Crash, Bang, Wallop (Today's economy reminds me of the 1930s)

The Wall Street Journal ^ | January 5, 2004 | EDMUND S. PHELPS

[David]

"The depression was a MONETARY (read Milton Friedman) and TRADE (Smoot-Hawley tarrif) driven economic event. End of story."

Well we can agree that the depression was a "monetary" event allright. But Friedman's explanation is wrong. Friedman, like Bernanke and Greenspan are simply apologists for the fed--the explanation they offer is the one we heard in basic economic classes--in detail if you studied economic cycles. And it simply does not match the facts.

Friedman argues that the depression was caused by failure of the fed to make enough liquidity available in the early 1930's--he continues to argue that in the face of the Japanese experience where they did exactly that and the problem got worse. Maybe he still thinks so--where Greenspan and Bernanke are also now doing the same thing with the same result. Economic students in the 2020's will learn that Friedman, Greenspan and Bernanke were dead wrong.

The way the fed adds liquidity, as Friedman argues they should have done in the 1930's is to add bank reserves to expand borrowing--the borrowed liquidity then goes into the economy. Problem is that with the borrowing goes a debt service burden which is the real problem--subsequent liquidity flows to the borrower go to debt service instead of future investment and consumption spending.

Further, Fredman, Greenspan and Bernanke are also dead wrong on the facts--the fed got the discount rate down to 1% right away and kept it there; plenty of bank reserves and plenty of liquidity.

The monetary cause of the depression was failed fed monetary policies in the 1920's. Like the 1990's, the fed created substantial additonal liquidity through the debt process--in the 20's through the stock market margin process. The sole source of liquidity for debt service was the stock equity and when it became clear the equity was worth less than the debt, the debt service requirement brought the market down.

Look forward to a repeat performance shortly.

As to the trade argument, Smoot-Hawley was long after the fact; and there is no data anywhere to support the proposition that Smoot-Hawley had anything to do with the depression--that too is just another argument dreamed up by the fed apologists to obscure the real cause of the depression which was failed fed policy in the 1920's.

There is no evidence that expanding the domestic cheap labor force through illegal immigration or depreciating the value of the dollar has had any positive impact on the trade deficit. And it is an undisputable fact that much of our present economic difficulty is caused by arbitrage of the cheap overseas labor force against domestic labor.

I have no argument with the proposition that the unions are a very negative influence on our domestic economy as is government interference in the free domestic labor market. But "free trade" is not free trade either--Japan, China, and most of the rest of the world are engaging in anti-free trade practices that preclude the US from obtaining any material benefit from our economic advantage of high tech and other inovation and in other areas including agriculture. Under the circumstances, it is in our clear economic interest to take a more self oriented look at our so called free trade policies.

[bvw]

Lucky you said unlikely.

[bvw]

End of story

History's over too. So said a BIG thinker.

When I hear that catch-pharse "end of story" used like you did, it just resonates with me. Reminds of some "It's a done deal. Why bother?" that I've heard. Resonates the same way.

[arete]

"Since the early seventeenth century, American governments (colonial, state, and federal) have tried and failed to restart business expansions by reflation. That is, they have tried to revive an inflation-driven economic boom that has stalled or collapsed by pumping new money into the system. In other words, they have tried reflating as the cure for the evils introduced by inflating. They have not yet succeeded in skipping over the inevitable contraction of the business cycle, but they have succeeded in worsening its severity and length and delaying sound recovery."

Reflation in American History

Richard W.

[bvw]

I'd argue the cause of the Depression was that which it cured .. the Prohibition.

[Tauzero]

"By cutting the tax on dividends 50% Bush has made equity investing vastly more attractive than it was immediately befroe the cut."

Bzzt. Most money is in tax-sheltered vehicles anyway.

[gipper81]

From "A Monetary History of the United States, 1867-1960."

"But it is hardly conceivable that money income could have declined by over one-half and prices by over one-third in the course of four years if there had been no decline in the stock of money.” [p.301 - re: The Great Contraction] Do you have a copy, David?

A couple of things -

1. Friedman is NOT a Fed apologist
2. I am not a fan of Greenspan
3. I am not a monetarist, but sympathetic to Friedman

You tend to jump around from subject to subject so it is difficult to determine where you are coming from on central monetary issues and events. At times you agree with Friedman's statements at other times you contradict them.

