What Can We Learn from the 1930s?

From Mr Thomas Janichen.

Sir, Why create another bad bank ? We have enough already.

-Letter to the editor, Financial Times, January 17/18, 2009.”

Conspicuous intelligence seemed actively unwelcome in the Bush White House.

-David Frum, speechwriter for George W. Bush during his first term.

His administration staged some 200 ‘town hall’ events attended by pre-screened participants... yet at the end of it all, support for Mr Bush’s proposal was lower than when it began.

-The Economist, January 17-23, 2009.

Bush - or at least his reputation - is dead. Long live Obama. The Economist magazine makes a decent fist of providing a not entirely partisan assessment of the achievements of George Walker Bush (in a special article entitled “The frat boy ships out”, and to be fair they endorsed him the first time around) but it is plain where the journalistic, if not editorial, sympathies broadly lie now. Princeton historian Sean Wilentz is cited: “Many historians are now wondering whether Bush, in fact, will be remembered as the very worst president in all of American history.”

Americans, of course, do not follow the strict Anglo-Saxon “King is dead” protocol that venerates the role, if not necessarily the incumbent, following a change-over in the administrative hierarchy. But then they claim to be republicans, with that small ‘r’. In any case, Barack Obama has inherited a right royal mess of pottage.

Perhaps the biggest danger is to assume, in a crisis, that politicians are in much of a position to help anybody, other than themselves. From what I remember of my pre-O level days, my school didn’t commit the biggest resources to the study of the Great Depression. But I distinctly remember a half hour devoted to the topic, and the general implication was: Franklin Roosevelt helped end it. After reading Murray Rothbard’s America’s Great Depression (Fifth edition 2008, by the Ludwig von Mises Institute), I am no longer so sure. In fact, after reading Rothbard’s study of the economic disaster of 1930s North America / rest of the world, I am left wondering whether pretty much everything I had been led to believe about that time is wrong. Since we are poised on the precipice of our very own 1930s, the question bears repeating.

Rothbard died in 1995. He was therefore unable to comment about the colossal bonfire of vanities stoked by Wall Street and the mortgage banking system over the past decade. It is unlikely, however, that he would have approved. He was not exactly a fan of the role of banks, nor of the perhaps fundamentally flawed model known as fractional reserve banking.

If it were a more perfect world, schoolchildren would at least be taught the bare minimum about the real economy, and not least about the way banks work. (One of the statutory objectives of the UK’s Financial Services Authority is to “promote public understanding of the financial system”. If the UK financial regulator can’t pull that trick off now, it will never get a better opportunity in the history of the world.) What we know as fractional reserve banking equates to letting banks keep a tiny fraction of their deposits (their depositors’ money, one should perhaps add) in order to lend out the remainder for profit (theirs, not the depositors’, one should perhaps add). Simultaneously, they retain the obligation to redeem all depositors immediately upon demand. More astute readers, or anyone who has maintained a bank deposit account over the last two years, will see the subtle flaw in this system. In the words of Murray Rothbard:

Banks are “inherently bankrupt” because they issue far more warehouse receipts to cash (nowadays in the form of “deposits” redeemable in cash on demand) than they have cash available. Hence, they are always vulnerable to bank runs. These runs are not like any other business failures, because they simply consist of depositors claiming their own rightful property, which the banks do not have. “Inherent bankruptcy,” then, is an essential feature of any “fractional reserve” banking system.

Rothbard goes on to cite Frank Graham (“Partial Reserve Money and the 100% Proposal,” American Economic Review, September 1936):

The attempt of the banks to realize the inconsistent aims of lending cash, or merely multiplied claims to cash, and still to represent that cash is available on demand is even more preposterous than... eating one’s cake and counting on it for future consumption... The alleged convertibility is a delusion dependent upon the right’s not being unduly exercised.

