January 17, 2003
ATLAS SHRUGGED, AGAIN:
The history of the Fed: The biggest mistake the Fed ever made (Allan H. Meltzer, January 10, 2003, Times of London)As the world economy moved toward deflation and depression. The Federal Reserve¹s principal concern was inflation. To contemporary economists, this concern is puzzling because the price level fell slowly from 1927 to 1929, and then more rapidly.Federal Reserve officials did not base their concern about inflation on price changes or sluggish money growth. To most of them, rising stock prices and growing use of borrowing to purchase shares was all the evidence of inflation they needed. Their interpretation relied on the real bills doctrine: the belief that credit extended for common stocks, real estate, government securities or commodity speculation created inflation because the additional credit did not give rise to additional output.
Deflationary policies contributed to the start of the 1929 recession. When the Federal Reserve raised the New York discount rate in August 1929, part of the world was in recession. Although it was not known at the time, the United States economy was at a peak. The Great Depression had started.
There is no single cause of the Great Depression or a unique monetary shock. A series of financial shocks followed: bank failures, Britain¹s departure from the gold standard followed by other departures, and financial failures in the United States. Most Federal Reserve officials favoured a passive policy. They viewed the Depression as the inevitable consequence of excessive speculation in stocks financed by credit creation. On their view, the proper response was to purge the economic system of its excesses.
If the Federal Reserve had maintained monetary growth, the country and the world would have avoided years of depression. Failure to act during the Great Depression was the Federal Reserve¹s largest error, but far from its only one. Failure to expand can be explained as the result of prevailing beliefs about the inevitability of a downturn following the stock market boom.
What's most frightening about this is that Alan Greenspan, who's widely considered a financial genius, did exactly the same thing in the late 90s, driving the U.S. economy into recession by cranking up interest rates to combat a non-existent inflation. Posted by Stephen Judd at January 17, 2003 7:29 PM
It exists. Even 2% inflation -- slightly less than
the current actual rate -- if continued year
by year amounts to a terrible tax on people
whose assets are inflexible, which is most of us.
The deflation right now of commodities is a
serious problem. But it is possible to have
simultaneous crises of producer deflation and
consumer inflation. We have only about three-quarters
of this crisis on hand, but with a bit of luck, we
can go all the way.
On another view, the problem with reflating
in the '30s was a liquidity crunch, addressed
(see Kindleberger) by establishing lenders of
last resort.
These lenders have since intervened scores of
times, usually more or less successfully.
It is true, though, that deflation was missed
(except by Tugwell and the Columbia
agricultural economists) as a serious problem
in the American economy in the '20s. The
farm depression started in 1922, not 1929;
but the conservatives were fixated on
industrial policy, urban labor and shares. They
didn't give a hoot about farmers or farm
labor, although they represented about 40%
of the population at the time.
The disaster of 1929 was created, insofar as
the US was concerned, by the torpor of the
Republicans. In Europe, by dislocations and
destruction of capital stock (not to mention
human stock) in the war.
even greenspan ha tetified that inflation is overstated by at least because of failure to modify the baket of goods to reflect current consumer trends--for instance, why include cigarettes?--so inflation is really pretty close to 0%.
Posted by: at January 18, 2003 12:07 PMThat's why people never complain about
their cable TV or medical bills. They never
go up, do they?
Those of you who have Wall Street Journal online subscriptions can access this chart
from this coming week's Barrons, showing that American debt as a percentage of GDP has been between 100% and 140% of GDP throughout the last century except in two episodes -- first exceeding 140% in 1928 before reaching 265% in the early '30s, and then in the '80s, '90s, and 2000s -- it has been climbing steadily since 1977 and has now reached 295%, a record. It was this huge debt which made the Depression last, along with the bank failures that deflated credit. We may see how much public policy has improved since the Depression. My guess is, not much.
Didn't the Smoot-Hawley Tariff Act play a role in the Depression?
