By Doug Gentry, on July 21st, 2011
The country pulled together to fight in WWII – stimulating economic growth
When we study the Great Depression, and the double dip recession of 1937-38, the class discussion inevitably ends up with the role that World War II played in bringing an end to a decade’s worth of poor economic performance. Which leads us to the question – is going to war good for economic growth, and if it is should we adopt war as an economic growth strategy?
The simple answer is, “no” - war just diverts a nation’s scarce resources from one activity to another. Even if some resources are idle, the gain is short-lived and a poor investment in long term growth. (Think of a tank burning in the Iraqi desert versus a fleet of trucks hauling freight for 20 years.) In the case of the Depression and World War II, the threat of Nazi Germany and, later, Japan, gave Congress and the President political cover to use deficit spending which in turn stimulated the economy. Ultimately, though, the country’s economic growth came from private investment and private demand after the war.
 No worries about the government borrowing money (through the sale of bonds) in the face of an enemy This brings us to the “Broken Window Fallacy”. With a hat tip to econ major Ryan Chaddock, there’s a nice summary of this parable here. The fallacy poses a similar question – should we go around breaking windows in order to generate more work for glaziers?
Bastiat’s point, in a way, is about opportunity cost- unless resources are idle, they must be shifted away from one activity in order to be shifted toward another.
[...] Even if breaking the window were to increase production in the short run, the act cannot maximize capital or wealth in the long run simply because it will always be better to not break the window and spend resources making valuable new stuff than it is to break the window and spend those same resources replacing something that already existed.
By Eldon Mast, on February 16th, 2010
Dick Robertson – If I Ever Get A Job Again (1933)
If I ever get a job again,
I will never be a snob again;
I’ll live within my means,
Carry a dollar in my jeans,
If I ever get a job again.
If I ever get a break again,
Brother, what I’ll do to stake again!
No turning out the light,
Bidding my appetite good night,
If I ever get a break again.
I’ll get two rooms and a kitchenette,
Furnished comfortably;
With two rooms and a kitchenette,
I’ll get a sweet somebody to move in with me!
If I ever get a job again,
I know that two hearts will throb again,
She told me with her eyes
We’ll be rehearsing lullabyes,
If I ever get a job again.
If I ever get a job again,
I will never be a snob again!
I’m through with stocks and bonds,
I’d rather spend it all on blondes,
If I ever get a job again!
If I ever get my pay again,
I’ll save it for a rainy day again,
But let me tell you, bud,
I’m gonna save up for a flood,
If I ever get my pay again.
I’ll get two suits and an overcoat,
Like a millionaire!
Just two suits and an overcoat,
And then when things get better, I’ll buy underwear!
If I ever get a job again,
With my old friends I’ll hobnob again,
What great fun it will be, saying
“Just have one more on me!”
If I ever get a job again.
By Ajay Shah, on December 30th, 2009
In thinking of protectionism, the Great Depression, the Great Recession, and what might come next, here are two interesting angles.
Governments with their backs against the wall
Ideally, stabilisation using monetary and fiscal policy, alongside actions by the private sector, should restrain the decline in consumption, and yield conditions which are not too harsh for households. At the time of the Great Depression, much less was known of economics. Pegging the currency to gold meant giving up monetary policy autonomy; the US Fed succumbed to contractionary monetary policy once you take into account the closure of banks; the fiscal policy response at the time was miniscule.
It has been argued that the the Smoot-Hawley Tariff Act came about in the US in June 1930, at a point in time where the politicians were coming under enormous pressure to do something. After seven months of inaction by macro policy, with mounting difficulties in the economy, the politicians succumbed to protectionism. This appears to have been of decisive importance in sending the world down the destructive path of competitive trade barriers and cometitive devaluation. In the graph made famous by Barry Eichengreen and Kevin H. O’Rourke, at month 7 there was almost no decline in world trade. Douglas A. Irwin is worth reading on this.
Protectionism adversely impacts the recovery
Greg Mankiw and Scott Sumner point out one more channel through which Smoot-Hawley damaged prospects for the recovery was through the impact of protectionism on confidence.
The private sector saw protectionism as symbolising government backing away from responsible thinking in economics, and responded with a weakening of investment demand. This served to exacerbate the downturn.
Will this time be different?
The bulk of world GDP is now endowed with inflation targeting central banks. This ensures that monetary policy will be counter-cyclical: under bad business cycle conditions, inflation forecasts will drop below targets, and central banks will use every trick in their book to push inflation back up to target.
