Posts Tagged ‘Great Depression’
Central banks killing capitalism

The central banks are distorting markets and maintaining artificially high asset prices. Apparently this is for our own good. Heaven forbid the prudent amongst us should purchase assets from the imprudent at prices which enable us to service any loans required for the purchase, while making a profit:

Dear EBA, the central banks and emerging markets have got this: The extension of central bank liquidity eased the pace of asset-shedding observed in late 2011, but did not turn the underlying trend. If the banks in the EBA sample, for instance, failed to roll over their senior unsecured debt maturing over a two-year horizon, which amounts to more than €1,100 billion (€600 billion among banks with a capital shortfall), they would have to shed funded assets in equal measure. By covering these funding needs, the LTROs and dollar swap lines helped avert an accelerated deleveraging process. But many banks continued to divest assets in anticipation of the eventual expiration of these facilities. Banks are also mindful that a sustained increase in their capitalisation would facilitate both regulatory compliance and future access to the senior unsecured debt market. The BIS paper available here.

Any surprise the banks are not lending money? There is a shortage of demand from those they believe will be able to repay it. The shortage will remain until such time as asset prices fall to a level reflective of their value or their profit generating capacity rises to better reflect their price. Central bank and other government measures stopping defaults and declining asset values are stopping this from happening.

The economics literature is stuffed full of material on the detrimental effects of sticky prices. For example, how inflexible labour markets slow an economy and increase unemployment. Exactly the same phenomena is observed with sticky inflexible asset prices. They slow an economy and result in unemployed assets and hence labour. It beggars belief that a bunch of central bankers so in thrall to the nostrums of mainstream economics are not across this possibility. At least it would be if we did not have documented evidence of how out of touch they are.

Timing can make all the difference in life. Maintaining real wages with job security can initially seem to mitigate any downturn. Those employed continue to earn a good income, they maintain demand and asset prices. Over time the rigid economy develops an insider/outsider phenomena and may come to resemble the British economy prior to Thatcher.  It becomes sclerotic and does not engender much growth or increase in living standards.The rigidities and distortions caused by government interventions “for the good of the people” cause ever more crises.  The government in turn intervenes to mitigate these effects – a nationalization here, a price control there, a regulatory barrier somewhere else. Before you know it there are zombies everywhere. High unemployment and low or negative income growth are the norm.

Meanwhile the economy with a more flexible labour market may initially plunge faster and further. But eventually assets become bargains, then they become better than bargains. They get snapped up and put to work, growing the economy and wages from a firm less leveraged foundation. Before too long the country with the more flexible economy is outperforming the one rife with sticky prices and government interventions. People are employed and their real incomes rising.

The problems in the economy subject to central bank and other government initiatives to induce price rigidity are inevitable. Also inevitable is the pain and suffering inflicted on many of the least able in society as described here. While penalizing many of those in most need, central bank measures also penalizes those holding the cultural values most amenable to wealth generating capitalism. The bourgeois middle class. If ever there were grounds for abolishing the Fed and other central banks, it is their susceptibility to these sorts of policies. If they keep it up much longer, it may not just be their jobs at stake.

Why the Left lie

The left love to quote President Hoover’s Treasury Secretary, Andrew Mellon, as evidence of Hoover lack of government action during the depression. They then cite Hoover’s failure to prevent the depression as evidence of how misguided Mellon’s approach was. For example:

Hayek’s fellow countryman, Joseph Schumpeter, went further: “Gentlemen!” he announced to his students at Harvard University (there were no ladies). “A depression is healthy! Like a good ice-cold douche!” If depressions did not exist, Schumpeter thought, we would have to invent them. They were “the respiration of the economic mechanism.”

Agreeing with Schumpeter was Herbert Hoover’s Treasury secretary, Andrew Mellon. In his memoirs Hoover was bitter toward many, but bitterest of all toward Mellon, whom he called the head of the “leave it alone liquidationists.” Hoover quotes Mellon: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.” Hoover opposed Mellon’s policies, he said, and worked to undermine them. But what could he do? He was, after all, only the president. And Mellon was Treasury secretary.

The massive interventions by Hoover are part of the historical record. As he says himself:

“These programs unparalleled in the history of depression in any country and in any time, to care for distress, to provide employment, to aid agriculture, to maintain financial stability…..

