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BERNANKE CONFUSES DEPRESSION CURE WITH DISEASE (For all you funny money lovers out there)
Financial Sense Online ^ | December 8, 2005 | Peter Schiff

Posted on 12/08/2005 2:26:55 PM PST by hubbubhubbub

An article in yesterday’s Wall Street Journal discussed how self-proclaimed “Depression buff” Ben Bernanke claims understanding of how the Fed caused the Great Depression and precisely what he would do to prevent such a calamity from reoccurring under his tenure. Not only are his assertions naïve and egotistical, but flat-out absurd.

Though he claims to have studied The Great Depression in depth, Bernanke is completely clueless as to its actual cause. However, he is partially right about one thing: the Fed did help create the Depression, but for the opposite reasons Bernanke believes. The Fed-induced credit boom of the roaring 1920s laid the foundation for the inevitable bust that ushered in the Great Depression. Bernanke has mistaken the disease for the cure, and his antidote, were it ever administered, would prove to be economically fatal to the U.S. economy.

The mistake made by the Fed during the 1920s was expanding the supply of money and credit too rapidly. However, as increasing productivity prevented consumer prices from rising, the Fed was unconcerned about the inflation it was creating. Instead, the excess money and credit that spilled into financial and real estate markets caused asset prices to rise, which resulted in claims of a “new era” (sound familiar?). The bust of 1929 led to the Great Depression of the 1930s not as a result of Fed tightening, as Bernanke claims, but due to the misguided economic policies of the Hoover and Roosevelt administrations. By preventing market forces from efficiently correcting the imbalances created during the inflationary boom of the 1920s, the Federal Government turned what otherwise would have been a normal, though severe, cyclical recessionary bust, into what became known as The Great Depression.

During the 1920s the British pound, then the dominant world currency, was under pressure. In an effort to prevent British inflation from causing the pound to weaken against the dollar, Federal Reserve Chairman Benjamin Strong decided to increase inflation in the United States as well. By debasing the dollar along with the pound, their relative values could be maintained, thus preserving the illusion of pound stability. Through competitive devaluation, Great Britain exported its inflation to the United States, much the way the U.S. now exports its inflation to China and Japan.

However, the money and credit supplied by the Fed unexpectedly produced the speculative stock market bubble of the roaring 1920s. When Benjamin Strong died in office in 1928, his successor George Harrison (not of Beatle’s fame) understood the problems and addressed them by correctly tightening monetary policy, reversing the inflationary expansion that occurred under Strong.

It is to this action which Bernanke objects and for which he blames the ensuing Great Depression. However, the problem was not that stock and real estate prices collapsed, but that they rose so much in the first place. It was not the mistakes of Harrison that caused the bust, but those of Strong that produced the false boom, making the subsequent bust necessary.

Had Harrison allowed the monetary expansion to continue, as Bernanke suggests he should have, the result would have been hyper-inflation, which would have produced even more dire economic consequences than did the bursting of the bubble. The problem is that Bernanke, like Harrison, will soon replace Greenspan, the modern version of Benjamin Strong (though a more accurate comparison may be to Montague Norman, the governor of the Bank of England during the 1920s.). However, unlike Harrison, Bernanke will likely make the wrong policy choice.

Ben Bernanke believes that credit expansions need never end - that a boom can be prolonged indefinitely simply by printing enough money. The fact that the incoming Fed chairman believes such nonsense is similar to a cold-war president having believed he could win a nuclear war. However, Bernanke’s finger will not be on the button, but on the printing press: and he seems itching to crank it up as he is convinced he will win the deflation war.

When asset prices are too high, credit out of line with savings, and consumption out of line with production, serious economic imbalances result. Curing those imbalances is a painful but essential process. In attempting to prevent the adjustments from taking place, Bernanke will do far more harm then good.

As a result of his confusion, Ben Bernanke wants to cure the disease by killing the patient. The best analogy is to a heroin addict continuously shooting-up to avoid the unpleasant reality of withdrawal. He may “succeed” but only by dying. In economic parlance, hyper-inflation is the monetary equivalent of a drug overdose, and Dr. Ben (Kevorkian) Bernanke seems dead set on administering it.


TOPICS: Business/Economy; Constitution/Conservatism; Crime/Corruption
KEYWORDS: auricshillmaster; bernanke; buymygold; fed; goldbuggery; goldgoldgold; goldmineshafted; goldshillery; greatdepression; yukoncornelius
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1 posted on 12/08/2005 2:26:56 PM PST by hubbubhubbub
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To: hubbubhubbub
Bull puckey. Money shrank in the 20s.