Fiscal policy has responded well this time around, thanks to better understanding of business cycles when compared with 1929. But there is little headroom to go further.
The world has as little ability to rein in some players engaging in competitive devaluation (e.g. China) today, as was the case in 1930. But with the bulk of world GDP being placed with inflation targeting central banks, the extent to which such tactics will be used will be relatively limited.
So far, we have had an upsurge of protectionism, but nothing on the scale of that seen from 1930 onwards. This could partly reflect the dramatic actions which governments have undertaken through monetary and fiscal policy, through which politicians have been able to reduce the domestic political difficulties that go along with business cycle downturns. But if, in coming months, the world economy remains mired in recession, then we could get fresh pressure to do something. In a recent voxEU post, Jeffrey Frieden points out that the path of adjustment of macroeconomic imbalances and currency distortions will involve political pain along the way, which could spillover into protectionism.
Some protectionist decisions could reflect bargaining tactics aimed at getting China to reduce or end their market manipulation of the currency market. But if there is an upsurge of protectionism beyond this, it will further damage the recovery by hurting investment, giving a spiral of bad economy -> protectionism -> reduced investment demand -> worse economy.
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By G.L.C., on October 13th, 2008
The Securities and Exchange Commission (SEC) was set up as a reaction to the stock market crash of 1929 to provide oversight of brokerage firms and protect investors. Last month, Morgan Stanley and Goldman Sachs Group, Inc., filed to become bank holding companies. Now with the sale of Bear Stearns, the bankruptcy of Lehman Brothers Holdings, Inc., and the sale of Merrill Lynch & Co. to Bank of America Corp., the SEC now has no large firms left to oversee.
A recent report by Inspector General David Kotz has concluded that the SEC missed numerous warning signs leading up to the shotgun sale of Bear Stearns Cos. Bear Stearns, one of the most aggressive investment banks, agreed to be sold to J.P. Morgan Chase & Co. According to the report, the SEC failed to require the investment bank to rein in its risk taking. It failed to carry out its mission in its oversight of Bear Stearns. Despite the SEC staff having identified in 2006 precisely the types of risks that evolved into the subprime crisis, the SEC did not exert influence over Bear Stearns to use this experience to add a meltdown of the subprime market to its risk scenarios. There are many who blame the present crisis on years of looser regulations that allowed Wall Street firms to take on greater risks without adequate oversight.
The report details how the SEC made no efforts to require Bear Stearns to reduce its debt or raise money, failed to take steps after identifying numerous shortcomings in Bear Stearns’ risk management of mortgages, and also missed opportunities to push Bear management to address the problems. The report criticized the SEC for allowing internal auditors at Bear Stearns, not external auditors who would presumably be more objective, to perform critical work in reviewing the firm’s risk management. The SEC also did not review Bears Stearns’ strategy for informing investors about its funding plans following the failure of two of its hedge funds in July 2007. The SEC took too long to review Bear Stearns’ 2006 annual report and seek more information from the firm, which would have resulted in Bear disclosing more information about its mortgage portfolio to investors.
The SEC maintains that the failure is a result of the SEC not having enough authority to effectively oversee the banks and that the SEC has already expressed its concerns to Congress. The SEC staff completed its review of Bear Stearns’ 2006 annual report after its collapse.
Another report found that the SEC conducted in-depth reviews for only six of the 146 brokerage firms registered with the agency. The failure to carry out the purpose and goals of the Broker-Dealer Risk Assessment program hinders the SEC’s ability to foresee or respond to weaknesses in the financial markets.
As lawmakers take a second look at financial oversight, these reports could be nails in the coffin for the SEC. The power of the SEC could be dispersed to other agencies, such as the Federal Reserve. These reports document the failure of the SEC to either make its oversight program work or seek authority from Congress so that it could work.
By Evelyn Black, on October 1st, 2008
When I was a kid (I’m 55 now), I looked forward to holiday dinners because that was when my parents and my grandparents held their traditional “Was FDR a scoundrel or a savior?” debate. My grandparents, who worked for public utilities and, thus, survived the Great Depression with conservative opinions intact, argued for FDR the scoundrel. My father, who worked for a public utility company on the blue collar side and was a union steward, argued for FDR the savior.
The FDR argument was a traditional debate in our household even though the issue itself was a historical one, and though I already knew what every single participant was going to say, I looked forward to it because it was so exciting to see people I loved all vehemently disagreeing without really hurting each other. That’s the democracy I saw as a kid and the one that I miss today; a democracy that encouraged informed debate and tolerated strongly divergent views.
