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Jin Haeng Lee
Government Policies and People’s Unrealistic Goal
When one looks back on the history of the economy, he would definitely notice the
changing role of the government over time. Unlike the early days, when the concepts of
economics were vague, the government became more involved with the market. While
many people assert that the government should be influential with the market, others
believe that that the market works better with a small government. This is one of the
reasons people try to understand the market and figure out proper relationship between
the government and the economy.
An efficient way to understand the relationship between the government policy
and the stock market would be approaching it in a social studies context. As one learns
the history of the stock market and its relationship with the government, he would learn
that it was people’s overestimated expectation that made them believe they could enjoy
prosperity forever. Moreover, he would notice that the government encouraged or
participated in people’s building up the very vanity.
Before discussing each significant moment of the stock market, it would be better
to talk about the origin of it. First of all, although the original Wall Street was created in
the 17th century, Wall Street we know today was not created until the late 18th century.
Stock-interested traders gathered informally under a buttonwood tree around Wall Street.
Then in 1792, the traders announced the ‘Buttonwood Agreement’, which noted the
beginning of the New York Stock Exchange, or Wall Street that people usually think of
(The Library of Congress).
After a century, Wall Street experienced its first hardship: the panic of 1907. In
1907, the banks plummeted due to the Heinze family His brother tried to corner the
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copper market, which ended up as a failure. Due to this failed manipulation, the
newspapers began to spread scary news that agitated people even further which caused
the stock exchange to plummet, leading to the panic of 1907 (FettigDavid).
As the market went through disaster, the famous banker, J.P Morgan entered to
save it. He gathered up millionaires of the time, such as Rockefeller, and discussed the
situation for weeks. The discussion led to a conclusion that the big companies should
help smaller businesses.
The panic of 1907 was important in a sense that it showed that people become so
greedy in the market that they try to fool the market with a scheme, as the Heinze family
tried to manipulate the copper industry. However, the panic of 1907 had a positive aspect
in a sense that it led to a weak, yet the very first, governmental intervention with the
market. Continuous flaws of the market worried people and the government, and the
U.S government came up with new laws to solve the problem. For example, the congress
passed Owen-Glass Federal Reserve Act in 1913 to create the Federal Reserve System
(U.S history).
World War I changed America greatly; it finally made the U.S becomes more
interventionist; before the break out of World War I, the U.S government insisted on an
isolationist perspective. However, as the U.S went through the war, it became an
interventionist. Moreover, the U.S economy boomed thanks to World War I; during the
wartime, the U.S remained almost intact. Also, there have been several inventions that
augmented the production greatly. For example, the conveyer belt, invented by Henry
Ford, boomed the automobile and every industry that was related with the automobile
production. In short, the First World War made the U.S a more influential country
throughout the world, at the same time booming the economy of the U.S.
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However, this boom in production was not always a positive aspect. The U.S went
through economically disastrous time from the nineteen thirties to the early forties: the
Great Depression. The Great Depression began in 1929, and there were several reasons
behind its occurrence.
First of all, although the U.S enjoyed a great growth in industries, the agriculture
had to face recession. It was true that the farmers were able to harvest more crops than
ever due to newly invented technologies. However, the new technologies increased the
harvest too much. In other words, the supply became so high, while the demand
remained quite same over the twenties. The overproduction did not happen only in
agriculture section, but also. in other industries, such as automobile (economics help).
Moreover, although the U.S was enjoying an economic boom on a superficial level,
it was a totally different story deep inside. First, there was a huge discrepancy in wealth
distribution; the majority of the people of the time were not earning as much money as it
seemed. Second, the banking system of the time was very weak; there were more than
30,000 small-medium sized banks during the nineteen twenties, which meant that the
banks were vulnerable to what happened in the market (economics help).
Furthermore, the people of the time were not investing in the stock market, but
they were only speculating. People became irrational when it came to the stock market.
As soon as they heard discouraging news from a company, they hastily sold their stocks,
causing the bust. In fact, the Dow Jones Industrial Average Index dropped from 381.170
to 41.220 over three years, showing how severe the situation was (StockCharts).
