Saturday, December 6, 2008

Anything sound familiar?

from The Mystery of Banking by Murray Rothbard:

After the Fed inflation led to the boom of the 1920’s and the bust of 1929, well-founded public distrust o fall the banks, including the Fed, led to widespread demands for redemptions of bank deposits in cash, and even of Federal reserve notes in gold. The Fed tried frantically to inflate after the 1929 crash, including massive open market purchases and heavy loans to banks. These attempts succeeded in driving interest rates down, but they foundered on the rock of massive distrust of banks. Furthermore, bank fears of runs as well as bankruptcies by their borrowers led them to pile up excess reserves in a manner not seen before or since the 1930s…

Before 1929, every administration had allowed the recession process to do its constructive and corrective work as quickly as possible, so that recovery generally arrived in a year or less. But now, Hoover and Roosevelt intervened heavily: to force businesses to keep up wage rates; to lend enormous amounts of federal money to try and keep unsound businesses afloat; to provided unemployment relief; to expand public works; to inflate money and credit; to support farm prices; and to engage in federal deficits. The massive government intervention prolonged the recession indefinitely, changing what would have been a short, swift recession into a chronic debilitating depression. (pg 247-248)

The analogy is not perfect. We are no longer on a gold standard. Federal guarantee of bank deposits has served to stave off bank runs (although protection from bank runs has allowed the proliferation of unsound banking practices which are a major part of the problem.) The specific triggers are different. As a whole, our country is richer with fewer people living at the margin so that it is primarily our wealth and savings at risk, not our survival. Still, it is worth the time to study that era closely, from many angles and many points of view, to help us learn from experience as best as we are able, and hopefully not unnecessarily repeat the painful errors of the past.


Burgess Laughlin said...

> "As a whole, our country is richer with fewer people living at the margin so that it is primarily our wealth and savings at risk, not our survival."

Could you elaborate a little on this last point?

For example, are you thinking that (1) famine was a possibility in the 1930s; and (2) now we have so much accumulated wealth (for most individuals and for "society as a whole") that we could live off of it for a long time before famine appeared?

Anonymous said...

This is a great post. It is related to some statements I posted last month about the psychology of the markets. The distrust is present, albeit in a different guise, this time around. We need to get the psychology changed so consumers and businesses are spending again. How to do this?

Some other considerations compared to the 1920s are the lack of domestic manufacturing and the increased proportion of imports relative to GDP. The connection between our economy and the rest of the world is also a consideration which makes it important that we be very careful about what we do or don't do to get our economy moving again. Another point to keep in mind is that free market innovations in the credit arena that didn't exist in the 1920s have created a system that can spin out of control pretty easily (e.g. credit default swaps, options, etc.) and as we have seen a problem in the US can quickly become a problem worldwide, the extent of which is almost impossible to estimate.

We can apply what we learned from the Great Depression, but we need to keep in mind that the dynamics and connections are much different.

Anonymous said...

Re: Burgess's request

His interpretation is a little different from mine...I hadn't considered it.

Did you mean that the margins we have now are far enough above mere subsistence that during an downturn the survival of those on the margins is not at stake?

I think a long and deep enough famine (or depression) could push those at the margins below subsistence, but it would probably take longer today than previously.

Anonymous said...

"We need to get the psychology changed so consumers and businesses are spending again. How to do this?"

I understand from a lot of people's opinions that the tried and failed Keynesian approach is the approach de jure; however, consumer spending doesn't spur capital accumulation (i.e. long-term growth). If all it took to achieve never ending economic growth was for consumers and businesses to spend than it would appear that we wouldn't have business cycles (necessary corrections for malinvestments). Economic growth requires investments and the production of capital goods, thus we can't spend our way out of economic downturns. The Fed's manipulation of interest rates is an additional distortion. I have post a blog discussing a tenet of this belief -

Anonymous said...