Watching the wrangling in Washington over the current banking crisis reminded me of that debate. The holidays are approaching, lots of Americans are scraping for turkey money, and, in an effort to maintain calm, the press is trying hard to replace the “D” word (Depression! Run for your lives!) with the more awkward but also more calming phrase “possible severe recession.” Once again we are witnessing an autumnal debate about the role of government in business and financial markets. Once again we are witnessing the spectacle of a televised tag team match between Emergency Socialism and Unfettered Capitalism.
Was FDR a scoundrel or a hero?
I don’t know. I do know that our current economic situation is similar in some ways to the one our grandparents (or in many cases, great-grandparents) survived. The stock market collapse that kicked off the Great Depression in 1929 came at the end of a bubble that included high-rolling, unfettered speculation and wildly indulgent personal lifestyles. The Dust Bowl disaster of the 1930s is parallel in some ways to our current climate change and energy crisis, with the displacement and disenfranchisement of huge numbers of people due to Katrina and now Hurricane Ike, and the promise that these kinds of monster storms will most likely become the norm, not the exception.
Like working Americans during the Great Depression, working Americans today are witnessing a rapid increase in costs concurrent with wage stagnation. Unemployment, while nowhere near Depression era levels of 25%, is rising rapidly and will rise even more rapidly should the current credit crunch continue. Just as in the aftermath of the stock market crash of 1929, we have a Hoover-like presidential candidate and an FDR-like candidate, acting out their respective roles in the holiday FDR debate on the national stage.
But there are real differences between our current situation and the one FDR seized by the horns in the ’30s.
The first difference is that American industry was still strong in the 1930s, and gearing this industrial base up for WWII arguably helped FDR turn the country around. Now, not only is U.S. infrastructure shot, our industrial base is gone, too, shipped overseas by multinational corporations in the wake of NAFTA for better profit margins.
A second difference is a loss of skills in the general populace. While my grandmother loved to regale me with stories about how she walked six miles for a 20 pound sack of government-issued potatoes once a week and fed her family of six on that and not much else, today’s consumer would be hard pressed to know what to do with a potato if there wasn’t a Wendy’s nearby. While we can relearn these skills (and many are doing just that: agricultural markets are “ripe for picking,” so to speak, and purchase of vegetable seed skyrocketed this year), in the short term, we have lost a lot of self-reliance and capability as individuals.
But maybe the most striking difference between that time and this one is the lack of a unifying political vision. My parents and grandparents argued about FDR at the Thanksgiving dinner table in part because FDR, scoundrel or hero, was able to bring everyone together for the common good, at least for awhile. Today, we have political machines that are still feeding the culture war in America, drawing a line between red and blue and even underhandedly pitching to white – something we all hoped we were past but clearly are not.
Who has the 21st century New Deal for America?
Hank Paulson doesn’t. But between the stock market’s meltdown after the House rejected Paulson’s bailout plan on Monday and tonight’s Senate vote on their version of a financial rescue package, we are finally hurting bad enough to come together to fix the mess wrought by 25 years of free market capitalism. Even then, freeing up U.S. credit markets will not in and of itself stop the free-fall in home values and home sales. It will do nothing to bring back the tax bases of our major cities. It will not encourage energy independence or investment in U.S. industry and infrastructure, and it will not address the problem of declining wages and rising costs.
Finally, helping Wall Street get its credit markets back on track will not bring together a populace split down the middle over issues of religion and personal lifestyle. It will not stop the feckless political pandering that has brought us to this sorry state.
I think we do need a New Deal, a vision of where America wants to go and who America wants to be on the world stage. Until that emerges, we will be seen only in terms of what we once were, and our suffering will continue. Debt cannot be a nation’s only commodity if that nation intends to prosper.
The parallels to our time and the time of the Great Depression are there alright.
But we haven’t seen anything, yet.
By Evelyn Black, on September 26th, 2008
If you watch the news at all these days (and a case could definitely be made for avoiding this habit), then you already know that the United States imports way more cheap stuff from China than it sends over there for sale to the Chinese people. That big difference between the huge amount we import and the tiny amount we export is called the trade deficit, and you’ve almost certainly been hearing for eight years now about how it keeps going up and how that isn’t such a great thing.