Rothbard wrote the following in 1963. The subsequent 46 years have not dulled the message:

There are other values in deflation, even in bank runs, which should not be overlooked. Banks should no more be exempt from paying their obligations than is any other business. Any interference with their comeuppance via bank runs will establish banks as a specifically privileged group, not obligated to pay their debts, and will lead to later inflations, credit expansions, and depressions. And if, as we contend, banks are inherently bankrupt and “runs” simply reveal that bankruptcy, it is beneficial for the economy for the banking system to be reformed, once and for all, by a thorough purge of the fractional reserve banking system. Such a purge would bring home forcefully to the public the dangers of fractional reserve banking, and, more than any academic theorizing, insure against such banking evils in the future.

But the savaging of fractional reserve banking is only a small part of the message of Rothbard’s “America’s Great Depression”. Contrary to the received wisdom that interventionist government (under, Rothbard points out, the administration of Herbert Hoover for some years before Roosevelt took the presidency) ameliorates and foreshortens a dismal business depression, Rothbard suggests that the very intervention so clamorously called for (both then and now) actually extends and amplifies it:

If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt? The first and clearest injunction is: don’t interfere with the market’s adjustment process. The more the government intervenes to delay the market’s adjustment, the longer and more gruelling the depression will be, and the more difficult will be the road to complete recovery. Government hampering aggravates and perpetuates the depression. Yet, government depression policy has always (and would have even more today) aggravated the very evils it has loudly tried to cure. If, in fact, we list logically the various ways that government could hamper market adjustment, we will find that we have precisely listed the favourite “anti-depression” arsenal of government policy. Thus, here are the ways the adjustment process can be hobbled:

1. Prevent or delay liquidation. Lend money to shaky businesses, call on banks to lend further, etc.
2. Inflate further. Further inflation blocks the necessary fall in prices, thus delaying adjustment and prolonging depression. Further credit expansion creates more malinvestments, which, in their turn, will have to be liquidated in some later depression. A government “easy money” policy prevents the market’s return to the necessary higher interest rates.
3. Keep wage rates up. Artificial maintenance of wage rates in a depression insures permanent mass unemployment. Furthermore, in a deflation, when prices are falling, keeping the same rate of money wages means that real wage rates have been pushed higher. In the face of falling business demand, this greatly aggravates the unemployment problem.
4. Keep prices up. Keeping prices above their free-market levels will create unsaleable surpluses, and prevent a return to prosperity.
5. Stimulate consumption and discourage saving. We have seen that more saving and less consumption would speed recovery; more consumption and less saving aggravate the shortage of saved-capital even further... Any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is all consumption... Any increase in the relative size of government in the economy... shifts the societal consumption-investment ration in favour of consumption, and prolongs the depression.
6. Subsidize unemployment...

One does not have to agree with every one of Rothbard’s admonitions to see the value in the general argument. What stand out most ominously amid the current “race to avoid (i.e. cause) depression” are features 1, 2 and 5 in the current crisis. When a surfeit of easy money largely provoked the banking crisis, it is difficult indeed to see how even more of the same can help to resolve it.

Rothbard was a fervent free marketeer. His conclusion:

Only governmental inflation can generate a boom-and-bust cycle... the depression will be prolonged and aggravated by inflationist and other interventionary measures. In contrast to the myth of laissez-faire, we have shown (in “America’s Great Depression”) how government intervention generated the unsound boom of the 1920s, and how Hoover’s new departure aggravated the Great Depression by massive measures of interference. The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy, and placed where it properly belongs: at the doors of politicians, bureaucrats, and the mass of “enlightened” economists. And in any other depression, past and future, the story will be the same.

The taxpayers’ money committed to the banking crisis has been, by any measure, stunning. Bloomberg suggests the total US tally of liabilities, to date, now sits at $7.8 trillion – or $24,000 for every man, woman and child in the country. The Daily Telegraph suggests that the UK total sum of taxpayers’ liabilities spent or pledged amounts to almost £1 trillion – or £33,000 per taxpayer. One is entitled, as voter and taxpayer, to ask precisely what “improvement” in economic or banking conditions such stupendous capital commitments have provoked.

It is not my wish to carve out of Rothbard’s stirring call-to-arms its fundamental appeal, merely to hint at it. Readers intrigued by his thesis, not least in how it stands markedly at odds with conventional wisdom in fighting the current banking crisis, should simply buy the book and read it for themselves. But profound depression is likely to be the inevitable outcome, in both senses of the word.