1) The money growth fell behind manufacturing growth for the entire decade; and the U.S. maintained a balance of trade surplus or, at the worst, was even, throughout the 20s;

2) in addition to that, we had net inflows of gold, for which the Fed was to pump up the money supply proportionally---it didn't;

3) there is NO scholarship that can identify a stock "bubble" as defined by stock prices wildly out of kilter with company values and/or reasonable expectations. The very stocks that were soaring were the same companies that were booming---utilities, cars, radios, and so on. What's interesting is that several economists have asserted a bubble existed, but as of 2000 when I last surveyed the scholarship on this, there were not studies that found a bubble and two that found exactly the opposite;

4) the Fed allowed the money supply to plunge 1/3 after the stock market crash, and failed to perform the role of lender of last resort for crucial big banks like Bank of United States and the big Nashville bank (whose name escapes me).

We came up waaaaayyyy short on money compared to goods---the classic definition of deflation. Bernanke is 100% right.

2 posted on 12/08/2005 2:32:46 PM PST by LS
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To: hubbubhubbub

BTTT


3 posted on 12/08/2005 2:43:42 PM PST by Fiddlstix (Tagline Repair Service. Let us fix those broken Taglines. Inquire within(Presented by TagLines R US))
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To: hubbubhubbub

The Great Depression was in truth the "great deflation." It wasn't just stocks that fell in value. Too few dollars, chasing too many goods. Prices had to fall as a result, and did.


4 posted on 12/08/2005 2:46:17 PM PST by RegulatorCountry
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To: LS
You seem knowledgedable on economics. Maybe you can answer a question for me.

You frequently hear people talk about the gvt "just printing more money". However my understanding is that this does not in fact really happen. It would seem to me their control of money would be mainly limited to:

1) Changing the reserve rate to alter the multiplier effect.
2) Changing the federal funds rate in an attempt to alter the general interest rate, thereby again altering the multiplier effect.
3) Buying or selling obligations to absorb or distribute dollars.

So what am I missing?
5 posted on 12/08/2005 2:51:36 PM PST by Pessimist
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To: LS

1) The money growth fell behind manufacturing growth for the entire decade; and the U.S. maintained a balance of trade surplus or, at the worst, was even, throughout the 20s;

False. If U.S. had balance of trade surplus throughout '20s as you contend, then by definition (Econ 101) money supply grew through this trade.

2) in addition to that, we had net inflows of gold, for which the Fed was to pump up the money supply proportionally---it didn't;

False again. By definition if the U.S. had inflows of gold going into their vaults as you contend, then they printed more money to redeem the gold with. Or, is it your wild contention that citizens made DONATIONS of gold to the government. Point in fact U.S. money supply growth was 60% in the Roaring 20s. It was in fact reckless. It was done to help bail out England from WWI.

3) there is NO scholarship that can identify a stock "bubble" as defined by stock prices wildly out of kilter with company values and/or reasonable expectations. The very stocks that were soaring were the same companies that were booming---utilities, cars, radios, and so on. What's interesting is that several economists have asserted a bubble existed, but as of 2000 when I last surveyed the scholarship on this, there were not studies that found a bubble and two that found exactly the opposite;

False. See my earlier point on money supply growth which led to the bubble and a host of malinvestments. True there were companies that were booming during this time but once every household which had electricity bought a radio, washing machine and car - where were the new customers supposed to come from after that? Hence a business downturn was due.

4) the Fed allowed the money supply to plunge 1/3 after the stock market crash, and failed to perform the role of lender of last resort for crucial big banks like Bank of United States and the big Nashville bank (whose name escapes me).

False. The Fed choked off money supply growth and raised interest rates starting in 1928. In fact, starting in January 1928 the Fed raised rates four times from 3.5% to 6% thus setting the stage for the market downturn. The smart money guys like Joe Kennedy and Bernard Baruch saw the money supply contraction taking place and got their money out of the market well in front of the crash. You did get one thing right in your entire post. The Fed did continue constraining money supply growth right through 1933. I'll give you credit for that. LOL


6 posted on 12/08/2005 3:10:53 PM PST by hubbubhubbub
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To: Pessimist
You know more than I do---I think the latter of the three you listed is currently the most common method of expanding the money supply.

In the 1920s, however, even the Fed had an additional restraint that we don't have now, namely, it was supposed to keep the paper money supply at some relatively fixed ratio to government gold. By the late 20s, however, many of the major nations abandoned the gold standard; and this placed additional pressure on those nations remaining on gold. It was reverse "gresham's law," in that if France was not on gold, you could buy dollars with francs, exchange dollars for gold, but we could not get gold for francs. So there was a net outflow of gold, which was seriously undermining the whole economy. If ALL had gone off gold, it wouldn't have been a problem. But by 1932, ONLY the U.S. was on the gold standard, and it was rapidly causing the collapse of the U.S. monetary structure, as the gold was just flowing out.

FDR's prohibition against owning gold privately and taking the government off gold are often berated by conservatives, but that action (and no other that he took, really) saved the banking system, which, after two years, was finally on an even playing field with the rest of the world.