What you may not realize, however, is that the recent federal bailout of the mortgage giants Fannie Mae and Freddie Mac stems in part from the strange and delicate trade relationship the U.S. has forged with China; a relationship that consists of lots of imported Chinese goods that Americans buy up with money that is essentially loaned to the U.S. by, you guessed it, the Chinese.
The Chinese do not issue loans directly to the U.S. the way that a bank would issue a loan to an individual. What the Chinese government does instead is buy up U.S. debt, mostly in the form of mortgage-backed securities. The recent tax rebate stimulus package designed to get shoppers out and spending money again to shore up the flagging U.S. economy came largely from this kind of investment by the Chinese in the debt held by American financial institutions.
While it may seem circular and confusing to think of the Chinese actually loaning the U.S. the money to buy Chinese products, the fact is that right now the U.S. government is heavily dependent on this kind of Chinese investment just for the continuation of its day-to-day business. In other words, without Chinese money being poured into the U.S. in the form of securities purchases, our government would experience such a budgetary shortfall, it would have to shut down.
The linchpin in this arrangement, obviously, is U.S. housing values. If the value of the properties backing the mortgage debt purchased by the Chinese remains stable or increases steadily, everything continues to hum along normally (or at least normally on the surface of it). The Chinese have an asset they see as increasing in value (that is, American mortgage-backed debt securities), and the U.S. government has the money it needs for its day-to-day operations. The Chinese make money off of their exports to the U.S. and off of their investments in U.S. housing-backed debt, and U.S. citizens continue to consume the cheap Chinese goods we have grown accustomed to buying.
That’s the U.S. consumer economy in a nutshell, and if it sounds a bit Orwellian, bizarre, and unbalanced, that’s because it is. Nevertheless, that’s how we roll these days, or did, until the housing bubble burst and the values of the properties actually backing all this mortgage debt began to drop precipitously. At first it was only subprime debt that went bad, but that spread to what is known in the mortgage industry as Alt-A debt (which is a notch above subprime and once considered quite a safe risk).
Now even homeowners who are in no danger of defaulting on their mortgages are seeing dramatic drops in their property values due to a badly inflated housing market and the subsequent bursting of that bubble. And as if that isn’t all bad enough, the problem is rapidly spreading to other kinds of U.S. debt: credit cards, car loans, home equity lines, and small business lines of credit.
To put it in just a few words: the actual assets backing U.S. debt are now depreciating instead of appreciating in value, leaving the Chinese holding substantial investments in the U.S. that are looking less and less profitable. The Chinese have been friendly to the U.S. because they are making lots of money from the relationship. With the bursting of the housing bubble, not so much. They have been growing more and more nervous about this fact.
What does that have to do with Fannie and Freddie?
Fannie Mae and Freddie Mac back most of the mortgage debt in the United States, but because they have always had a quasi-governmental status, they have not kept the kind of prudent reserves on hand that a private financial institution would be required to keep to mitigate such losses. As it became more and more clear over the course of the past year or so that Fannie and Freddie didn’t have adequate financial reserves to back the debt they held, the Federal Reserve and the Treasury Department began to talk about a bailout.
It’s a bad thing that housing values are plummeting in the U.S., but it has to happen because they were so wildly inflated during the boom years. That hard correction would be painful for the U.S. no matter what, and we are certainly feeling the pain already in the form of a major economic turndown that looks like it will last at least through the better part of 2009. But what would be even more catastrophic than the pain we are already feeling in our collective national pocketbook would be a decision by the Chinese to pull back on their investment in us. Such a move would literally throw us into a financial meltdown that would make the Depression era look pretty cheerful by comparison.
So, while it may or may not be true that Fannie and Freddie “are too big to be allowed to fail,” what is unquestionably true is that the U.S. government is too big to be allowed to fail, and fail it would without a steady influx of Chinese money.
All of this is more food for thought that I can possibly digest in a single sitting. If you pay close attention to the expressions on the faces of Bernanke and Paulson, you may well detect a hint of dyspepsia there, too.
The day is saved. Again. For now.
And yet once again, in the smoking (and indigestible) aftermath, a familiar and phrase rears its ugly head:
“What next?”
