Why "Constructive Inaction" is No Longer in the Feds' Lexicon

Question: How many finance chiefs does it take to perpetuate a monetary crisis?

Answer: Twenty…and all of them convened in Paris last weekend.

The finance chiefs from the “Group of 20” nations convened to propose and discuss various bailout schemes for the euro zone.

Many of the chiefs urged their European peers to amass even larger bailout firepower than the $605 billion European Financial Stability Facility (EFSF). Other chiefs suggested that the IMF play a much larger role than it has to date.

But no matter the precise proposals, all 20 chiefs agreed that the key to halting the crisis in Europe was more government action…and certainly not less.

“I think [the Europeans] have come to recognize that, if you underdo it, it’s going to be more expensive,” said US Treasury Secretary, Timothy Geithner, expressing the consensus viewpoint that government intervention is the solution to this — and every other — financial hardship.

But “under-doing” is probably not the greatest risk of the moment. Overdoing might be.

After all, isn’t overdoing it the very thing that brought us to this fiscal precipice?  The governments of the West have become so active in all facets of Western society that they are utterly hyperactive.

Tuesday’s Congressional Hearing of the Senate Homeland Security and Governmental Affairs helps to illustrate the extent of the government’s intrusiveness.

The witnesses in attendance included a bevy of federal officials with ominous, absurdly long titles like Homeland Security Undersecretary for Science and Technology, Assistant Homeland Security Secretary for Health Affairs, Assistant Secretary for Preparedness and Response, Assistant Director, Weapons of Mass Destruction Directorate and Senior Director for Biological Defense Policy.

During the repartee, the Assistant Secretary for Preparedness and Response extolled the government’s post-9/11 success in making America safer against bio-warfare:

“Critical to the success of the whole Public Health Emergency Medical Countermeasure Enterprise — or the PHEMCE, as it’s called — is an integrated approach with a formal government structure, and he should know that this includes all the components of HHS plus DHS, VA, DOD, USDA. So it’s truly an interagency effort — and that all parts now of HHS, CDC, FDA, NIH, BARDA work together with companies from the outset of the contract rather than at the end of the pipeline… Yet as we all know from the Weapons of Mass Destruction Terrorism Research Center report card, while we’ve made important progress…our preparedness is not yet sufficient…Without continued support and funding for our public health and medical systems, the infrastructure will degrade…”

Maybe all these bureaus, agencies and directorates are as essential as their Undersecretaries, Assistant Secretaries and Senior Directors would have us believe. Maybe not.

But two things we know for certain: all this government-sponsored hyperactivity is very expensive and very intrusive. It costs a lot of money to stick one’s bureaucratic nose into every citizen’s business.

After Sept. 11, America’s intelligence, surveillance and counter-terrorism agencies basically got a blank check to fund their efforts. The CIA got a billion dollars right away. So did the National Security Agency (NSA). “What we found in the years immediately after Sept. 11 was that the existing agencies grew enormously,” observes Dana Priest, a reporter for The Washington Post. “They doubled in size, many of them, and new organizations were created as well, big ones.”

In 2002, for example, there were 34 new federal organizations created to work at the top-secret level. In 2003, government created 39 more; in 2004, 30 more; in 2005, another 35; and more each year since. “Every year [since 9/11],” Priest goes on, “more than two dozen, sometimes three dozen, entirely new federal organizations dedicated to counterterrorism [were] being created.”

Do we really need all these agencies? Will any of us really notice or care if we lose a few government acronyms along the way?

By funding this proliferation of intrusive government agencies — all in the name of national security — we taxpayers are paying to be groped by strangers, metaphorically speaking. Maybe we could do with a little less groping. And certainly, we could do with a lot less “protecting” and “rescuing.”

Less is more, as the saying goes.

Thus, the one solution to the euro crisis — and also to the economic malaise here at home — is the one solution that no one seems to be considering: Benign neglect.

Doing nothing at all may be the very best thing to do, as Jim Grant suggests in a recent issue of Grant’s Interest Rate Observer. “Constructive inaction” is the term Grant uses to describe the government’s response — or rather, non-response — to the economic contraction of 1920.