There are page, after page of interventions detailed in The Memoirs of Herbert Hoover Volume: Vol. Three: The Great Depression 1929-1941:

I believe these extracts from Wikipedia are uncontroversial:

“Roosevelt campaigned on the Democratic platform advocating “immediate and drastic reductions of all public expenditures,” “abolishing useless commissions and offices, consolidating departments and bureaus, and eliminating extravagances” and for a “sound currency to be maintained at all hazards.”

Roosevelt campaigned and won on those grounds because of the extent of Hoover’s economic activism.

Roosevelt certainly helped things go down hill:

“After the election, Roosevelt refused Hoover’s requests for a meeting to come up with a joint program to stop the downward spiral and calm investors, claiming it would tie his hands. The economy spiraled

Roosevelt’s programs probably stopped the economy recovering. His policies were responsible for the duration and depth of the depression. Sadly similarly misguided efforts are looking likely to cause the Greatest Depression.

Bradford DeLong’s and the Left’s attempts to tar Hoover with the Mellon brush and thereby discredit Mellon’s policies is deceptive at best. A dishonest lie may be nearer the mark. Does this, sourced from Hoover’s Memoirs sound bitter? Does this sound like a man claiming he was thwarted by Mellon?

Two schools of thought quickly developed within our administration discussions.

First was the “leave it alone liquidationists” headed by Secretary of the Treasury Mellon, who felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula:

“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” He insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. He held that even a panic was not altogether a bad thing. He said: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.” He often used the expression, “There is a mighty lot of real estate lying around the United States which does not know who owns it,” referring to excessive mortgages.

At great length, Mr. Mellon recounted to me his recollection of the great depression of the seventies which followed the Civil War. (He started in his father’s bank a few years after that time.) He told of the tens of thousands of farms that had been foreclosed; of railroads that had almost wholly gone into the hands of receivers; of the few banks that had come through unscathed; of many men who were jobless and mobs that roamed the streets. He told me that his father had gone to England during that time and had cut short his visit when he received word that the orders for steel were pouring toward the closed furnaces; by the time he got back, confidence was growing on every hand; suddenly the panic had ended, and in twelve months the whole system was again working at full speed.

I, of course, reminded the Secretary that back in the seventies an untold amount of suffering did take place which might have been prevented; that our economy had been far simpler sixty years ago, when we were 75 per cent an agricultural people contrasted with 30 per cent now; that unemployment during the earlier crisis had been mitigated by the return of large numbers of the unemployed to relatives on the farms; and that farm economy itself had been largely self-contained. But he shook his head with the observation that human nature had not changed in sixty years.

Secretary Mellon was not hard-hearted. In fact he was generous and sympathetic with all suffering. He felt there would be less suffering if his course were pursued. The real trouble with him was that he insisted that this was just an ordinary boom-slump and would not take the European situation seriously. And he, like the rest of us, underestimated the weakness in our banking system.

But other members of the Administration, also having economic responsibilities—Under Secretary of the Treasury Mills, Governor Young of the Reserve Board, Secretary of Commerce  Lamont and Secretary of Agriculture Hyde—believed with me that we should use the powers of government to cushion the situation. To our minds, the prime needs were to prevent bank panics such as had marked the earlier slumps, to mitigate the privation among the unemployed and the farmers which would certainly ensue. Panic had always left a trail of unnecessary bankruptcies which injured the productive forces of the country. But, even more important, the damage from a panic would include huge losses by innocent people, in their honestly invested savings, their businesses, their homes, and their farms.

The record will show that we went into action within ten days and were steadily organizing each week and month thereafter to meet the changing tides — mostly for the worse. In this earlier stage we determined that the Federal government should use all of its powers:

What is it with the truth and the left? Yes I know they don’t necessarily believe there is such a thing as Truth. But even so, surely something else explains their ready resort to lies and deceit. They can’t all be looking for a job with an investment bank, or some fat consultancy or speaker fees.

Could it be cognitive capture? They can’t help but see the world through their pseudo-socialist prism. A horrid mish-mash of politically correct hogwash corrupts their view of reality. If so, then were they not so damaging they would warrant our pity.