When you say “Economic students in the 2020's will learn that Friedman, Greenspan and Bernanke were dead wrong.” That certainly begs for your professional economic qualifications and background (and a little more data support). Also, again, Friedman and Greenspan do not belong together on many, many issues.

[Beck_isright]

I wonder how many people will ignore the process of our debt repayment programs. It's a cyclical process tried by other nations, yet never living up to expectations.

[gipper81]

Interesting article. I wonder, however, where the author is getting his money supply data from the 1930s since it differs from the National Bureau of Economic Research.

[arete]

Interesting article. I wonder, however, where the author is getting his money supply data from the 1930s since it differs from the National Bureau of Economic Research.

Trask's e-mail address is at the end of the article. Best why to get an answer to your question would probably be to ask him.

Richard W.

[gipper81]

Good idea. Thanks.

[imawit]

See, betcha didn't know I don't sleep. Vampire abilities come in very handy when working with global items. So does my totally blacked out office when ne'er do wells come searching for me.

Anyway, nuff of kidding around. This link on global futures has been REALLY interesting all night. Now there are only three things up. The US dollar, oil and natural gas. Incomprehensible. It'll be really interesting today.

http://www.mrci.com/qpnight.asp

[David]

""But it is hardly conceivable that money income could have declined by over one-half and prices by over one-third in the course of four years if there had been no decline in the stock of money.? [p.301 - re: The Great Contraction] Do you have a copy, David?"

You and the guy who wrote that need to understand something about how our monetary system works and where the "stock of money" comes from.

Increases in the money supply result from the fed making additional bank reserves available to member banks (of the fed) which reserves the banks then use in the fractional reserve banking system to create loans.

Only way the money supply increases is if loans result (in excess of loan liquidations) because borrowers come in and borrow the money. When the money is not borrowed, the money supply does not increase; and goes down (because of continuing debt service principal repayment and retirement by default of existing debt). Makes no difference what the fed does. That is why the money supply numbers ("money stock") went down in the 1930's; that is why money supply numbers are going down today.

Sure there was a decline in the stock of money over "the course of four years" in the 1930's--but that was not the cause of the "drop in money income by half". The underlying factors which caused the decline in money stock were also the cause of the drop in income and economic activity--and those factors were beyond the capability of the fed to affect. The primary factor was debt service on excess debt resulting from mistaken fed policies in the 1920's.

The guy who wrote this nonesense is simply an academic fuzzball pitching the establishment economic line in support of fed and government "management" of the monetary system. He is wrong. The long term consequences of the error of this line of thought are now before us.

The monetarists all say the the fed's mistake in 1930 was not providing additional reserves fast enough at a lower price. One problem with that argument is that it is not a fact. (When I was taking an undergraduate course in business cycles in 1960, the professor had a film of an interview with a fed governor from the period--the critisism ignores the facts as he depicted them--"we knew there was a liquidity problem; we got the discount rate down under 1% and made unlimited reserves available; no one borrowed".)

But the serious problem with the underlying analysis is that additional cheap reserves not only don't solve the problem, they make it worse. Because the debt service requirements commit current liquidity flow to retirement of past obligations rather than new investments and consumption spending.

Friedman is one of the leading monetarists. His entire career is based on the proposition that monetary policy should be the primary tool for government management of the economy. He like all of the monetarists of our time have from time to time advanced this proposition that failure of the fed to provide additional liquidity in 1930 was the cause of the depression. That argument is advanced because it is perceived as an easier excuse for the fed--just a little human error at one narrow point in time; won't happen again.

Facts are that the whole concept on which the fed is based is defective--like all other forms of government management of the economy and money, it does not work. Over the long term, a group of individuals cannot do an effective a job managing the money supply to achieve favorable management of the overall economy. Their efforts have not only been ineffective in pursuit of positive objectives, they are responsible for all of the adverse economic cycles of the twentieth century as well as for an impending monetary implosion that will likely result in a far worse economic contraction than the depression.

And this group of individuals is really not all that talented at all--Greenspan has been an abject failure at everything he has ever undertaken in life. Most of the individuals are beauracrats who have spent their lives doing time to become senior; or educators who have never had any effective involvement in the real world. If any of them had real talent, they would have had real jobs.