According to Ben Bernanke, the current Chairman of the Federal Reserve (FED),
the FED was most responsible for not stopping the Great Depression. He claims that in
1929, when all the people rushed to exchange the dollar for gold, rather than supplying
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the market with more dollars, the FED kept the interest rate very high to keep the dollar
value constant. Moreover, the FED did not help the small banks from going bankrupt,
but rather stood by, further worsening the situation (AmadeoKimberly).
Once again, the economic bubble before the Great Depression shows that people
became so money seeking in the market that they expected to earn an unrealistic profit
through speculation. People thought they could make a fortune by sitting at home and
speculating in businesses that seemed to prosper forever. Instead of earning money
through legetimate manner, people speculated on the market. It also shows that
government’s inability of regulating people’s greed could cost a country a severe
economic depression.
The rest of the world was also not free from the effect of the Great Depression. As
America became an internationally influential nation, most countries that had economic
relationships with the U.S also suffered from the depression. The amount of international
trade dropped greatly as each country executed protected trading; most countries
imposed high tariffs on imported goods. For example, the Smoot-Hawley Act of June 1930
increased the tariff rate so much that it dropped the amount of imports from Europe to
the U.S from $1,334 million in 1929 to just $390 million in 1932. Exports from the U.S to
Europe also fell hugely, dropping from $2,341 million in 1929 to $784 million in 1932
(U.S Department of State).
The U.S government, under Hoover Administration, did not do much when the
Great Depression broke out. President Hoover maintained a laissez-faire approach as
most contemporary economists did; they all thought that the government should be less
involved in the market and should not intervene with prices at all.
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As the Great Depression hit all over the world, each country reacted to it in
different manner. Most countries in Europe executed what is called a “block economy,”
where the mother country, or the colonizer, forms a block with its colonies by requiring
the colonies to trade only with the mother country. Another way that the countries
overcame the depression was by abandoning the gold standard. Every major currency
started to abandon the ‘gold standard’ during the Great Depression. For example, Great
Britain was one of the first to do so. As Great Britain faced a lack of gold reserves, the
Bank of England declared that they would give up the gold standard in 1914, and in
September 1931 it ceased exchanging pound notes for gold (Tae Geon).
According to a lecture by H. Parker Willis, the first Secretary of the Federal
Reserve Board, the abandoning gold standard shows that the earlier a country stopped
using the gold standard, the faster it recovered from the economic depression. For
example, France, Poland, or Belgium kept using the gold standard until 1935, and later it
shows that those nations had a longer and harder time recovering from the depression
(Willis).
Some nations suffered an economic crisis even before the Wall Street Crash of
1929. For example, in Germany, after World War I, the Weimar Republic took control of
Germany. It had economic troubles from the very origin that it had debts to pay, which
was about £6.6 Billion. In order to pay it, the Weimar Republic pressed more Marcs,
which brought about hyperinflation. Adding insult to injury, as Wall Street encountered
Black Thursday in 1929, the U.S lowered its demand for German products. Also, the U.S
banks started to call in their loans to Germany, which only worsened the situation
(Bloy).
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As there seemed to be no hope for Germany to recover, Adolf Hitler stepped in
and took control over Germany in 1933. He believed that munitions industry was the
only way that Germany could overcome the depression, and expanded military
businesses. Hitler expanded the weapon manufacturing industry, through which
Germany “successfully” surmounted the depression.
There is another case in which a country overcame the depression through
militarism and expansionism: Japan. Heavily dependent on exportation, Japan, located
far from both the U.S and Europe, also was affected by the Great Depression. Its luxury
industries, such as silk production, were heavily impacted. Japan overcame the
depression through expansionism; Japan invaded the east part of China and founded a
puppet government called Manchuria, which it used as its own market (Adas).
It should be clear, however, that both what Hitler and Japan did cannot be
justifiable because they both commited unrevocable sins in the process of recorvery. Of
course, their expansionism and totalitarian approach helped their economies to boom in
the short term. However, both countries should not be proud of the wealth they
accumulated through such vices as ignoring human rights or killing millions of innocent
people. Moreover, in the long term, their decisions did not help their economies; as
defeated nations, Japan and Germany lost the sovereignty after the war ended; the U.S
carried out most of important operations in Japan; the U.S, France, the U.K, and the
Soviet Union divided Germany into four parts. After two atomic bombs dropped at
Nagasaki and Hiroshima, Japan lost most of its industrial district. It was only after the
Korean war that Japanese economy started to flourish, because the U.S used Japan as the
base camp for the war (Japan guide).