Or perhaps it is simply their view that the end justifies the means. Neither people nor facts can be allowed to stand in the way of progress. Their ideology approved the killing of millions of, Kulaks, Cambodians, men, women and children. Why would those in its modern incarnation let the facts and truth stop them?

They just know we need more government. Any lie or act of deception that furthers that aim is not just acceptable, but good. It’s enough to make you sick. Literally sick, there is ample evidence that being poor and unemployed decreases your life expectancy. Nice. Yet more human misery to heap on the immense mountain of Left induced suffering.

By lying about the past the Left are distorting policy in the now and causing misery tomorrow. Do not underestimate the importance of the history wars.

History repeats

The Greater Depression

It has long been noted that there are patters or cycles to many aspects of our existence. In human affairs it has led to the saying that history repeats, or more accurately rhymes.  A glance at the Memoirs of Herbert Hoover seems to confirm this. Although for reasons that will become apparent, let’s hope the cadence breaks down.

The Great Moderation

Not for nothing did Reinhart Rogoff call their book This Time is Different. 1929 had its version of our Great Moderation.

“Impulses to progress were so very great that, with the growing optimism, they gave birth to a foolish idea called the “New Economic Era.” That notion spread over the whole country. We were assured that we were in a new period where the old laws of economics no longer applied.” Page 5

With us the old laws might have applied, but we have better ways of managing the economy and superior knowledge. Or so some thought and are trying to prove.

Credit expansion

The role of credit expansion in creating the misery to come can hardly be exaggerated. Hoover puts it succinctly:

“It was difficult for the public to believe that such griefs and tragedies lay hidden in so obscure a process as credit inflation when forced on an already optimistic people. It set the stage for wicked manipulations and promotions of stocks. Its collapse brought hunger and despair to millions of homes. It destroyed the savings of millions of families.  It also furnished ammunition to radicals for attacks on the whole American system. The exhibition of waste, fraud, and greed which flowed from this artificial credit inflation appears in their literature as a typical phenomenon of our free civilization; whereas it was the exception.

There are crimes far worse than murder for which men should be reviled and punished”. Page 14

A glance at the ratio of total public and private debt to GDP in the US shows there has been a considerable credit expansion. In effect we have been maintaining consumption by borrowing money, effectively bringing consumption forward. Once the ratio of debt stops increasing, there will be a decrease in demand and a recession. If government steps in to ensure debt keeps growing then it simply delays the inevitable realignment at the cost of making the adjustment worse.

While much of modern economics seems to strenuously avoid the implications of credit expansion, Herbert Hoover was in no doubt of its effects. He was also clear as to its causes:

“We were due for some economic readjustment as a result of the orgy of stock speculation in 1928-1929. This orgy was not a consequence of my administrative policies. In the main it was the result of the Federal Reserve Board’s pre-1928 enormous inflation of credit” Page vi.

While there can be self serving element to memoirs, with attempts to justify performance. There is ample evidence of just how serious a problem Hoover regarded the credit expansion to be. In 1926 he said:

“No one doubts the extreme importance of credit and currency movement in the “business cycle.” Disturbances from this quarter may at once interfere with the fundamental business of producing goods and distributing them. Many previous crises have arisen through the credit machinery and through no fault of either the producer or consumer. . . . That the Federal Reserve System should be so managed as to result in stimulation of speculation and overexpansion has received universal disapproval.

Behind these alarms was my knowledge that the Federal Reserve Board had deliberately created credit inflation …The Federal Reserve Board, during 1925, had undertaken credit expansion by open market operations and by lowering discount rates.” Pages 6 & 7

“The consequences of the Federal Reserve Board action were disastrous to our economy. It induced unwise investment in European loans and bank advances. Worse still, it stimulated speculation in common stocks on American exchanges by making large funds available to those who wanted to borrow on small margins.” Page 8

Further evidence of his views are provided in a letter dispatched on December 23, 1925:

“It does not appear to me that the speculative purchase of large amounts of securities upon credit can be otherwise than dangerous, because it absorbs the credit funds of the country; because of the tendency of speculative fevers to extend into the commodities; and also because it must result in a collapse which will carry losses into every part of the country. .  . This gigantic expansion of credit upon which it has been carried . . . lends gravity to the situation, for its inevitable collapse would be even more dangerous to commerce and industry by virtue of its widespread character. .”

