How the Recession of 1937-38 Shaped the Response to the Great Recession of 2007-09

Article Information

Posted on Tuesday, February 28th, 2012

Written by Kelly Hanlon

Today’s policy makers—particularly Ben Bernanke and Barack Obama—are students of the economic and political history of the 1930s.

Federal Reserve Chairman Ben Bernanke authored a paper in 1983 on the cost of credit intermediation (i.e. cost of transferring funds from savers to borrowers) during the Great Depression.  He found that recovery corresponded with the rehabilitation of the financial system. The increased cost of lending translated into the fewer loans which resulted in consumers reduce their demand for goods and services which in turn reduced aggregate demand.

Once the 2007-09 recession took hold, Mr. Bernanke was quick to take action so as not to repeat the policy mistakes of the 1930s. His 1983 argument foretold of the policies of the Fed under his leadership. At all costs, Mr. Bernanke sought to avoid credit markets seizing up. Many, many never before seen policies were implemented to provide liquidity to the markets. Of those, quantitative easing and interest rate policies are two of the most profound. However, economic woes have not ceased even after two rounds of quantitative easing—with a third under consideration—and with interest rates held at record lows for extended periods.

All the while, President Obama has been working to enact the “New” New Deal with a series of entitlement programs, infrastructure projects, and an overhaul of the tax system. Treasury Secretary Geithner has been financing the President’s massive new expenditures with newly created dollars, while increasing the national deficit by more than $1 trillion annually.

Although the mechanisms and specific policies have changed slightly in the seventy five years between the two recessions, the outcome of our current recession remains to be seen. Writing in The Economist, Zanny Minton Beddoes compared 2012 with 1937. Beddoes writes, “There will be parallels with 1937, when a wrong-headed tightening of fiscal and monetary policy dragged down America’s economy and extended the pain of the Depression. The details are different, but in 2012, too, avoidable errors will ensure that the Great Stagnation lasts far longer than it needs to.”

As to the forecast for 2012? Beddoes predicts that 2012 will be the year of “self-induced stagflation” with “the most likely outcome [being] an economy not quite weak enough and a crisis not quite large enough to galvanize spineless politicians.”

Sound Money Through the Ages

Article Information

Posted on Thursday, February 23rd, 2012

Written by Kelly Hanlon

In The Theory of Money and Credit, published one hundred years ago, Ludwig von Mises wrote about the principles of sound money. He said

“It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the nonobservance of old customs by kings. The postulate of sound money was first brought up as a response to the princely practice of debasing the coinage. It was later carefully elaborated and perfected in the age which—through the experience of the American continental currency, the paper money of the French Revolution and the British restriction period—had learned what a government can do to a nation’s currency system.”

Edmund Burke writing in Reflections on the Revolution in France described one of these episodes in detail—the confiscation and sale of private property and the subsequent development and effects of paper currency. On the sale of church property, Burke recalled that

“pressed on all sides instead of the first plan of converting their bankers into bishops and abbots, instead of paying the old debt, they contracted a new debt, at 3 percent, creating a new paper currency, founded on an eventual sale of the church lands. They issued this paper currency to satisfy in the first instance chiefly the demands made upon them by the Bank of discount, the great machine, or paper-mill, of their fictitious wealth.

“The spoil of the church was now become the only resource of all their operations in finance; the vital principle of all their politics; the sole security for the existence of their power. It was necessary by all, even the most violent means, to put every individual on the same bottom, and to bind the nation in one guilty interest to uphold this act, and the authority of those by whom it was done. In order to force the most reluctant into a participation of their pillage, they rendered their paper circulation compulsory in all payments.

“Even the clergy are to receive their miserable allowance out of the depreciated paper which is stamped with the indelible character of sacrilege, and with the symbols of their own ruin, or they must starve. So violent an outrage upon credit, property, and liberty, as this compulsory paper currency, has seldom been exhibited by the alliance of bankruptcy and tyranny, at any time, or in any nation. " (Burke, 1790, pp.143-44)

In light of such an historical example, it was no stretch for Mises to introduce a “negative” liberty of the government in its responsibility of maintaining sound money. Mises concluded, “Thus the sound-money principle has two aspects. It is affirmative in approving the market’s choice of a commonly used medium of exchange. It is negative in obstructing the government’s propensity to meddle with the currency system.”

The End of Money?

Article Information

Posted on Friday, February 17th, 2012

Written by Kelly Hanlon

David Wolman, author of the recently released The End of Money: Counterfeiters, Preachers, Techies, Dreamers—And the Coming Cashless Society, predicts the fall of the dollar to some sort of purely electronic alternative whereby payments will literally be made without money…at least without money as we currently conceive of it.

Wolman began a recent column writing, “There are no atheists in the modern economy.  You may not have God or Buddha in your life, but you very much have faith—in money. … You have faith in its value.  Your trust in it depends on everyone else’s, which means that our faith in money’s value is really about trust in each other—a belief in shared purpose, or at least a shared hallucination.”

But it wasn’t always this way.  Until 1971, people trusted the value of a dollar because it was tied to gold—not because of their faith in one another, government bureaucrats, or hallucinations.  Why did people trust gold?  Gold has inherent value which it maintains for long periods of time.

Wolman continues, “a number of developments are ganging up on physical money like never before: mistrust of national currencies, novel payment tools, anxiety about government debt, the triumph of alternative currencies, environmental concerns, and growing evidence that cash is most harmful to the billions of people who have so little of it.”

Here, Wolman taps into the economic instability which arose from having a world dollar standard and through floating exchange rates.  Lewis Lehrman and John Mueller have extensively documented the ill-effects of these policies, collectively describing them as the “reserve currency curse.”

