The high government debt load and monster budget deficit are scaring many people right now. This is unquestionably the number one fear of investors and the argument most often invoked to justify an imminent fall of the stock market. For a lot of people, it is completely illogical to have used excessive debt to fight a crisis caused by… excessive debt ! They said it would have been better to purge capitalism by allowing irresponsible companies and individuals to go bankrupt.
This is exactly the advice that U.S. Secretary of the Treasury Andrew Mellon gave to President Herbert Hoover in the days following the crash of 1929. Here is it’s most famous quote:
Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate … it will purge rottenness out of the system.
Despite his misgivings, President Hoover eventually followed Mellon’s advice since it was the most popular way of thinking back then. Interest rates were increased and therefore the government restrained spending to balance its budget. Rising interest rates had also intended to protect the gold reserves of the Federal Reserve. At that time, the U.S. dollar was convertible into gold at a fixed price. The high interest rates then incited people to keep their investments denominated in U.S. dollars rather than convert them into gold (and thus empty the gold reserves of the Fed).
The result of this monetary policy was a total disaster! Ten years of misery and poverty that had a traumatic effect on the mind of several generations. The election of Franklin D. Roosevelt at the end of 1932 led to a 180-degree turn in monetary policy, but the damage was already so great that it was not until the end of the decade (and the beginning of an horrible war) that we got out of the doldrums.
With this historical perspective in mind, it is very easy to understand why central bankers around the world have adopted an approach diametrically opposed to that of the Hoover administration. The Fed chairman, Ben Bernanke (himself an expert of the 30s), certainly did not want to repeat the same policies that led to the Great Depression. A common conception is that man does not draw lessons from history. Fortunately for us, this is not always the case.
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