Comments

[kelm:]

Great article. I would add that we also need to remember that our initial conditions are different. We entered this debacle as a net debtor, net consumer/importer nation. Not only are we repeating the same mistakes of the past but our different entry conditions can make the outcome significantly worse. Imagine that we start off facing a depression with classic deflation as many project only to see it turn into Weimar Republic hyperinflation as we try and print our way out of it.

Jan 19 01:20 PM

[Still Renting:]

A huge difference between now and the great depression is that we won't have people selling apples in the streets this time.

They cannot aford the price nor time commitment of the permit process.

Jan 19 03:18 PM

[CLH:]

Very good article. Holding up prices and wages is the worst thing that the govt can do during deflation. A little over a year ago the democrats passed a law pushing up the mimimum wages (against the Republicans belief). Now the chickens have come home to roost as unemployment soars. Yes people are laid off because the company owners cant afford to pay high wages in a deflation.

WAke up Obama!!!! Are you really retarded?

Jan 19 06:38 PM

[E.D. Hart:]

If you are going to have a minimum wage, then it ought to keep pace with inflation. It hasnt kept pace with inflation --not by a long shot.

Sooo, recent attempts to raise it to keep pace are still far short or where it needs to be. The previous 8 years of the Bush presidency has been led by a nearly jobless recovery.

Few jobs were added and the minimum wage stagnated in real terms.

That is to say, employment didn't substantially increase even when wages were stagnant, or even declined in real dollars.

Thus, the absence of a meaningful minimum wage increase during the Bush years has corresponded with lack of employment growth. This is precisely the opposite of Republican orthodoxy.

Job losses now are from industry cutbacks, recession, and global deleveraging--not from an increase in the minimum wage.

Jan 19 07:00 PM

[MGA_1:]

#1 - This thing has *just* gotten started. '08 was the prelude. The great depression started with a stock market crash and then businesses started laying off.
#2 - The problem won't end until we can start paying for our imports which will require the resurgence of American manufacturing
#3 - I think it's going to turn into a depression (10% drop in GDP), maybe worse.
#4 - With trillion dollar deficits projected I'll be willing to wager we'll end up with an inflationary depression (along the lines of Argentina in 2000).
#5 - I wish the government could save us - I don't think they can, but we do have a much better social safety network than in the 30's.
#6 - I hope I'm wrong regarding all the above !

Jan 19 07:37 PM

[Vox Rationalis:]

jksisco wrote: "you deposit $10, the bank loans out $90 at interest..."

No, this is a pretty common error. Your bank loans out $9; it does not create $80 out of whole cloth. The $9 loan is used and deposited elsewhere, and the process repeats. As the number of these cycles approaches infinity, the amount lent (created) by the banking system approaches $90.

Jan 19 09:37 PM

[Vox Rationalis:]

CLH wrote: "A little over a year ago the democrats passed a law pushing up the mimimum wages (against the Republicans belief). Now the chickens have come home to roost as unemployment soars."

You really think unemployment's climbing in any significant measure because of an increase in the minimum wage from $5.85/hour to $6.55/hour or because it's going to $7.25 later this year? Seriously?

"Yes people are laid off because the company owners cant afford to pay high wages in a deflation."

How many of the job cuts we've been hearing about were minimum wage jobs? Wait, I'll answer that for you. NONE. Please, go ahead and show how wrong I am with some data.

Jan 19 09:44 PM

[Conan the B...:]

BS Detector: "How many of the job cuts we've been hearing about were minimum wage jobs?"

You said: NONE.

I'll ask you the same question you asked.

Please, go ahead and show me some data which Proves that NONE of the Job losses included people receiving the Minimum Wage.

LOL

Jan 19 10:53 PM

[Conan the B...:]

CLH: Let Obama get into office first.

While the Minimum Wage may slow new hiring, in a recession and in any business going through it, the workers with the higher paying jobs with higher benefits are more likely to be cut than the low income, low benefit earner.