Rothbard makes the Austrian business cycle case for the Great Depression but the monetarists, led by Friedman, provide an alternate explanation which is quite different. Mark Skousen contrasts the two briefly in this article:

I think the monetarists have a pretty good case for the Fed tightening credit when they should have loosening it. And I also think the Austrians make a pretty good case for an asset bubble :-)

- cfc

Burgess Laughlin said...

> ". . . the tried and failed Keynesian approach is the approach de jure . . . ."

I am only a layman, but my understanding is that the Keynesian approach is both du jour and de jure.

HaynesBE said...

Thanks to all for your comments. I found this batch particularly helpful and interesting.

Thanks for the question. It helped me step back and think a bit more. I was not thinking of famine for then or now. Clearly there was not famine in the 1930’s in the U.S., but I do think there was significant hunger and homelessness which accompanied the prolonged unemployment. I was writing with images of soup kitchens, breadlines, and hobo camps and Hoovervilles in mind. I guess I really don’t have the quantitative information on just how wide spread that level of poverty was back then, and what was the general level of savings which existed prior to the crash and subsequent depression. It would be interesting to compare that data with what the typical level of savings is today. People clearly have more stuff today than back then, but whether or not it is in a form that will give them a safety cushion to prevent hunger and homelessness, I don’t know. It would be interesting to find out.

I would agree with anonymous that a long and deep enough depression would push those at the margins below subsistence. I also think it would probably take longer today to get to that point, but I am realizing how little actual data I have upon which to draw that conclusion.

I don’t think it is just “psychology” that is the problem. People have lost faith in the banks and the stock market, but I see that as an appropriate and healthy development of mistrust in a currently flawed and out-of-balance system, in part because of what you refer to as “free market innovations” which allowed highly leveraged gambling look like investing. Since I don’t think we have a “free market” I don’t see them as “free market innovations.” What we have is an economy with a mixture of free market forces, heavily hampered by government intervention and controls. An important part of the task is to figure out what part of that mixture best explains the distorted signals which led to financial misjudgments. Even if you want to condemn it all as greed, something created the impression that those innovations and gambles were a good idea. Nobody wants to loose money.

Rothbard makes the case that government expansion of the money supply led to market distortions and malinvestments which needed a correction to get back to a more realistic and healthy state. He explains how the lack of free banking in conjunction with legal tender laws removes market discipline and allows poor banking and business practices to continue to the point of crisis, instead of being properly checked at an earlier and less destructive stage of development. I think these same factors are still relevant today.

Can you elaborate on what you difference see the “lack of domestic manufacturing” makes? Also, “the connection between our economy and the rest of the world” was certainly present in the 20s and 30s. The U.S. exported its depression by shutting down world trade with protectionist acts like Smoot–Hawley.

Thanks for the article link. Turns out Skousen has a series of helpful articles comparing the Austrians to the monetarists. ( , , , , )
What I found most interesting is the explicit distain of Mises, Hayek and Rothbard for statistical analysis and evidence, preferring to rely instead on pure theory. This is a definite weakness in their approach. I will have more to say on this in a future post (providing I can squeeze out the time!) Glad to see you are still lurking, and I greatly appreciate your input.

Anonymous said...

Burgess, watch yourself! De jure seems to be a matter of contention in some quarters.

Beth, the psychology to which I was referring is the apprehension of consumers and businesses to spend. Just a moment ago I heard on the radio news that 67% of consumers will spend less on holiday expenditures. I don't think those people are thinking in terms of not trusting banks or the stock market. They are thinking in terms of the possibility of losing their jobs. No question they are scared about the stock market, but losing faith is a different story. In fact, while mutual funds have seen accelerating redemptions (which accelerates the fall of the markets), I haven't heard of any aggregate reduction in bank deposits or reduction in acceptance of drafts. These developments would indicate a loss of faith in the banks. On the other hand, banks have held onto the bailout money distributed by Paulson because they have lost faith in the economy.