In contrast to what Japan and Germany did, Franklin Deleno Roosevelt (FDR) led
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the U.S in an effective way to overcome the depression; he did not try to break a war out
or expand military businesses. Rather, FDR tried the Keynesian approach, that the
government should invlove in the market more to create workplaces for the people.
This is when he came up with the famous plan to create “The New Deal.” The New Deal
was an unconventional governmental program that FDR tried in order to save the U.S
from the depression by making demand higher through deficit spending. Government
borrowed money to provide its citizens with jobs, thus encouraging consumers’
confidence.
The New Deal had two parts: the First New Deal and the Second New Deal. The
First New Deal was aimed for short term recovery, while the Second New Deal was
mainly huge programs run by the government that aimed for long term benetifts. An
example of the First New Deal was when FDR asked the congress to pass the
Agricultural Adjustment Act in 1933, in order to reduce agricultural production. The
pinnacle of the First New Deal was the Tennessee Vally Authority, where the
government created millions of jobs for people to build a dam that would run through
seven Southern states for 9 million citizens. The Tennessee Vally Authority was what
FDR wanted the Second New Deal to be (HIST).
During the executing of the Second New Deal, FDR wanted the federal
government to be more involved with the market. Therefore, he created several
organizations to run what he planned for. For example, in 1935, FDR founded Works
Progress Administration (WPA), the most ambitious New Deal agency, to create more
than 8 million jobs for Americans. Moreover, he founded Civilian Conservation Corps for
the people to work in national parks, also to create work places. The congress also
passed Wagner Act in 1935 to secure the workers from gathering for unions. FDR did all
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these in order to increase the consuming power of the people so that people could buy
more goods. FDR believed that by putting more money into the pockets of the people,
the demand would rise, which would revitalize the market (HIST).
It was the Second World War that truly ended the Great Depression. WWII
worked as a bigger scaled version of what FDR planned, as it created jobs for millions of
people and revitalized the market. FDR’s trials during the Great Depression have had an
ever-lasting impact on the U.S in that it truly changed the perspective of the economists
toward the role of government.
One can learn a valuable lesson from Japan and Germany, the deafeated nations
in World War II. Both countries started the war because they wanted to increase their
power and size; Germany believed that it could conquer Western Europe, while Japan
thought it could take take over Asia. As the U.S speculated on the stock market, Germany
and Japan speculated on military businesses and militarism.
As the Second World War ended with the U.S as the victor, the U.S became the
superpower of the world. During the post-war time, the U.S. began to recover its economy.
For instance, in the 1940s, Dow Jones Average saw an increase from 148 to 206. Several
wars after WWII, such as Korean War, showed that the U.S now was the world’s leader
both in terms of military and economy; the Dow Jones saw a 200% increase in the
average from a level of 206 to 616 in the 1950s (Geisst).
However, a serious economic crisis arose in the 1970s: the Oil Shock. In 1973,
during the Yom Kippur War, the U.S and Western Europe sided with Israel, supporting it
with modern weaponry. As a punishment to the U.S, OPEC lifted an embargo against it,
which made the oil price quadruple, thus acquiring the name the First Oil Shock. The
second Oil Shock came in 1979, when the Iranian people led by Khomeini, overthrew
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the Pahlevi Dynasty, a Pro-American government. The new government increased the
oil price by 180% during this time; it increased from $13.66 per barrel in 1978 up to
over $38.28 in 1981 (Kim). America was only able to overcome the crisis as the oil
prices went down as time went by. The chart belows shows that the price settled as
time went by.
(EIA)
.
Interconnected with the Vietnam War, the U.S went through stagflation in the early
1970s, meaning that the prices went higher although the economy was in recession
(Recession org).
On the contrary, Korea approached in a different way to the oil crisis. Unlike the
U.S, the Korean economy was barely harmed; in fact, it enjoyed the biggest economic
boom in the early 1970s. As the Korean industry was focused on light industry, which
rarely uses oil as the main source of energy, the skyrocketing oil price did not concern
the Korean economy at all. During the 1970s, the Korean construction businesses
advanced to the Middle East, and brought in huge amount of foreign currency. However,
Korea experienced economic devastation during the Second Oil Shock, as the Korean
industry shifted to heavy industry between the First Oil Shock and the Second Oil Shock.