Bernanke and Greenspan are pursuing or at least claim to be pursuing a policy based on the monetary solution--on the margin, they have managed to use vehicles like Fannie and Freddie and other interventions in quasi monetary markets and derivatives to create more money in the fractional reserve debt based banking system than during any other point in history. But notwithstanding their efforts, money supply numbers are now going down fairly rapidly.

The end game really started in 1996 when the economy started to contract; additional debt based liquidity resulted in a halt to the contraction which lasted three years as interest rate declines lowered debt service costs (and refinancing of most of the high interest areas of the economy saw injections of increased liquidity through creating of additional debt).

The contraction resumed in the third and fourth quarters of 1999. At this point, we are now reaching a point where the consequences will be very apparent.

We really don't need to think about or analyze this much longer--over the course of the next fifteen months, we will see the economy unravel exactly as I have forecast, without regard to the proposition that the fed has created more cheaper available credit than at any other time in history. The direct answer to your credentials question is that I have lots of paper academic credentials--probably more than the guy who wrote this economic history nonesense. But the real credential that supports my analysis as set forth here is the proposition that my reasoning is unassailable and my forecast will prove correct.

[gipper81]

The guy who wrote this nonesense is simply an academic fuzzball pitching the establishment economic line in support of fed and government "management" of the monetary system. He is wrong. The long term consequences of the error of this line of thought are now before us.

That is a direct quote, which attempted to start a scholarly discussion (my assumption), from "A Monetary History of the United States" by Milton Friedman and Anna J. Schwartz.

The reason I asked if you had a copy was to determine if you wanted to debate and discuss monetary policy specifics, strategy and data during the 1920s and 1930s. Instead, I got:

post 1: all sorts of interesting economic comments jumbled together, and

post 2: I'm right about this and Friedman is a "fuzzball."

Well, even for those who disagree with him in the academic and financial worlds from a policy standpoint, the serious economic work that Friedman has produced over his lifetime is beyond impressive. This begs for you to put your scholarly definitive economic research side by side for comparison (notwithstanding your Nobel Prize).

Lastly (and there could be many lastly's here), for you to say that Friedman is arguing the "establishment economic line in support of fed" very clearly demonstrates you have not read his serious critiques of the Fed over many years, books and articles.

[CobaltBlue]

I'd love to know what Friedman thinks about Bernanke and Greenspan these days.

I also think it would have been very interesting to see what von Mises and Hayek thought.

My guess is that they would be fascinated. There is historical precedent - the Chinese had paper money for centuries, without too much trouble until they made the common fatal error and debased the currency, which of course is possible to do with metal money, too.

One thing is certain - we are not seeing the 1930's redux. The economists at the Fed these days are far more sophisticated than, for example, those advising poor Hoover. Whatever mistakes Greenspan and Bernanke are making, they are not the same ones made then - which ought to be obvious.

I've been playing around for years with the idea that the biggest screw-up in the 1920's was due to lack of knowledge of the Mundell-Fleming trilemma, which isn't all that big of a problem unless your economy is heavily interconnected to that of other countries.

Every country that cut the gold link to the global economy in the 1930's immediately started to recover from the Depression - which I attribute, not to gold, per se, but to simultaneous globalization and ignorance of the trilemma. No country that was on silver experienced the Depression as anything but an inconvenience.

The US is letting exchange rates float, which is the choice we've made for years, since the 1970's, at least, and it works for us. That's the other reason (besides the Fed maintaining liquidity) that we won't see the 1930's redux.

[lelio]

One thing is certain - we are not seeing the 1930's redux. The economists at the Fed these days are far more sophisticated than, for example, those advising poor Hoover. Whatever mistakes Greenspan and Bernanke are making, they are not the same ones made then - which ought to be obvious.

That reminds me about the quip about not making the same mistakes twice -- you make newer and much larger ones.

[lelio]

Thanks for your insightful comments, learning a lot.

over the course of the next fifteen months, we will see the economy unravel exactly as I have forecast

How do we avoid this? Can we?

The two major problems I see with our economy are

• Manufacturing's offshored to China, which in turn holds a lot of our government debt
• Middle class programmer and back office jobs are offshored to India as they work for cheap

Both of these contribute to the lack of hiring -- the only segment of our economy that is hiring are low paying retail jobs.

I find it amusing when FReepers point to foreign car makers setting up shop in the US -- they're only doing so as we're giving them millions and billions of dollars to do so. Its like one big shell game where the government shuffles money around and generates more shells out of the blue.