7 posted on 12/08/2005 3:26:18 PM PST by LS
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To: hubbubhubbub
Are you nuts? The "money supply" doesn't magically appear: the Fed has to order the dollars by monetizing the debt. It didn't. But the evidence is overwhelming---not theory---EVIDENCE---that this did not happen.

You really don't understand this at all, do you? We had foreign trade balances where governments made payments to us to cover the debt in securities. Again, this did not automatically result in "more dollars." It would only do so if the Comptroller printed up more money, which did not happen.

Wrong. You have no evidence, only some crackpot theory that there was a stock market bubble. Find some evidence. Find some actual studies that support anything you say.

4) You agree with me. Thank you. That's exactly what I said in the whole post: the Fed did NOT keep up the money supply. Since you want to cite Econ 101, find me ANY measure of the money supply in the 1920s. You'll see they all fell; that prices fell steadily---not just after 1928. In fact, they fell since 1920, by a lot.

As for your notion about "big money" guys somehow getting off scott free, guess that didn't apply to Samuel Insull or thousands of other millionaires who lost everything.

8 posted on 12/08/2005 3:31:30 PM PST by LS
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To: hubbubhubbub
This could be too simplistic, but, in the early 30's, the money supply constricted by 31%.
It seems, if anything, it was a run on the banks that caused the constriction, or least was a huge contributing factor.
9 posted on 12/08/2005 4:02:21 PM PST by stylin19a (you can leed Freepers to spelchek, but you can't make 'em use it.)
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To: hubbubhubbub; LS; All

Wikipedia has a go too at this "Holy Grail" of economics:
http://en.wikipedia.org/wiki/Causes_of_the_Great_Depression


10 posted on 12/08/2005 6:46:29 PM PST by baseball_fan (Thank you Vets)
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To: hubbubhubbub
It was Milton Friedman who popularized the bizarre idea that the Federal Reserve caused the Depression by failing to cause enough inflation and credit expansion.

The confusing, and perhaps fatal, thing was that the expansion of the 1920's was superimposed, so to speak, on a period of genuine progress following the First World War. Contrary to the current mythology, technological and economic progress make things cheaper, not more expensive.

11 posted on 12/08/2005 6:59:32 PM PST by Christopher Lincoln
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To: hubbubhubbub

I'm amazed.

Really.

Most of the comments on this article are correct, and show a firm understanding of the cause and effects of the use of fiat money. Congratulations, Freepmates!

The article is wrong, as my Mates say above, because the Fed did cause the Great Depression by failing to increase the stock of high-powered money fast enough, as the collapse in bank deposits accelerated.

What they should've done, as Bernanke knows, is to buy government securities as fast as they could, and when they ran out of them, buy anything else they can find: stocks, bonds, wheat, real estate - anything to get money in the hands of the people.

Instead, faced with the Fed's failure to both understand and accomplish its assigned tasks, the US treasury ended up buying all the silver in the world, ruining the Chinese economy, and setting the stage for the Japanese conquest of the Celestial Empire.

The Fed's actions caused the war in the Pacific.

The Fed is the single most powerful entity on earth and it must be watched closely.


12 posted on 12/09/2005 3:34:08 AM PST by Santiago de la Vega (El hijo del Zorro)
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To: baseball_fan
One of the problems has been a failure of integration of these theories. They aren't all right, nor all wrong. Keynes, mostly wrong. Peter Temin proved that there was some slowdown in the housing market prior to the Crash, but not much, and not enough to explain the GD. Friedman has really not taken into account the impact of gold, as has Barry Eichengreen ("Golden Fetters"), but it's more than gold. Neither Eich. nor Friedman really show the significance of the Hawley-Smoot Tariff, as Jude Wanniski did (and as new studies by Doug Irwin and Mario Crucini support).

I give a brief overview of where all the literature stood as of 1994 in "Business History Review" in an article called "American Commercial Banking: A Historiography," or some such title.

What is important is that most of the research is starting to find a position to the right/center, which is that a) there was no bubble, or not enough of a bubble to cause the GD; 2) the stock market crash was caused by the HS Tariff AND by business expectations of what the HS Tariff would do, 3) COMBINED WITH the ongoing deflation (that few serious scholars deny), which had the effect of making (as Irwin shows) the real effect of HS about a 5% hit on the U.S. economy. (This is the equivalent of 5-10 "9/11s" in terms of damage to the economy, as Irwin and Crucini show).

Friedman was mostly right in that the Fed simply failed to keep up with the productivity and output, but he failed to really tie this into the declining gold stocks, whereby under the old Fed rules and the International Gold Standard, governments were OBLIGATED to print new money in proportion to rising gold stocks, and to take money out of circulation with falling gold stocks.

