Friday, September 26, 2008

Comment: The Failed Bailout of the Great Depression

Some analysts have astutely commented that the recent bailouts including that of massive AIG failed to do what was expected of them. They did not calm down the markets as promised by the administration.

Will the much larger bailout plan currently in negotiations fare differently? Is it simply a matter of throwing more money at the problem?

If we look at the historical example of the Great Depression, we find that government attempts at propping up the free market do not work.

Following the panic of 1929, the federal government made numerous attempts to stem the tide of bank failures. This culminated in the formation of the RFC by the Hoover administration in 1932 and this was further supported by Roosevelt who came into power in 1933. The RFC was tasked basically with bailing out struggling large businesses and banks.

Well, obviously the strategy didn't work. The Great Depression continued for another decade until the general mobilization during World War II.

The difference between that bailout and the current one, is the Great Depression scheme occurred together with sharp deflation of prices, while the current one is happening in inflation-based environment.

A bailout could worsen inflationary problems, which was not a problem during the Great Depression when prices were sagging and hurting business people. The country will largely have to rely on foreigners to finance the debt needed for the Paulson plan.

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