By G.L.C., on September 10th, 2008
Crime rates should drop during good economic times and rise during bad ones. So very soon if you are walking the streets of New York late at night, you may be at risk of being mugged by gangs of investment bankers, driven to acts of desperate violence by the travails of the credit markets. This seems logical at first glance – people who lose their jobs may turn instead to burglary and theft to get what they want. But there is little evidence to suggest that crime rates drop during good economic times and rise during bad ones. Crime rates rose every year between 1955 and 1972, even as the economy surged, with only a brief, mild recession in the early 1960s. A bad economy doesn’t always bring more crime. Crime rates fell about one third between 1934 and 1938 while the nation was struggling to emerge from the Great Depression and weathering another severe economic downturn in 1937 and 1938.
Declining wages for poor young males drew them to crime as crack ravaged inner cities during the economic boom of the late 1980s. Low wages and the lure of crack profits thus discouraged young men from finding honest work. Economists and criminologists who can refer to data from all 50 U.S. states to help them understand what is going on have found little indication of a strong link between economic growth and crime. They instead credit some of the sharp fall in crime in the U.S. in the 1990s to larger police forces and harsher prison sentences. More stringent laws and larger government expenditures have also played an important role in the fall in the crime rate.
The truth is that broad figures on crime conceal large differences in specific crimes, each with its own particular explanation. Crimes, broadly speaking, have been falling for a decade. Car thefts are down because cars are harder to steal. Modern televisions and other home electronic equipments tend to be either too large to steal or too cheap to bother with.
That should take the focus away from crime. The economic downturn is threatening an increase in crime, illegal immigration, and extremism, putting further strain on tight police budgets. Illegal working is forecast to increase as migrants’ opportunities for legal employment decline and businesses seek to save costs.
Economic downturn also risks increasing the appeal of far right extremism and racism. Experiencing racism can be one of the factors that can lead to people becoming terrorists.
Local police resources could come under increasing pressure. The ever increasing gas prices might leave the police forces facing financial pressures.
So if the war against crime is to be won, then more stringent laws and increased federal, state, and local spending on law enforcement are needed. In other words, crime declines not because the economy is booming but because the government passes stringent laws and spends money – larger prisons, more police, and tougher punishments.
By Evelyn Black, on September 9th, 2008
By the time November rolls around, Americans will have heard more economic numbers crunched in more creative ways than anyone ever would have imagined possible. That’s the mathematical formula for recreating any candidate in the image of a populist hero: numbers and more numbers. Bury ‘em in numbers, and if they start asking questions, well, pull out some more numbers!
While Mark Twain’s infamous line about “liars, damn liars, and statistics” is more than apt here, it’s also true that sometimes numbers tell a story more powerfully than any orator. Such is the case with a pile of numbers put together in an article in the New York Times by Princeton economist Alan Binder, who took the time to discover that, statistically speaking, during the period from 1948 through 2007, the U.S. economy grew faster under Democratic presidents than Republican presidents. (See chart below right.)
Binder reports that “data for the whole period from 1948 to 2007, during which Republicans occupied the White House for 34 years and Democrats for 26, show average annual growth of real gross national product of 1.64 percent per capita under Republican presidents versus 2.78 percent under Democrats.” He continues that that statistical difference between parties of 1.14 points, “…if maintained for eight years, would yield 9.33 percent more income per person, which is a lot more than almost anyone can expect from a tax cut.”
In other words, what Binder is not-so-subtly suggesting is that if Americans had stayed with Democratic economic policies instead of experimenting with Republican supply-side theories, ordinary people would be a lot better off financially today: specifically, 9.33% better off. While hindsight is always 20/20, these numbers are interesting to say the least. And what’s more, they only tell half of the story.
The other half of the story, the half you may have heard much more about, is that income inequality has been steadily growing over the last 30 years, largely as a result of Republican economic policies. While the original idea was something to the effect of: more money at the top will result in more jobs and eventually more money for everyone; we know that in practice what has happened is that more money has simply floated to the top and stayed at the top. Real wages are falling, jobs are moving overseas, the middle class lifestyle that once flourished during the manufacturing era is showing signs of critical strain.
What’s worse, the trend is strengthening.
In 1947 the median family income in the U.S. was $23,400. By 2007 it had (roughly) doubled to $50,233, after hitting a pinnacle of $58,400 in 2005. During that same time period, the income of the top one tenth of one percent of all households has soared from $2 million to over $10 million. So, while the family smack in the middle of the census tables saw a doubling, more or less, of household income, the family at the very top 1/10th of 1% saw household income increase fivefold.
According to an AP article released on Labor Day, “all the data that Wall Street has seen lately seems to be pointing to a dual economy, one in which businesses are generally faring better than consumers.” The article continues, stating, “Evidence of this divergent economy keeps building — the average consumer is suffering, but business spending, particularly abroad, appears to be keeping the U.S. economy from sinking severely, even as the financial sector continues to struggle.”