“90 years ago,” Grant explains, “in the teeth of a slump much deeper than our Great Recession, the government did what today would be unimaginable.”

It did nothing.

“The US government — the Wilson administration through March 1921, the Harding administration thereafter — met the emergency mainly by getting out of its way,” Grant relates. “To most of the policymakers of the day, it was, indeed no ‘emergency,’ but essays of the business cycle, unpleasant but inevitable.”

Importantly, the government of 1920-21 did not stand aside because it had no idea what to do; it stood aside because it had some idea what not to do. The administrations of Wilson and Harding stood aside because they trusted market forces to resolve the crisis more effectively that the government could.

“Market forces didn’t fail in 1920-21,” says Grant. “They were virtually the only forces in play… The Federal Reserve in 1919 was celebrating its fifth birthday, while the welfare state of finance — too big to fail, TARP, TALF, etc. — was not only unborn but also unimagined.”

Anticipating the deep recession of 1920-21, the Ben Bernanke of his day, Benjamin Strong, governor of the Federal Reserve Bank of New York, had this to say in 1919:

[“There will be] a considerable degree of unemployment, but not for very long, and… after a year or two of discomfort, embarrassment, some losses, some disorders caused by unemployment, we will emerge with an almost invincible banking position, prices more nearly at competitive levels with other nations, and be able to exercise a wide and important influence in restoring the world to a normal and livable condition.”

Therefore, in anticipation of both an imminent deep recession and also at a rapid, vibrant recovery that would restore the world to a normal and livable condition, Strong proposed neither bailout plans nor “stimulus measures” to alter the economy’s natural course.

He simply watched. And as he watched, he saw his predictions fulfilled. The economy did contract, fiercely so. But shortly thereafter, the economy launched a powerful recovery. The whole thing lasted less than two years.

“The point cannot be overstated that the slump did end,” Grant points out, “and that the post-1921 labor market mounted a powerful recovery and that the incumbent Republicans remained in power until Herbert Hoover decided to meet the Great Depression, not through inaction but through an aggressive intervention.”

But constructive inaction is not even a topic of discussion among the G-20. Today’s discussion is all about destructive action. In the name of “stabilizing the system,” the G-20 wishes to amass hundreds of billions of taxpayer dollars into a kind of economic funeral pyre.

“The supposed lessons of the Great Depression, as interpreted by the former Princeton economics professor who now directs the nation’s destiny at the helm of the Federal Reserve Board, constitute the guiding light for today’s policymakers,” Grant explains.  “Intervene early and often… print money, run up the federal debt, slash interest rates, extend jobless benefits and soften the sting of foreclosure…”

Accordingly, the leaders of the EU and IMF are planning to “save the system” by sending money to governments that overspent foolishly and banks that invested foolishly. Why bother saving that system?

The system that deserves saving is not the one that rewards incompetence and reckless risk-taking. The system that deserves saving is the one that rewards prudence. That’s the very same system that permits bankrupt investments to go bankrupt…that separates fools from their money.

The system that deserves saving is not the one that tries to slap green paint on every piece of dead wood and call it “healthy.” The system worth saving is the one that respects the power of market forces — that allows the dead wood to rot and decompose right where it sits, so that it may fertilize the next generation of productive enterprise.

“The bailout funds [in Europe] — no matter how large they grow — will merely slow the march toward inevitability,” we observed several weeks ago. “The destination is certain; the timetable is variable.”

Greece will default…eventually. Why not let it happen? And if the euro fails, the euro fails. Why not let that happen too?

The leading policymakers of the European Union would like to halt the crisis in its tracks. Not gonna happen. These guys and gals should probably stop practicing their speeches into a mirror. They are forgetting that the images before them are flip-flopped. Left is actually right. Right is actually left. Rescue plans are actually failure plans. Failure is actually the first part of any enduring rescue.

Eric Fry
for The Daily Reckoning

The Daily Reckoning