I don't know what the numbers are, but I believe we manufactured a larger percentage of our consumption in the 1920/1930 period. So, when the economy picked up jobs were created here, not in China. This leads to my next point: given the amount of outsourcing, which, as I understand it is unprecedented, we are more interconnected throughout the world than we were in 1930. You seem to make a good argument to the contrary, though. (I need to add a book on the Great Depression to my reading list.)

The point of my reference to "free market innovations" was that in contrast to equities, plain vanilla bonds, mutual funds, and other strictly regulated securities, credit default swaps are currently not regulated. The markets for them are therefore freer than for other securities. Additionally, I think the complexity of collateralized debt obligations, such as mortgage backed obligations, receivables securitizations facilitates wiggle room on whatever regulations there are, allowing more freedom (some of this freedom was illegal promotion and sleight of hand accomplished by using credit default swaps to insure the securities, so they would be rated investment grade). Also, I believe that restrictions on financial institution leverage and elimination of some regulations (Glass/Steagal) allowed banks and insurance companies to engage in higher risk activities formerly the domain of investment banks. So, comparatively speaking, the financial markets were freer immediately prior to the sub prime melt down than they were a decade or so before that. I interpret the whole of this to indicate that it was the "freer" market innovations that caused the problem and proper regulation may have eliminated or attenuated the problem. (Of course, the problem with regulations is they are usually a step or two behind the harmful innovations.)

Regarding your comment that nobody wants to lose money, I agree. And the people creating the complex derivatives and selling them walked away with millions (billions?) even after the losses incurred when the whole thing imploded.

I'll add Rothbard to my reading list. You may have a point, but something about blaming unhealthy banking practices on regulation and legal tender laws doesn't sound right. The question I would ask is 'would removal of regulations make engaging in currently illegal activities less likely?'

Finally, the 'stuff' we have I don't think is in a form that will stave off starvation. Savings will do that, and as I understand it, we are not doing too well at that, given our recent penchant for using houses as ATMs, to pay off credit card bills which we then run back up to the limit.

At this point my economic head is spinning. What with Laffer's new book touting the great expansion that was a result of Kennedy lowering the marginal tax rate to 70%, then complaining because the current 35% is too high; the Austrians; the monetarists; you all beating up on Keynes. I'm going to go read. If curiosity doesn't get the best of me, I'll see you next year refreshed, further informed and ready to debate again. Have a happy Holiday Season!

HaynesBE said...


RE: mistrusting banks vs. fear of loosing jobs and lost confidence in the economy.

I think you hit on the more pertinent reasons here. Thanks.

Just reading about this in Rothbard's America's Great Depression pg 21-25. From his point of view, a depression begins when the money supply stops being artificially increased. Malinvestment prompted by the inflationary "boom" phase leads to business failure and liquidation when inflation ends. Deflation doesn't have to occur, but generally does as people fear loss of employment, wait to purchase while expecting prices to fall, and banks hold on to money allowing the liquidation dust to settle before bothering to risk investing or loaning again. He sees the business readjustments and the "hoarding" as part of the needed recovery process. Prices and investments must adjust back to their "natural" level before sustainable progress can occur.

RE: the form of our stuff.

You may be right on this. I need more information on now and then for a real comparison. Clearly, we are living on debt---which is not a good thing.

Let me know what you find of interest in Laffer's book. I have looked at it with longing, but it just isn't high enough on my priority list right now. I have added J.K.Galbraith's book on the depression for a Keynesian take. Any other tips on books with a straight forward explanation or defense of Keynes would be appreciated.

I made it half way through Klein's book and am glad I read that far. She seems to have correctly identified Pinocet's economic strategy as corporatism, but then she equates that with laissez-faire capitalism and attempts to dispense with both of them with a single blow. I see more similarities between socialism and corporatism than between corporatism and capitalism. The book, however, is an excellent case for not letting the ends justify the means.

Have a great holiday. I look forward to you coming back and adding your perspective to the discussion.