On the Mississippi bubble of 1927-1929

One trouble with every inflationary creation of credit is that it acts like a delayed time bomb. There is an interval of indefinite and sometimes considerable length between the injection of the stimulant and the resulting speculation. Likewise, there is an interval of a similarly indefinite length of time between the injection of the remedial serum and the lowering of the speculative fever. Once the fever gets under way it generates its own toxics. This renewed action to inflate credit was begun by the Reserve Banks

The central role of credit expansion in 1929 and now seems to support the idea that history rhymes. Reinhart Rogoff’s book suggests the rhyme has been going on for eight centuries.

Obama, Gillard and Keynesians make things worse

While the phrase “never waste a crisis” was uttered in the US, it applies to Australia as well. The evil it encapsulates is clear in the following quote:

“I give more attention to the campaign of 1932 than might be otherwise desirable, because I then accurately forecast that attempts would be made to revolutionize the American way of life. The effort to crossbreed some features of Fascism and Socialism with our American free system speedily developed in the Roosevelt administration. The result was that America failed to keep pace with world recovery. Instead we continued with subnormal levels of lessened productivity, high unemployment, and costly relief measures until our man power and industries were absorbed by the war eight years later, in 1941.

That our administration policies were right is amply evidenced by the fact that after the world turned toward recovery in July, 1932, the twelve nations retaining their free economies, and pursuing our policies, fully recovered, within two or three years, to levels above the boom year of 1929.” Page vii

Dr Steve Kates gave an excellent paper on this very subject in the Productivity Commission in around 2008. His evidence was0 irrefutable, Keynesian policies extend rather than relieve downturns. The lost decades in Japan ought to be evidence enough. Although peoples cognitive failings mean that Keynesians will twist and distort reality to support their ideology rather than admit they are wrong.

The next section demonstrates why we must hope that there are limits to how closely we follow the past.

Revolution and War

Hoover clearly outlines the consequences of the economic adjustments associated with the last Great Depression:

“The immediate effect of Central Europe’s collapse was the terrible unsettlement of all economically sensitive nations everywhere. Among the dire consequences were Britain’s suspension of payments to foreigners, abandonment of the gold standard by scores of nations, trade wars, political revolutions in more than a dozen countries outside of Europe, and disaster for the American economy.

The eventual effect of this gigantic catastrophe was to kindle political and social revolutions in all the defeated nations of Central and Eastern Europe. Communism reached its dread hand into those areas, and Fascist dictators arose as the antidote. In the end, these forces were to plunge the world into a Second World War”. Page vi

With the number of countries likely to be adversely affected by the coming crisis, it is inevitable that some will follow the pattern of the 1930’s. If they include countries with a martial history and sufficient size, their neighbors could have problems. It is probably not the best time for the West to disarm, something their budget woes will almost certainly result in their doing. Politicians will disarm rather than dismantle the Welfare State.

Relevance of when Wall Street crashes

Prior to reading the memoirs I certainly thought the Great Depression started because of the Wall Street crash. Hoover makes a good case that this is not so:

“A study by the National Bureau of Economic Research states: “Several countries entered the phase of recession in 1927 and 1928, long before the date usually taken as marking the crisis in the United States, that of the Wall Street crash of October, 1929

The report enumerates Bolivia, Australia, Germany, Brazil, India, and Bulgaria as having entered the depression phase before the American stock market crash.” Pages 2 & 3

Hoover adds:

“Large areas of the world are not very sensitive to economic tides— such as China, Russia, Central Asia, and Central Africa. Eliminating these countries, the economic situation began to decline in more than four-fifths of the economically sensitive peoples of the world before it began in the United States.” (page 3)

When the history of what could prove to be the Greatest Depression is written, they may conclude that is started some time ago. We could be living through the economic equivalent of the English summer of 1939:

“When the sun shone down on a happy, careless people, who worked and played, reared their children and tended their gardens in that happy, easy-going England that was so soon to be fighting desperately for her way of life and for life itself” Mrs. Miniver (1942)