Lehrman and Mueller and Wolman agree that national currencies, manipulated as they are by central banks, are faltering and that ever-growing government debt is problematic.  Too, they agree that there are new technologies which will improve transaction efficiency.  And, they agree on looking at alternative monetary regimes.  On the particulars of this final point, however, the authors depart from one another.

Wolman argues that alternative currencies such as Ithaca HOUR, BerkShare, Facebook Credits, and Bitcoin will move us towards the non-national currency of the future.  Meanwhile, Lehrman and Mueller suggest that gold, a non-national currency and devoid of manipulation by central bankers, will be the currency of the future. Lehrman proposes to

“limit manipulation of central bank credit and exchange rate policy intended to gain trading or employment advantages through currency depreciation—that is, to ‘beggar thy neighbor’ by exporting unemployment to other countries through currency depreciation and undervaluation.  In principle, mutual convertibility to gold—without the ‘exorbitant privilege’ and insupportable burden of official reserve currencies—established a necessary, self-denying ordinance by participating nations, in the interest of the common good, in order to enhance mutual prosperity and to preserve free and fair trade among sovereign nations.”

While Wolman describes the transaction-based financial problems of the world’s poor such as access to banking services, Lehrman and Mueller are more concerned about the declining value of the dollar and its effect on the working class.  Lehrman argues that under a true gold standard, “the future purchasing power of wages, salaries, savings, and pensions is preserved.  Security of the most vulnerable in society is assisted by maintaining long-term stable purchasing power of the currency for those on fixed incomes” (emphasis original).

Although Wolman convincingly argues that today’s monetary regime is inefficient at best and harmful at worst, the currency of the future isn’t likely to be Bitcoins or Facebook Credits.  Wolman himself acknowledges the challenges of these sorts of alternative currencies.  He writes, “the hazards are just as real, too.  For alternative currencies, the risk of a mismanaged money supply is alive and well, and a misstep, or a crisis in confidence…could cause the [currency’s] value to plummet.”

Wolman concludes, “A closer look at the long history of cash, its present-day costs and the flood of emerging technologies suggests that we may very well be on the brink of a monetary revolution.”  On this final point, Lehrman and Mueller might agree that we are, in fact, on the brink of a monetary revolution—one that is long overdue.  For Lehrman and Mueller, however, the monetary standard of the future will be gold-based rather than the fictitious currencies that Wolman imagines.

A Recipe for Calamity: The “Soft” Dollar Standard

Article Information

Posted on Tuesday, February 14th, 2012

Written by Kelly Hanlon

Economists often talk about the rules of the game—common standards, along with their virtues and vices, by which market participants are expected to behave.

Lawrence Busch, a sociologist at the University of Michigan, published a new volume titled Standards: Recipes for Reality. In it, Busch reflects on the nature of standards, their origins, and the many social, cultural, legal, and even economic implications of standards.  The book is far-ranging, examining everything from agricultural and accounting rules to communication and health regulations.  Fascinating stories and historical facts abound throughout the book.  Of monetary exchange, Busch argues that for “transactions to be possible, there must be a standard for money (today it is in the form of coins or bills), as well as for any weights, measures, or scales involved in the transaction.  Without those standards, a money society is virtually impossible.”

Moreover, Busch cites texts from the major religions of the world each of which ascribes importance to standards, including those pertaining to the honest trade through the exchange of goods and services.  Summarizing these texts, Busch writes, “each of these ancient revered texts links standards with divinity as well as justice, and emphasizes the moral duty involved in upholding standards, both in the literal sense of providing true weights and measures and in the figurative sense of measuring up.”

Indeed, there are moral implications about a society’s chosen monetary standard.  For America and the world, these implications are profound.  Writing in The Age of Inflation, Jacques Rueff accurately predicted our current state as a “deficit without tears.”  Lewis E. Lehrman further explores this point in The True Gold Standard, describing the long-term effects of current Treasury and Federal Reserve policies, which have resulted in record-breaking twin deficits, as a “Ponzi-like scheme.”

In consideration of the bailouts of the 2008 recession, Lehrman writes, “Sending millions of small businesses and families to bankruptcy court—while bailing out both foreign governments and cartelized and subsidized banks and businesses—eviscerates free and fair markets.  Such a corrupt abuse of taxpayer resources destroys the confidence, incentives, and moral dispositions of all prudent and disciplined market participants” (emphasis original).  Meanwhile, Busch describes the taxpayer bailouts of banks during the 2008 recession as “nationalizations, putting governments in control of a significant portion of the world’s financial assets.”  While true, Busch fails to address the root of the problem—a “soft” monetary standard—by which governments have seized control of nearly all assets through arbitrary valuations of the dollar.  Such valuations are not based on market demand and supply but rather on elite policymakers best guesses.  Under the classical or true gold standard, Lehrman argues that statutory convertibility to gold will end the “undisciplined, virtually unlimited discretion of the Federal Reserve Board.” A two-fold effect will result: 1) “inflationary financing of government budget and balance-of-payments deficits [will be] forestalled” and, 2) budgetary and payments equilibria over the business cycle [will be] reinforced” (emphasis original).

As cited earlier, Busch, albeit indirectly, concedes that establishing a sound monetary standard is one of the most profound decisions that a society makes since it effects not only the current generation but every generation yet to come.  Indeed, the American founders recognized this and were universally averse to paper money, preferring instead gold- and silver-backed currency.  The Constitution declared that nothing but gold and silver coin shall be made legal tender.

Given Busch’s far-reaching exploration of standards of all kinds, one would have hoped that the monetary standard would have been more carefully and fully considered.  After all, the “soft” dollar standard has been a “recipe for reality” resulting in ever-increasing economic calamities for most of the last century.