In other words, yet another batch of numbers seem to show that U.S. businesses are holding up because exports and investment overseas are going well. Consumers, who have seen their jobs go overseas with all that corporate investment, are hurting. The fact that business has been able to thrive and prop up the economy while Americans wither on the vine is disturbing to say the least. That raw fact raises difficult questions about the capacity for the free market to self-regulate in ways that are not severely harmful to the U.S. populace at large. The mantra of the free market is sounding more and more hollow; and for sure it isn’t helpful at the grocery store or the pump these days.
If healthy businesses do not create healthy families, plentiful jobs, and consumers with money to spend, what interest should working Americans take in keeping business healthy? At the very least, the latest statistics indicate that issues of free trade, fair wage and labor laws, bankruptcy, and health are urgently in need of review and probably reform. The similarities to the the Depression era are striking.
The U.S. is not facing another Great Depression, or that, at least, is the consensus among experts. However, the U.S. working family is facing a painful protracted period of declining wages, increasing costs, and seeming governmental indifference.
When rhetoric, ad campaigns, and punditry grow tiresome (and do they ever), sometimes it helps to look at the numbers and ask yourself, am I voting my own interest? Am I better off than I was ten years ago? More and more Americans know the answer to that question without even having to think about it. They don’t need Alan Binder to prove it to them statistically, but it’s nice to know he can.
By J.D. Seagraves, on August 18th, 2008
We are taught in school that the Great Depression was a result of the 1929 stock-market crash, and that the crash was caused by unregulated financial markets or “unfettered capitalism.” Even so-called conservative history teachers and professors tend to share this view, and certainly the leadership of both American political parties accept this myth as gospel. But yes, it is a myth.
In 1913, the Federal Reserve Act was passed at the urging of the nation’s biggest bankers. It was said that the Fed would operate in the “public interest” and that the Act would allow the government to prevent the booms and busts of the pre-Fed era—or at least, make them more moderate. But just sixteen years later, the stock market crashed and we entered the Great Depression. Clearly, the Fed, at the very least, failed in its mission. But the truth is that the Fed caused the bubble that made the crash inevitable—just as it caused the NASDAQ bubble of the late 90’s and the real-estate bubble of recent years.
The key to understanding how this is the case is the Austrian Business Cycle theory. But before we go there, let’s briefly review the pre-Fed history of banking in the United States.
The Original Silver Dollar
The “dollar” became the most commonly accepted medium of exchange naturally via the free market and not by government decree. The original American “dollars” were Spanish coins containing 0.88 troy ounces of silver. Although people would gladly accept other silver and gold coins, the “dollar” was the most popular, and thus, other coins naturally traded at a discount. This is no different than today, when most Americans would accept euros in place of dollars, though not at full exchange value.
During the Revolutionary War, the Continental Congress printed paper dollars that were nominally backed by real silver dollars. But as governments are wont to do, the nascent U.S. quickly printed more paper dollars than the treasury had silver coins, and the people could see through this façade. Soon, paper dollars traded at huge discounts to silver dollars, and eventually the government paper was worthless. Hence the saying, “not worth a Continental.”
The government could have never made people accept pieces of paper as money without telling them that those pieces of paper represented silver coins. Even this wasn’t good enough when it became clear that there weren’t enough coins to redeem all of those paper dollars. This flies in the face of the current understanding of money as a “state institution.” Historically, money has been something that people valued for its own sake, not merely as a medium of exchange and certainly not because the government forced people to accept it.
Anyhow, after the horrible experience with paper money, the framers of the new Constitution prohibited the states from recognizing anything but gold or silver as legal tender and prohibited the federal (central) government from declaring anything legal tender at all. It also prohibited the issuance of “bills of credit”—paper money. This was all thrown out the window, of course, in 1913, but there’s still a little more monetary history to cover before we get there.
The Era of “Free Banking”
With the Coinage Act of 1792, the new Congress exercised its power to “coin money and regulate the value thereof” and created new American dollar coins, which contained roughly the same amount of silver as the Spanish dollars (0.867 troy ounces). Notice, however, that these dollars were not “legal tender”—individuals could not be forced to accept them nor was trading in other currencies made illegal. In fact, many people still preferred the old Spanish dollars.