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OPEC and Iran should not be the only entity getting all the blame for the oil
shock of 1970’s. The oil shock can be seen as the result of selfishness on the part of both
the U.S and OPEC. For example, one of the reasons that OPEC decided to augment the oil
price was that the U.S acknowledged and took Israel’s side. The U.S helped Israel in the
Yom Kippur war because the U.S. has a deep historical commitment to Israel. This was
why the U.S supported Israel with modern weapons, leading Israel to victory over
numerous Arab nations. To take a revenge on the U.S, who helped its enemy, OPEC
raised the oil price, imposing embargo against the U.S. Therefore, OPEC cannot be the
only side that should get all the blame for such a sudden raise in the price. What one can
learn from the oil crisis of 1970’s is that the government’s policies can be influential in
the market, not whether the U.S made the right decision. From a political perspective, it
is definitely justifiable for the U.S to side with Israel for its loyalty to its ally; for Jewish
Americans, it was the primary issue. However, from an economic perspective, the U.S
made a bad decision, because it cost the huge amount of money.
The valuable lesson from both oil crises is that both oil crises happened due to
the U.S’s belief that it should have a strong influence in the Middle Eastern area. In the
First Oil Crisis, the U.S supported Israel because Israel was the base for the U.S to
intervene in the Middle Eastern politics. The Second Oil Crisis happened because the U.S
supported the Pahlevi Dynasty that suppressed Iranians and ignored their human
rights; the U.S. took an overly aggressive role in the Middle East politics; the U.S
government’s aggressiveness in the area triggered Oil Shock of 1970’s. One can also
notice that the Korean Republic also became aggressive before the Second Oil Crisis that
it shifted its industry to heavy industry, because it believed that heavy industry would
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bring more money to the country; the Korean government passed laws that were
favorable for heavy industries.
When it comes to more recent issues, it is easier to see how easily people
become overestimating their expectations and how government influences people to be
so. There are three recent cases where the economy of a country changed greatly due to
government policies that enabled people’s unrealistic expectations. For example, in 2008,
there was a huge real-estate bubble that influenced the U.S. market. In 2008, Lehman
Brothers filed for Chapter 11 bankruptcy for the economic effect of sub-prime mortgage
crisis. The bankruptcy happened mainly due to the government’s inability to control the
market; it let the real-estate bubble grow too much. This housing bubble resulted in
numerous homeowners refinancing their homes at lower interest rate, which triggered
consumer confidence. As the demand for houses increased, so did the price of the houses,
and this led to a boom in construction business (Bear).
However, as the economy started to boom, there was speculation in the housing
market. In the U.S, there are four classes of credit score, and depending on the credit
score the interest rate is determined. From 720 and up are called “excellent credit”;
681-720 is “good credit”; 621-680 is “fair credit”; below 620 is “poor credit” (Curry).
The so-called subprime mortgage is the mortgage for those with “poor credit”,
who wanted to buy houses without money, because it seemed a promising business. The
problem was that the banks loaned money too easily with low interest; poor creditors
started to over-speculate on housing market, which caused bubbles to form; the
practice of predatory lending was widespread during the time. Banks loaned money to
poor creditors because back in the mid 2000s, the housing price increased everyday;
bankers thought they could collect their money back easily by sequestering the house in
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the worst cases. As even those with bad credits emerged as a consumption force, the
demand for real estate went up radically, which caused the mortgage market to be
overheated; both good creditors and poor creditors wanted houses, raising the housing
costs radically.
The panic was severe in the U.S because the government allowed the bubble to
grow too much. There is a contrasting example in Korea that shows how government
intervention in the market can regulate people’s overestimation in their expectations.
Unlike what most people think, the Korean economy was not heavily influenced by the
mortgage problem in the U.S. Of course, the economic crisis influenced the Korean
market too, but it was only because the U.S market shrank, not because Korea went
through similar real estate speculation, because of a different banking system.