Jeff Guinn
It cannot be emphasized enough that the
Depression began in American agriculture in
1922. In the farm states, the banks had been
wiped out before the stock market crashed
and before Smoot-Hawley.
The depression in Europe also dated from
around 1920.
A beggar-thy-neighbor tariff policy around the
world just added to the problems.
Reagan's economic advisers welcomed an
increase in national debt, because they counted
it as savings.
While this seems absurd to me, in practice it
has some validity, apparently.
pj:
That's just not possible. Total debt today is 6.3 trillion http://www.brillig.com/debt_clock/
) of a GDP over 10 trillion. If they counted consumer debt too then they should have deducted home equity and 401k savings to get a true comparison. It wouldn't be pleasant, but if everyone liguidated 100% it seems likely that all consumer debt would be more than paid off.
Harry:
I know you're fond of beating that horse, but the GDP grew during the 20's, which is not a recession, let alone a Depression.
It was a depression in what Mencken liked to
call the cow states.
My whole career has been devoted to teaching
people to disaggregate economic information.
It's nice to know what the aggregates are,
but then you have to analyse them.
By the way, you are fond of telling us how
incompetent the Japanese economy is. They
also could liquidate everything and come out
with cash on the balance sheet.
oj:
Weren't the farm states (influenced by William James Bryan) in the Democrats camp during the 20's?
oops, scratch that.
Misread GDP for GOP.
Harry:
They have so much bad bank debt and government debt that seems unlikely, but at any rate their economy is shrinking, ours is growing.
Ali:
Bryant wanted loose money to drive up the prices farmers got for their goods--sort of Weimar economics.
Greenspan is a menace. He helped create the 1987 crash then presided over the 90s bubble through a financial policy that pumped money into the economy at the wrong time and then created a credit crunch at the wrong time. Anyone who believes there's no inflation today hasn't been shopping for some time. Everyday commodities are far more costly than they were five years ago. What irks me is that taxes aren't included in inflation statistics. When is the last time the government, state, local, or federal eliminate a tax? The rate of government spending has far exceeded inflation in the past eight years and there is no end in sight.
Further, I love the way the government measures inflation. They no longer use a strict shopping basket approach but rather rig the game. Price of a pound of steak is up 30%, well then lets use chicken instead. Valid comparison? Only in the eyes of a politican or government economist.
Japan has about 5 trillion in almost liquid assets, more
than enough to cover all its debts. And it should.
But that would return it to about 1970, and the people don't want to do that.
It's economy is not shrinking, though, it just isn't growing.
It also is not a consumer economy, so it reacts differently.
The U.S. economy is unique. Every other country either consumes more than it produces or it saves something close to half its production.
The U.S. falls in between and has for a very long time.
Thus, consumer purchasing drives our economy more than it does Germany's or Japan's. And if 40% of your population is not consuming, as happened in the '20s, then you're going to crash as soon as the 60% have acquired a flivver and a radio.
Harry:
That's simply wrong. If you include home ownership and 401ks/IRAs, America has perhaps the highest savings rates in the world.
oj - The WSJ stat is all government, business, and household debt.
Re home equity, the Barrons article notes: "Americans' equity in their homes, net of debt, has dwindled to 57%, compared with 85% a half-century ago, even with the recent powerful surge in home prices. Economist Gary Shilling calculates that 39% of U.S. homes are owned free and clear -- and that the remaining homeowners have debt burdens exceeding 80% of the value of their homes."
If everyone liquidated 100%, there would be no buyers, and prices would plummet. This is what actually happens in debt-induced depressions. It's why the Great Depression was so fierce, why Japan is struggling now, and why we're again at risk.
Orrin, I am aware that the U.S. savings rate is well above the zero that Democrat economists like to claim. But there are different kinds of savings. Selling bonds overseas is one kind (to a Republican, not to me), owning part of a house is another, and a forced account with the assets made available for new capital stock is a third.
In terms of driving economic activity, they are hardly equivalent, I suspect, though I am not smart enough to quantify the differences.