The Minimum Wage is designed to help Entry Level Unskilled Labor cope with higher inflation and acquire the skills necessary not only to survive but to get a better education. Today's unskilled Labor will eventually improve the Nation as a whole.

The increase was necessary, the timing could have been better.

Small business which is the Backbone in the creation of new jobs must contend with the constraints of Minimum Wage increases and a Deep Recession.

I hope the Obama administration when it is in office, provides small businesses everything it possibly can in the manner of Tax Credits not just for equipment but for New Hires as well. IMHO

Jan 19 11:17 PM

[Maxe Paul:]

LOL, don't hold back on the critisism will you! Love the analogy.


On Jan 19 03:09 AM Sentinel wrote:

> The thing we can learn from the Great Depression is this is not the
> Great Depression.
>
> It is more like the Long Depression of 1873-1896 particularly in
> the way that it started...(real estate bubble bursting, albeit in
> Europe, which led to a global credit squeeze).
>
> However, mix in huge government intervention (which did not happen
> during the Long Depression but did in the Great Depression, lack
> of cheap, domestic fuel supplies, which we had during both Depressions
> and no longer have, and crushing governmental and personal debt,
> which we did not have during both Depressions, and we are certainly
> looking at a new kind of Depression for a new Century.
>
> Well.....we did vote into office for eight consecutive years a high
> functioning retard who promised to protect us and did not and a Messiah
> who will be incapable of saving us.
>
> And we all voted to hop on the Mortgage and Derivitives Lady and
> ride her like a whore.
>
> Yeah,,,,throw out the textbooks....this one is going to be nasty
> and unpredictable.

Jan 20 02:59 AM

[Charlie Tuna:]

The last time that the Economist magazine printed at article criticising a world leader this harshly, was Winston Churchill; and we all now know how accurate that prediction turned out to be.

Jan 20 03:51 AM

[Randall Arnold:]

CLH, raising the minimum wage will have zero effect on the current crisis. But surely you knew that, and just wanted to bag on Democrats (it can be fun after all).

However, I hate to break it to Republicans, but the answer to all of this really is regulation. You call it "accountability" but have this quaint notion that such a system can come about solely by virtue of honor. History tells us this is naive. They do teach history to Keynesians, right?

How regulation became a dirty word I do not know, but if it is an evil it is a necessary one. Regulation, ie ensured accountability, throttles the excesses that cause disruption the system cannot tolerate. Necessary disruptions (such as technological advance) are special causes that must be managed as well, else they destroy the status quo a bit TOO fast.

Anyway, interesting article to be sure!

Disclaimer: I do not belong to any political party mentioned.

Jan 20 09:11 AM

[Randall Arnold:]

paultat, you're missing the point of BS detector. Ok, maybe 1 or two "burger flippers" lost their jobs recently. But the low-end service industry is where I'm seeing the job vacancies. And yes, by and large the people being laid off in droves (ie, tens of thousands at a time) were making much, much more than minimum wage.

Again: the increase in minimum wage had nothing to do with this disaster, and really won't affect it, either.

Jan 20 09:15 AM

[Milton:]

Crocodilian,

You are wrong. There is a large difference between placing one's money in a demand account (a.k.a. Checking) and in placing one's money into an investment account (a.k.a Savings).

Average Americans have been led to believe that Banks do exactly what you say they shouldn't do: hold their money safely. Banks should only lend money that customers want them to lend and reward them for the use of THEIR money with a mutally agreed upon interest. Fractional reserve lending has been a fraud born in deception from the beginning.

Fractional reserve banking allows private institution to create money and charge interest on loans without any consideration (collateral of value). Even worse, our current arrangement allows central banks to 'bailout' failing banks, preventing the corrective measures necesssary (bank runs) to keep banks from indulging in the easy temptation of lending too much.

Government should be the sole creator of money and it should create it debt-free (i.e. Lincoln's United States Notes). The supply of money should be set to increase at a set rate to match population growth (3-5%). If however Government prints too much, inflation will occur, and we'll throw the dogs out. If deflation occurs, we know exactly who to hold accountable.