In the U.S, the loan to value reached up to 94% before 2008, meaning that a
person could borrow 94 dollars from the bank if he had a hundred dollars’ worth of real
estate. Moreover, in the U.S, although one did not pay back the money he borrowed, it
did not affect his credit rating after seven years. On the other hand, in Korea, the loan to
value was at most 48%. Moreover, whether one is behind in his auto loan payment is
very important in Korea that unless he pays all his debt, he could not borrow any money
from the bank. This system worked so well that the mortgage crisis did not affect the
Korean market much (Bear). In other words, the Korean government was more awaken
to real-estate problem and regulated more than the U.S government did. As the result
showed, the regulation by government helped Koreans be less greedy in real-estate
bubble than Americans were.
However, the Korean economy has its own problem, as Korea heavily depands
on exportation. In fact, a few percentage less than 40% of the total GDP relies on export,
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and among G-15, only China(38%) and Germany (41%) have higher percentages than
Korea. According to Babybear, the CFO of Joinsland Press, Korea should be more
Keynesian that the government should increase its deficit spending to revitalize the
market through higher demand (Bear). The 2008 economic crisis displays how
important a government’s reaction to the market is; if the U.S. Federal Reserve Bank had
set its loan to value lower and regulated people’s greed on real-estate, America could
have experienced less severe crisis.
Economic crises in 2008~2009 in the U.S influenced the economies of other
continents, such as Europe or Asia. Among the European countries, Greece experienced
the biggest depression in 2010. In 2010, it was reported that Greece has debt of 120
billion Euro, the highest among the E.U. nations (RobertsDan). In order to rescue its
member, E.U. asked several other members, such as Germany, while according to
Wearden Graeme, the Germans gave hostile reaction, thinking “the Greeks have far too
comfy a life and don't feel they deserve rescuing” (WeardenGraeme).
Angela Markel, the prime minister of Germany, although agreed to rescue
Greece from the financial crisis, wanted to enforce a new strong rule for the E.U.,
worrying that the financial crisis in Greece could bring about domino effect in Europe.
The president of European Central Bank Jean-Claude Triche claims that Greece has been
faking its deficit spending to the E.U., and Greece should cut its deficit spending as the
crisis happened due to excessive spending. He also mentioned that the European
Central Bank would only loan money if Greece raised its tax rate, reformed its pension,
and froze wages in public sector, which were all accomplished. (ElliotLarry).
The main reason that Greece was vulnerable to the world wide crisis is that
Greece based its economy on tourism and shipping industry (BECATOROSELENA).
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However, consumer confidence shrank due to the international economic crisis, which
severely hit the Greek tour industry. In other words, Greece could not get through the
financial crisis because of its concentrated industry on tourism. Again, if the
government set various programs and plans to encourage other industries instead of
tourism, Greece could have avoided the crisis. Moreover, as German reaction shows,
Greek had been spending too much money as private as for the purpose of leisure and
as public as for the purpose of pension; reckless spending dragged the Greek economy,
and the Greek government could have run campaigns for cutting the excessive spending
trend.
In Korea, a similar situation happened in 1997; The Internation Monetary
Fund(IMF) declared that Korea possessed too little foreign curreny due to reckless
spending by the people just like Greece, and it needed help from the IMF. Korea was
able to overcome the IMF only after a national campaign of gathering gold; Koreans
donated their gold and gathered 300kilograms of gold in total (BBC News). Although the
amount of gold gathered was imperceptible, it still showed that both the government
and the people were willing to surmount the hardship. Moreover, it showed that
Koreans gave their personal greed up for the economic revival. Koreans were able to
have such a national movement because the Korean government encouraged people
through different campaigns. The Greek government can learn from the Korean IMF
case to overcome its financial crisis.
Various examples throughout the history show that it often happened that
government was unable to stop the unrealistic expectations of people; from as far back as
the panic of 1907 to as recent as 2010 Greek financial crisis. It happens all the time that
people think the bubble would last forever and they can make money out of the market
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whenever they want to; sometimes government policies help people think so. However,
people should keep in their minds that the bubble can bust sometimes and try not to set
an unrealitic expectation in making money. In order to do so, government’s policies are
important too, for they can both allow and prevent people from setting an unreachable
goal.
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