Keynes was right only that there was a skewed wealth curve, but didn't get that that was normal and desirable in a GROWING economy, especially one filled with inventors pouring out new inventions, as occurred from 1900-1930.

In short, all the modern scholarship points pretty strongly to a consistent story of the GD in which primarily the government is the culprit, exacerbated only by businesses' expectations of what else the government might do.

See my book, "The Entrepreneurial Adventure," (Harcourt, 2000) especially the sidebar section on the most recent economic studies, althoughwe repeat much of the essence of this in "A Patriot's History of the United States."

13 posted on 12/09/2005 3:48:32 AM PST by LS
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To: LS
The money growth fell behind manufacturing growth for the entire decade;

A better comparison is credit to GDP. In 1929, it reached 260%, today it's more like 300% which the Fed controls mainly by adjusting reserve requirements. You can see in this table http://www.federalreserve.gov/releases/h3/hist/h3hist5.txt that reserves are up about 25% since 1975 while the monetary base (the banks' supply of credit) has increased from 108 billion to almost 800 billion.

14 posted on 12/09/2005 4:11:53 AM PST by palmer (Money problems do not come from a lack of money, but from living an excessive, unrealistic lifestyle)
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To: hubbubhubbub

The article is basically correct. Creating money to fight deflation is like pouring gasoline on a fire in the hope that it will spread up and not out. By not allowing it to happen, the inevitable contraction is only made worse and worse. In the end the only two remedies are depression and hyper-inflation and we all know which one will be chosen by the spineless politicians and their appointed money-monkey.


15 posted on 12/09/2005 4:16:26 AM PST by palmer (Money problems do not come from a lack of money, but from living an excessive, unrealistic lifestyle)
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To: hubbubhubbub
Upon further reflection, what we arguing about here is the tail and not the dog. The real problem in the 1920's and today is overproduction of goods. There are always ways to encourage or discourage production through manipulation of the money supply but the real cause of overproduction is psychological. If everyone believes they can sell more widgets and start producing them all at once, there will be an oversupply followed by a reduction of production followed by a ripple through the rest of the economy. Many times overproduction in different parts of the economy is not synchoronized so there is no overall expansion and contraction.

But money supply tinkering is an especially good (or bad) way to synchoronize the entire economy which is what happened in the early 20's after the contraction of 1921 which was caused by the post WWI boom. The current overproduction is mostly abroad with China's non-capitalist economy contributing far too much production to the world market. There is unfortunately every incentive for communist businessmen in China to overproduce widgets of every type for both internal and export markets. The inevitable contraction to correct this would be so devastating to the Chinese economy and society that the central government refuses to do anything about it (such as floating the currency).

The bottom line is the current world overproduction will lead to a world contraction irregardless of money supply increases. The money will sit in banks unloaned which will prompt Bernanke to do his helicopter thing which will bring on hyperinflation and economic disaster.

16 posted on 12/09/2005 4:36:40 AM PST by palmer (Money problems do not come from a lack of money, but from living an excessive, unrealistic lifestyle)
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To: palmer

synchronize (which is bad), not synchoronize which is just bad spelling.


17 posted on 12/09/2005 4:38:50 AM PST by palmer (Money problems do not come from a lack of money, but from living an excessive, unrealistic lifestyle)
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To: Santiago de la Vega

"The Fed is the single most powerful entity on earth and it must be watched closely."

But it won't allow us to watch it anymore (M3 going stealth next year). Why? What does the Fed know about '06 that it's not telling us?

Notice how Gold has gone up almost everyday since the M3 announcement and Bernanke was confirmed. Something smells here.



18 posted on 12/09/2005 5:38:10 AM PST by hubbubhubbub
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To: LS

Fellow crackpot. Quit your stammering and spouting and engage your brain.

My sources are Rothbard (America's Great Depression), Reed (Great Myths of Great Depression) and Friedman/Schwartz (Monetary History of the U.S.) What are yours??


19 posted on 12/09/2005 5:44:11 AM PST by hubbubhubbub
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To: LS
Thanks for your response.

Last night I read the WSJ article about Bernancke that started this conversation. I know that by all accounts the guy is a conservative macro economics genius, so I imagine he'll be fine in the long run.

But I have to say I too question some of his assertions and plans.

I think the notion that its the pricking of the bubble that causes problems is essentially flawed. Apparently its based on the notion that its eventual natural deflation would not have been so cataclysmic. Unfortunately the article doesn't point out any evidence that would support that assumption.

Maybe more concerning though is his apparent intention to specify a target rate of inflation. No doubt Greenspan had some figure in mind anyway, but it was never exact or publicizes. To telegraph your intentions the way Bernancke wants to seems to me an open invitation for currency speculation and arbitrage.

Anyway, what do I know. He's a macro economic genius and I'm just an engineer, so I'm sure his points are probably going right over my head.
20 posted on 12/09/2005 7:30:36 AM PST by Pessimist
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