In the pre-Fed era, banks were free-market institutions that printed their own bank notes. Far from “counterfeiting,” these notes were simply receipts for the underlying gold or silver the bank held in its vaults. A customer could take 100 silver dollars to a JP Morgan bank and exchange them for twenty $5 JP Morgan bills. He could then use these paper bills, which would fit more neatly in his wallet, to make transactions. Eventually, someone with the bills might want to turn them in for silver coins, which he could do by taking them to a JP Morgan branch or some other bank with which JP Morgan had an agreement.
This was an ideal banking system. But soon, bankers got greedy and realized that they had a lot of gold and silver sitting in their vaults that was doing nothing. Why not issue more paper notes, in the form of loans, than they had coins and make some extra interest income? All would be well so long as everyone didn’t try to redeem their paper dollars for coins at once. Surely, the banks could get away with issuing 10% more notes than they had coins, right?
Well, they did. And then they issued 50% more notes. And then double the notes. And then five or ten or twenty times the notes that they had coins for. Bankers who wanted to be honest could not compete in this environment and were put out of business. But eventually, a customer would come in and demand a redemption of his paper dollars for which the bank had no coinage. As soon as the word got out, all of the bank’s customers would try to withdraw their coins, and the customers of other banks would, too. This was known as a “bank run” and it exposed the bankers’ deception.
Now, under a free market, the bankers should have been held accountable for their crimes. They were engaging in counterfeiting, for which the punishment, under the Constitution, is death. But these were men of influence, so far from being held liable, they were able to get governors and presidents to issue “bank holidays” forgiving them of the responsibility of redeeming their notes. This was not a problem of the “free market,” but instead, a problem of government intervention into the free market.
The Federal Reserve Act virtually nationalized all of the nation’s banks and essentially made them agencies of government. Now the banking industry was cartelized, and “fractional reserve banking”—the process of counterfeiting that had gotten bankers into trouble—was made legal. What’s more, the U.S. dollar was unconstitutionally made legal tender, which meant that people could no longer refuse it or opt for other currencies.
Enter the Fed
Between 1913 and 1929, the U.S. dollar lost 42% of its purchase power. In the sixteen years prior to the Fed Act, the dollar had strengthened. This 42% loss of value was due to the Federal Reserve’s monetary expansion, which also led to the stock-market bubble. Similar policies were pursued under Alan Greenspan, which led to a variety of bubbles and busts.
This is the distilled Austrian theory of the business cycle: Central bank-created inflation causes a misallocation of investments during the boom phase, which inevitably leads to the liquidation of those investments and a bust. The Fed’s ultra-low interest rates led to the housing boom, and now that those mortgages (bad investments) aren’t panning out, we’ve entered a serious recession. This is not the fault of the free market, for none of this would be possible under a truly free market in banking, in which inflationary money creation—the cause of booms and busts—would be illegal. The government gives banks permission to inflate, and thus, it is the government—not the free market—that is to blame for booms and busts.
By Evelyn Black, on July 23rd, 2008
Recently, in an attempt to generate some calm in the wake of the IndyMac Bank failure, I published an article (on another website) about FDIC insurance and how it works. My intent was to settle some of the rampant fear that kicked off the week of July 15, 2008. I work in a bank, and trust me, people all across America were freaking out, worried about their money and whether or not it was safe.
Almost immediately after publishing (what I thought was) a very basic, purely informational piece, I began to receive e-mails advising me that I was ‘misinformed’ about the history behind FDIC insurance and the Great Depression, and that specifically, the Great Depression was intentionally created by a worldwide banking cartel so that this selfsame cartel could buy up smaller banks and entire corporations at discount rates and eventually run the whole world. FDIC, I was told, was created by this cartel to give the ordinary people the illusion of deposit security so the cartels could control their money unmolested.
Oh. Really?
Well, no, not really. I mean, I really did get the e-mails. But no, the corrections the e-mailers made to my piece were themselves incorrect. These ideas are the brainchild of filmmaker Peter Joseph, who released the ideas (and so many others) in the form of a 2007 film entitled Zeitgeist. After circulating on the internet for the past year (it is also one of the most popular YouTube videos) the film has earned a degree of respect and credibility that it in no way deserves.
Zeitgeist doesn’t restrict itself to a single conspiracy theory involving bank presidents, world wide banking cartels, and the Federal Reserve, nor does it limit its historical rewrites to America in the 20th century. If you watch the film, you will also learn that the historical Jesus was a myth, that our own government planned and staged the 9/11 World Trade Center attacks, and that income taxes are unconstitutional and you don’t have to pay them. This argument, you will be told, holds up perfectly in a court of law, but most Americans are too stupid to know this, so we just keep paying.
