2013 Looks a Lot Like 1937 in Four Fearsome Ways

Many analysts are asking whether or not there will be another market drop similar to the one in 1937, after the re-election of Democratic president Franklin D. Roosevelt. In 1937, industrial production dropped by 34.5 percent and the Dow Jones Industrial Average dropped by half.

By Amity Shlaes
Nov 18, 2012 4:30 PM MT
Bloomberg

Will 2013 be 1937? This is the question many analysts are posing as the stock market has dropped after the U.S. election. On Nov. 16, they noted that industrial production, a crucial figure, dropped as well.

In this case, “1937” means a market drop similar to the one after the re-election of another Democratic president, Franklin D. Roosevelt, in 1936.

The drop wasn’t immediate in that case; it came in the first full year after the election. Industrial production plummeted by 34.5 percent. The Dow Jones Industrial Average dropped by half, from almost 200 in early 1937 to less than 100 at the end of March 1938.

It’s hard to imagine stock indexes dropping by half today, or unemployment rising past 15 percent, as they did in the “depression within the Depression.” But the parallels are visible enough to be worth tracing. They have to do with the danger of big government, and can be captured in a few categories.

-- Pre-election spree that sets records. In the old days, federal spending amounted to about 19 percent or 19.5 percent of gross domestic product. That ratio was so reliable that economists took it as a given, the American normal, from which divergence was unnatural and temporary. By the old 19 percent rule, federal spending would have dropped back once the worst of the 2008 economic crisis passed.

That didn’t happen. Instead the federal government continued to spend. Most important, even in 2012, when the crisis was long past, the government went on a spree, spending the equivalent of 24.3 percent of the economy, more than the 24.1 percent for the year earlier.

In 1936, a similar barrier was breached. Up until 1936, federal spending flowed at smaller levels than the spending by states and towns combined, with wartime being the exception. Roosevelt slowly ratcheted up the outlays, and in 1936, Washington spent more than the states and towns. This shift was dizzying for a country based on the principle of federalism, of strong states.

-- Bath of cold water afterward. After this year’s election, President Barack Obama made it clear that budgeting was his priority: “I’m ready and willing to make big commitments to make sure that we’re locking in the kind of deficit reductions that stabilize our deficit, start bringing it down, start bringing down our debt. I’m confident we can do it.”

Roosevelt too opened his second term on a sober budget- cutting note. The president, wrote journalist Anne O’Hare McCormick in 1937, was like “the Dutch householder who carefully totes up his accounts every month and who is really annoyed now that he is bent on balancing the budget, that Congress can’t stop spending.”

-- Fearsome attack on the status quo. In his first news conference on Nov. 14, Obama went out of his way to make clear his tax increases would fall on the rich: “What I’m concerned about is not finding ourselves in a situation where the wealthy aren’t paying more or aren’t paying as much as they should.”

Roosevelt was also ferocious, telling the old guard: “I should like to have it said of my first administration that in it the forces of selfishness and of lust for power met their match. I should like to have it said of my second administration that in it these forces met their master.”

When Roosevelt followed through in 1937, both with high taxes and his effort to pack the Supreme Court with more progressives, markets shivered.

-- Fallout from first-term legislation. Obama signed his health-care act in 2010, postponing much of its enforcement until 2013, after the election. Now that the effects of the act are so proximate, markets are wondering whether they or investors can handle the changes demanded. Roosevelt’s equivalents were threefold: Social Security, the Wagner Act and a new Federal Reserve law, the Banking Act of 1935, all passed well before the election. The last law gave the Fed a new tool, the easy ability to order changes in reserve requirements for banks.

In all three cases, the full effects of the laws weren’t felt until after the election. It was only in 1937 that Americans had to pay into Social Security, diverting cash from the economy. And it was only in 1937 that John L. Lewis, the labor leader, pushed his hardest for wage increases and strikes, forcing companies to pay higher wages than they could afford. In 1936 and 1937, the Fed increased reserve requirements, effectively doubling them. The consequence of these laws was reduced available cash, increased uncertainty and lower business confidence.

The obvious question is why an announcement by Obama or Roosevelt to cut back just after the election doesn’t reassure those who dislike government expansion.

Wary Markets

The answer is that the markets, which observe a giant march forward and then a step backward, don’t believe the step back is permanent. Giants are giants. Expansionists tend to revert to expanding government, as FDR did, most drastically, in World War II. The mandate matters more than the austerity chatter.

Benjamin Anderson, the chief economist at Chase National Bank in the 1930s, tried to capture the problem of the big- government president by titling one of his books “When Government Plays God.” His advisers warned him to suppress the title, arguing it might offend. Anderson shifted to the more banal: “Economics and the Public Welfare.” But Anderson’s phrase still reverberates: A government that “plays God,” or at least “plays powerhouse,” can spook markets and employers, whatever the decade.

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