03/18/2010 05:12 am ET | Updated Aug 29, 2011

Why Ron Paul is Wrong

In a recent article in Forbes Magazine, former Presidential candidate Ron Paul expounds on why the government has screwed the entire bailout up and that we are heading into a Great Depression even potentially worse than the one that hit in the 1930s.

He's wrong.

Lets take a look, step by step, through his argument.

His first argument is that although the economy seems to be improving, it is a false recovery similar to the false recovery in 1932 and that "the interventionist policies of Hoover and Roosevelt caused the Depression to worsen, and the Dow Jones industrial average did not recover to 1929 levels until 1954."

This is an unfair comparison. Hoover's, and then Roosevelt's, interventions were of a much different flavor than today's stimulus package. In 1930, Hoover signed the Smoot-Hawley Tariff Act, which put tariffs on thousands of imported goods, effectively ending all trade with foreign countries. While Obama has recently put on a small tariff on some Chinese goods, the overall trade situation has not changed much and has had very little intervention that would cause trade to be inhibited. Singlehandedly, Smoot-Hawley made the Depression ten times worse than it could've been, and there is no comparable act now.

In 1931, a full two years after the Depression started, Hoover set up the National Credit Consortium which pushed larger banks to lend to smaller banks. It didn't work. Bernanke and Paulson (and now Geithner), to avoid this pitfall, just directly had the government put money in all the banks (the TARP bill), significantly speeding up the process by which, eventually, money will start to flow through the system.

In 1932, Hoover raised taxes so that the top tax rate went to 63% on personal income and corporate tax went from 12% to 13.75%. While tax hikes might be in our future, so far none have been put in place.

In 1933, Roosevelt signed the National Recovery Act (Hearst referred to the NRA bill as "No Recovery Allowed"), which fixed wages. He did this with good motives: to stop the deflation in people's incomes. But the results of fixing wages produced the opposite effect as employers simply stopped hiring or would hire under the table and wages ultimately fell 21% over the next several years. No such interventionist bill is even being contemplated.

These are just a few of the "interventions" that Bernanke, Paulson, Geithner have avoided in their attempts to fix the current issues without repeating the mistakes of the fast. The comparison is unjust at this point.

Ron Paul states, "Anytime the central bank intervenes to pump trillions of dollars into the financial system, a bubble is created that must eventually deflate."

If a bubble is being created, I'd like to see it. When there's a bubble, everyone will feel flush. Just as they did in 1999 from the internet bubble and in 2006 from the housing bubble. There's no bubble right now. In fact, the M2 money supply is actually decreasing. We are in a deflationary environment that desperately needs to be reflated. Until that happens, there's no worry about bubbles.

Ron Paul further says, "Those banks and financial institutions that took on the largest risks and performed worst were rewarded with billions in taxpayer dollars, allowing them to survive and compete with their better-managed peers."

Well, over 100 banks now have been shut down by the FDIC. And one of the largest broker-dealers, Lehman Brothers, was allowed to fail (with disastrous consequences). It sounds nice in theory to allow the excesses work through the system and I do believe that to a large extent is possible, Paulson and then Geithner have been allowing this to happen. But you don't want the system to collapse. Some institutions can only fail if we're willing to risk the tens of millions of checking accounts that people have with banks and the millions of credit lines that small businesses have with banks to make basic needs like payroll, etc. While it's fine to speak theory about our excesses, the average man, woman, and business can't change the status quo too much without significant personal pain being felt.

Perhaps Ron Paul doesn't mind because a better system would be the result, but I think the consequences in the short-term would be unbelievably painful and would rival the misery of the dustbowl Great Depression.

Ron Paul says, "Even with the massive interventions, unemployment is near 10%".
Most of the stimulus bill is taking effect in 2010. Even the "shovel ready" projects that were supposed to begin in 2009 are getting a slow start thanks to bureaucracy and won't have an effect until sometime next year.

Not only that, companies did exactly what they were supposed to do in the beginning of this recession -- they slashed inventories faster than any other time since 1940, and they fired the people used to make those inventories. Well, the world didn't end, and now they have to rebuild those inventories. And the hiring rate will be the fastest it's been in 50 years, as we need to completely restock the shelves. Paul doesn't take this into account in any of his discussions about the state of the current economy, and yet this is probably the most important statistic out there at the moment.

Paul says, "foreigners are cutting back on purchases of Treasury debt"

Well, that might be true, but interest rates are still near all-time lows because US citizens have been upping their purchases of Treasury debt as our personal savings rate reaches a ten year high.

Paul says, "As the housing market fails to return to any sense of normalcy"

Actually, the Case-Shiller Home Price index has been up the past four months in a row. So lets calm down a little bit and wait and see what happens. But its wrong to say its "failing to return to any sense of normalcy".

Finally, Paul, in a fit of rage about a declining dollar, says, "The Fed has already overseen a 95% loss in the dollar's purchasing power since 1913."

Well, the stock market is up 10,000% since then. And in every way the quality of our lives is better than 1913. I'd much rather live in 2009 than in 1913.

At the end of the day, don't succumb to populist panic. Capitalism works and is on its way to a recovery if we just sit back and let it happen.