Question from a reader-"I'm confused about a question that rests at the heart of efforts to revive the economy. What ended the great depression? Was it the war, war spending, or some other mechanism? I think I've been taught, and I easily accepted that it was the war spending along with the 'full employment' of labor that cracked the downward spiral of the 1930's. I just can't imagine that all the wasted resources paid for with war debt during the war could have had less of an effect on the nation's economic future than the spending now necessary to create jobs, provide healthcare, and rebuild the infrastructure of the nation."
Answer---This is a controversial topic on which economists and investors disagree, and we'll probably never know the answer. Although the unemployment rate improved markedly from about 25% at the depths of the depression to about 11% by the late 1930s, the nation's economy was still depressed prior to the war. Some observers claim that the New Deal programs just did not spend enough while others feel that the government spending actually hampered the recovery.
In our opinion, it was the war spending that ended the depression, although it wasn't that simple, and it doesn't mean that we can necessarily spend ourselves out of the current crisis. Although some people erroneously concluded that the war itself was good for the economy, it was really the spending that did it rather than the war. Viewed simply, it seems that if a nation spends enough it can spend its way out of depression, and that the problem before the war was that the nation just did not spend enough. Carrying this thought further, you are probably correct to think that spending on items that can be used rather than destroyed is more helpful to the economy.
Having said that, the problem is not that simple. World War ll brought the nation back to full employment, but since so much of the wartime production was wasted there were not enough products and services on the market to meet the potential demand created by the newfound income resulting from the production of war goods. Therefore, to prevent soaring inflation the government resorted to rationing a wide array of key products and the sale of war bonds to siphon off income into savings and depress consumption. This resulted in a big buildup of savings that was available for consumer spending after the war. In addition the military force was expanded to about 11 million in a population far smaller than today's. And, of course, transferring 11 million people out of the labor force into the military was a huge factor in reaching full employment. Let's also not forget that there was a paucity of civilian big ticket items produced during the war, resulting in a big increase in replenishment demand in the post-war period.
Therefore conditions after the war were ideal for a resumption of prosperity---lots of consumer savings, little debt, loads of pent-up demand and millions of newly-released veterans who needed housing. In other words, there was an abundance of consumer liquidity that took many years to run down. Conditions are obviously a lot different today. While the economy is far less depressed than during the 1930's, consumers are still heavily in debt, savings are low, housing is in oversupply and foreigners own too much of our government debt. Overall, we have a lot of doubt as to whether, as a nation, we can spend ourselves out of the recession, although doing nothing would be disastrous as well. That's why we have been so bearish on stocks.