Wow.
How can a person with an interest in finance and economics not love a movie that right off the bat explains not-so-patiently that the viewer is stupid and gullible? Usually it takes a conversation a few minutes of give and take to get around to name calling, but in this case, we get the abuse right up front: “Listen up: First of all, you’re stupid. Secondly, Jesus never existed and last but not least, a worldwide banking cartel controls your life. Stop paying your taxes right now you moron you. Any by the way your Mom made up that whole tooth fairy thing. Gimme that cookie.”
If you take the time to watch this movie, it becomes immediately apparent that the loosely constructed, wide-ranging premise is wacko to the n-th degree, but what really bothers me is the credibility that this particular piece of sludge has gained with otherwise sane, intelligent people who, in most other cases, are able to read books and do their own thinking. It’s kind of like the notion that Eskimos have 100 different words for snow. That idea was repeated in a few academic papers fifteen years back with no reliable documentation to back it up, and soon it became accepted fact even though Eskimos do NOT have 100 words for snow. Seriously, they don’t.
To this day people still repeat that ‘fact’ without thinking twice. Eskimos have a couple words for snow instead of the single word snow with modifiers, like we have (wet snow, dry snow, and so forth) but factually speaking, for Eskimos and most other people in the world, snow is snow.
The idea of snow jobs does apply here though.
Something about Zeitgeist’s outrageous revisionism seems to appeal to the worst in all of us; our darkest fears and suspicions, and most of all our very visceral need to that believe someone, anyone, is in control during chaotic times, even if that controlling entity is itself dark and menacing. Better the Devil writ large than some kind of amorphous, hard-to-grasp chaos created by ordinary human folly and greed. A well-defined, coherent Devil is easier to understand and thus, to fight. That’s the idea anyway.
A popular quotation exhorts:
“No good of himself does a listener hear,
Speak of the devil he’s sure to appear”
[Stevens Point Journal, Wisconsin, February 1892]
Invoke the Devil and you will always see him forthwith, but among all his more romantic titles (Prince of Darkness, etc and so forth) is one we would do well to remember: “Prince of Lies.” Some would go so far as to say that the Devil himself is a lie, a human invention, a device whereby human weakness and deceit is projected outside the self and personified. The Devil is nothing other than our own weakness, writ large and reflected back to us in the magic mirror of fear, hatred, and blame.
Using this sort of familiar conjuring, the fact that people are by nature sometimes greedy and short-sighted becomes a worldwide banking cartel. The reality that ordinary people on the other side of the globe have reason to want to blow us up because of their own beliefs and frustrations becomes a vast conspiracy created by a worldwide banking cartel. And should you feel inclined to think this through a bit more carefully and be cautious and kind, remember that all of your religion is the invention of a worldwide banking cartel and you keep believing it because you are stupid.
I did watch the movie. I’m (obviously) not impressed. It takes more than insults and pumped-up rhetoric to persuade me that nonsense is reality, and I hope it takes more than that to convince Amateur Economists’ readers too. But I’ll tell you what does scare me.
The title.
Zeitgeist?
Does anyone recall another time in history when a Western nation, once respected and powerful, but by and by battered by war and economically damaged, saw its currency plummet in value so rapidly that people became afraid and angry and many of them, especially the youth, backed a tyrannical, radical political sect as a way to re-empower themselves?
Most of the young people today who buy into the ideas in Zeitgeist probably don’t remember much about Nazi Germany. They weren’t born yet. The internet didn’t even exist. So why should they care about it?
The Great Depression was brought about by greed and unbridled speculative trading on Wall Street, the same kind of greed and unbridled speculative trading that went on during the housing bubble that preceded our current economic problems.
Pure unfettered Capitalism will always create this drama. Karl Marx knew that, but so did our own government for much of our country’s history. That’s why we regulate banks and financial institutions. We don’t regulate them to just to be irritating, we do it to put some brakes on a train that has a known tendency to run off the tracks. Over the course of the past 25 years we’ve witnessed the removal of those brakes by two major Republican administrations, and now its deja vu all over again.
Are some people way too rich right now? Definitely. Do they collectively comprise a worldwide banking cartel that goes back centuries?
No. Sadly, they are not nearly that smart.
So keep let’s them away from YouTube, OK?
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