Moral capitalism requires a Full Reserve Debt-free Monetary system and moral capitalism is sustainable.

Monetary Reform Act = No National Debt, Accountable Inflation, Lower Taxes
www.themoneymasters.co...

Jan 20 09:24 AM

[Vox Rationalis:]

paultaut wrote: "I'll ask you the same question you asked. Please, go ahead and show me some data which Proves that NONE of the Job losses included people receiving the Minimum Wage. LOL"

In response to what I wrote: "How many of the job cuts we've been hearing about were minimum wage jobs? Wait, I'll answer that for you. NONE. Please, go ahead and show how wrong I am with some data."

First, I'm still waiting for the question you said you were going to ask. Second, all I'm asking is for somebody to find a single news release or article announcing that any recent job cuts were minimum wage jobs. Seems pretty easy, rght? In comparison, it's not possible for me to provide sufficient data to prove what you (didn't) ask; how could we be sure I'd found all of the cut jobs?

Jan 20 09:42 AM

[Conan the B...:]

BS D: This is Your statement from the comment directly above mine. You said " How many of the job cuts we've been hearing about were minimum wage jobs?"

You promptly answered your Own Question:" NONE ".

You then went on to ask CLH to show you some data to prove how wrong you are.

My request was very simple and I really do not understand how you could have possibly missed your own words quoted back to you.

You said None of the job losses were minimum wage jobs.

So I want you to prove your statement with some facts and figures.

Is this clearer than the previous question.

You made a very clear statement but you obviously knew that CLH couldn't answer it. Of course, I knew you couldn't answer my query for the very same reason.

Which is why I included the "LOL".

Jan 20 10:24 AM

[Conan the B...:]

Randall: by any chance were you addressing paultaut?

If you were, the you obviously chose to ignore my response to CLH.

One of the arguments used by opponents of the Minimum Wage hike was the associated decrease in hiring by small businesses. Small Businesses which are trying to cope with a Deep Recession with tight credit conditions will have another obstacle with the implementation of the second phase of the Minimum Wage.

paultaut

Jan 20 10:50 AM

[Randall Arnold:]

Sorry, paultat, I don't believe minimum wage will be an obstacle. It may be touted as one by opponents, but that's just a red herring. After all, as many often argue, who really pays minimum wage? I fail to see how it hurts anyone seeing as how the real wage bottom tends to be above the established minimum.

Jan 20 02:29 PM

[Vox Rationalis:]

paultaut wrote: "My request was very simple and I really do not understand how you could have possibly missed your own words quoted back to you."

I missed nothing. I pointed out that you wrote that you would ask a question and then did not. Parse the words.

Now to the substance. I'm asking for one example of a job cut announcement including a single minimum wage job. You're asking for proof that every job cut announced does not include a minimum wage job. Do you not see how much simpler my request is than yours?

No, perhaps you don't.

Jan 20 09:15 PM

[Crocodilian:]

On Jan 20 09:24 AM Milton wrote:

> Crocodilian,
>
> You are wrong. There is a large difference between placing one's
> money in a demand account (a.k.a. Checking) and in placing one's
> money into an investment account (a.k.a Savings).

You'll see, if you read the fine print, that "checking" accounts have become "interest checking" accounts. In order to pay interest, the banks have to do something with the money other than to hold it in cash, and typically, if you look at the checking account agreements, you've agreed to that.

>
> Average Americans have been led to believe that Banks do exactly
> what you say they shouldn't do: hold their money safely.

Sorry: where does it say that? Banks have FDIC insurance, and state quite clearly which products are insured, and to what levels.

> Banks should
> only lend money that customers want them to lend and reward them
> for the use of THEIR money with a mutally agreed upon interest.

Huh? You're suggesting that banks ask depositors for permission to make loans?

OK, if that's what you want, here's what you do. Take all your money out of the bank, in cash. Rent a safe deposit box, in their vault. Or build a vault in your basement.

Put your cash in it.

You've accomplished what you say you're trying to do.

> Fractional reserve lending has been a fraud born in deception from
> the beginning.

I'm not sure what this is supposed to mean.

Jan 28 08:37 PM