austrian school, big government intervention was directly responsible for turning a serious recession that would have lasted a couple of years into a major global depression that dragged on and on until World War II. You can even make a case that the Great Depression was directly responsible for World War II, since economic conditions in Germany and Europe provided the environment in which Hitler could rise to power.

And there is something else about the Rothbard’s analysis that is particularly important for us to consider now, as the House considers passing one of the biggest and quickest pieces of big government intervention in the private sector ever conceived. Quoting again from the Wikipedia article on the Great Depression:

“Rothbard criticizes Milton Friedman’s assertion that the central bank failed to inflate the supply of money. Rothbard asserts that the Federal Reserve bought $1.1 billion of government securities from February to July 1932, raising its total holding to $1.8 billion. Total bank reserves rose by only $212 million, but Rothbard argues that this was because the American populace lost faith in the banking system and began hoarding more cash, a factor quite beyond the control of the Central Bank. The potential for a run on the banks caused local bankers to be more conservative in lending out their reserves, and this, Rothbard argues, was the cause of the Federal Reserve’s inability to inflate.”

Anyone looking for an answer to why the stock market didn’t crash disastrously on Monday, then recovered somewhat on Tuesday and stayed basically unchanged on Wednesday, then fell about 350 points the day after the Senate passed their bloated version of the Bailout should look at the approval numbers of Congress. I would be willing to bet that the Stock Market will fall more if this Bailout passes than it has already fallen over the past few days. Do you seriously think that the American public is going to make decisions on what they do with their money based on faith in the ability of Congress to fix anything?

And does anyone seriously believe that, if the Bailout goes through, credit is going to loosen up now much more than it did back in 1932? Haven’t we ensured through this mess that non-conservative bankers and institutions are not going to be around? And that lending policies are going to continue to tighten as bankers wait for another shoe to drop? And that after being frightened out of their wits most people are going to tighten their belts and not make major expenditures for a while since they don’t know when the next crisis will strike?

Use some common sense.

This massive infusion of tax dollars is not going to “restore confidence” because people have been hearing a constant drumbeat from the Democrats on how bad the economy is, how shaky things are, and how it is all the fault of Republicans and their buddies on Wall Street and in the Big Oil Companies. Now the Democrats are leading the charge in a bail-out of Wall Street and the banks–and yes, I know that this isn’t about that, it is about credit for small businesses and car loans and student loans and home loans, but the volume of negative phone calls and emails Reps and Senators keep receiving should demonstrate that it is Wall Street and “Big Business” that is still taking the hit here.

And Republicans of course. Republicans always take the hit.

Thanks to the Democrats.

And who loses if the Bailout fails, as I am certain it will fail? Well, obviously, the average American loses. And Republicans will lose, quite obviously, for they will take the blame for failure no matter what happens. The Democrats are too good at spinning the blame game, and the press is too good at making sure the Democrat perspective is the only one that gets heard.

But the country is going to lose and lose big if something is not done to stop what comes next. The Democrats have already positioned themselves for what comes next in ways that nobody on the other side of the aisle are thinking about as we slouch towards Bethlehem this election year.

Again, quoting from Rothbard: “Franklin D. Roosevelt, elected in 1932, primarily blamed the excesses of big business for causing an unstable bubble-like economy. Democrats believed the problem was that business had too much power, and the New Deal was intended as a remedy, by empowering labor unions and farmers and by raising taxes on corporate profits. Regulation of the economy was a favorite remedy. Some New Deal regulation (the NRA and AAA) was declared unconstitutional by the U.S. Supreme Court. Most New Deal regulations were abolished or scaled back in the 1970s and 1980s in a bipartisan wave of deregulation. However the Securities and Exchange Commission, Federal Reserve, and Social Security won widespread support.”

Can you say “New Deal Part Deux?” I think that if you cannot, you had better learn to say it pretty fast. Re-read that quotation above and change “Franklin D. Roosevelt” to “Barack Obama, Nancy Pelosi and Harry Reid” and see if the first couple of sentences doesn’t sound a lot like the current Democrat talking points.

Eerie, isn’t it.

And Barack Obama keeps getting higher in the polls as John McCain stays silent or goes along with the march toward an extremely unpopular, massively expensive, precedent-setting government intervention in the private sector. And the rest of the Republican Party is following along like lemmings toward a supposed safe haven of the Bailout that is going to turn out to be a huge cliff.

The danger here is not that Barack Obama will ride this crisis into the White House. The danger is that he will ride it into a New New Deal that will institutionalize government control of the economy and every aspect of everyday life in ways that will be as impossible to roll back once enacted as was the “temporary” income tax or the Social Security program.

And that will make any recession or depression that we are heading into deeper, longer and more painful for Americans.

If Republicans, and Conservatives, stand for anything at all anymore, then they had better stand up, stand together, and have the guts to say that they will not stand for this kind of bloated, untried, unproven and un-American government intervention. This is a 700 Billion Dollar albatros that potentially is going to sink the Republican Party and the Conservative movement for decades to come.

What happens if the Dow continues to head south after a Bailout is passed? What happens if it drops 1000 points next week, or 2000 points? Well, one thing that it will mean is that, in the eyes of the majority of Americans who did not favor the Bailout plan in the first place, the people will have been right and Congress will have been wrong yet again. And the Senators and House members who voted in favor of the Bailout are going to be about as popular as the Republican Congress and Herbert Hoover were back at the beginning of the Great Depression.

It might be nice if the Democrats could take the blame on this one this time, especially since it it the Democrats who truly deserve a lion’s share of the blame. Consider carefully what is at stake here.

Failure to pass the Bailout may mean that we have another Great Depression.

But passage of the Bailout may mean that we have another Great Depression too…it depends on which school of economic theory is correct. And we will only know who is right after the fact. And possibly not even then.

And while we’re on the subject of the Great Depression, I will candidly admit that watching the Democrats position themselves as the Saviors of America from financial crisis–and watching Republicans fall in line and fall all over themselves jumping on a bipartisan bandwagon to Hell agreeing with them and implicitly taking blame for a mess Republicans did not cause–makes me feel very much like a small, furry animal who sees Lennie Small walking towards me with a friendly smile on his face.

For mice and for men, things are about to gang agley indeed…

If you are a fiscal conservative then you cannot be in favor of this Bailout no matter what rationalization you use. Any vote other than “no” is a vote from fear and/or short-term self-interest. If you cannot hold to your principles in a time of crisis, then you have no principles.

We are gambling with the entire free market system and every Republican who votes in favor of the Bailout for good, sound, compassionate reasons–or from fear of political fallout if the economy falters farther–is just giving ammunition to Democrats that “they” knew the system wasn’t working, “they” knew deregulation didn’t work and did it anyway, “they” knew that Big Business couldn’t be trusted…and “they” finally voted with the Democrats (who were right all along) when it was too late to prevent disaster.

And “they,” of course, are those evil Republicans who are against the common people and the “little guy.” Republicans are going to take a hit on this one in the short term no matter whether the Bailout passes or fails again. And Republicans are going to be hit with the blame in the short term when the economy continues to head south, as it will no matter whether the Bailout passes or fails again.

If a hit is inevitable, then at least take a hit for something that you truly believe in. In that way, the party and the conservative movement may be positioned to say “I told you so” when massive intervention fails yet again. And we may be able to put the pieces of our broken economy back together quicker and better for the sake of everyone.