What Use Is Economic History?

In the blogosphere, 2=trend, and recently two high-profile financial journalists — Alan Beattie of the FT and Justin Fox of Time — have come out with heavyweight new books of economic history. Beattie’s False Economy looks at global development, while Fox’s The Myth of the Rational Market looks at the history of the efficient markets hypothesis. What I didn’t know until today was that Beattie and Fox are both distant relatives of misguided liquidationists — something which came out when I asked them both about economic history.

How relevant is economic history at times like this, I asked. Can studying history prevent us from repeating past mistakes, or does it just end up forcing us into committing new ones? And how much of a good thing is it that an economic historian is chairman of the board of governors of the Federal Reserve?

Beattie replied first:

- yes, I think it definitely helps when looking at such once-in-a-century events to have a discipline which focuses on specific similar episodes in the past, not least because the sample size is so small. And that does seem to be having some effect on the policy response now. Despite the best efforts of some, I don’t think the Montagu Norman/Andrew Mellon liquidationist instinct or the 1930s “Treasury view” on deficit spending are getting much serious traction in the US or UK, for example. (Irrelevant trivia: I am very distantly related by marriage to Andrew Mellon - something like a third cousin three times removed. She divorced him in a spectacular case involving all sorts of legal shenanigans and managed to walk off with a sizeable chunk of the Mellon loot, though not a nickel has trickled down to me.)

- but of course you need to learn the *right* lessons and pick the right comparator. the current German reluctance to increase fiscal stimulus, for example, seems to be assuming that this is a 1920s/1970s inflationary situation, not a 1930s deflationary one.

- it is good that an economist *who is also an economic historian* is Fed chairman. Not sure you’d want someone who was reading entirely out of the previous playbooks without also being able to recognise that the monetary transmission mechanism has changed out of all recognition. The General Theory is a bit light on what to do about credit default swaps, for example.

Then Justin weighed in:

My book is basically the story of a bunch of guys who decided to ignore financial market history (the dodgy parts, at least) in order to create more elegant models of financial markets’ future. That didn’t work out so well, so yeah, knowing economic history would seem to be useful. But Alan’s right that there are lots of different lessons that can be drawn from the past, and sometimes people draw the wrong ones. I too am related to a liquidationist, by the way—George Washington Norris, the hard-line president of the Philly Fed in the early 1930s, was my great great uncle.

On Bernanke, I’d certainly rather have somebody with his background in that job than an ahistorical rational expectations type who believes bubbles and panics don’t happen. He’s not really a historian, though. He’s a macroeconomist who’s done some research on the financial system breakdown of the early 1930s. He’s worked really hard to avert such a breakdown over the past two years, and on balance that’s a good thing. But he hasn’t really been a student of what causes financial crises in the first place. Still, he’s an open-minded guy who reads a lot, so maybe he’ll figure it out.

I’d be interested in what Brad DeLong — one of the foremost economic historians of our own time — thinks about whether the “Treasury view” is getting much serious traction — I suspect he might have killed it before it had a chance to spread widely, and it certainly doesn’t seem to have been mentioned much since January 20.

And in general I think that economic historians are having something of a day in the sun right now, with lots of people looking back to previous economic crises around the world, and fewer people finding modern theory-based economics particularly helpful from a policymaking perspective. Maybe economic history is a classic countercyclical asset.

Comments

[bricki:]

Economic history gives us something to point at; for example the purchasing power of the dollar declined 97% so we know we are doing something wrong.

Unfortunately the more desirable state of affairs would be that this history could be used to tell us what to do to actually fix an economic problem. Sadly Economics hasn't advanced to the point where it has fine grained predictive power. Until is does economic history will be a narrative rather than a body of data that can be used to build a future on.

May 28 06:16 PM

[puravidavid...:]

It is near-heresy to talk of the "Myth of Rational Markets." Bravo for Fox.

The notion that finance is best explained by classical economics should be ending soon. There is no fixed supply, no endogenous demand, nor any clearly distinct buyers (consumers) or selllers (producers) of financial market shares, bonds, etf's, etc. How can there be a price determined by supply and demand when every buyer is a trader who is a willing seller at another price?

Finance and markets are - at heart - a mood driven, herding activity based more on primal survival instincts than on (estimated and speculative) PE ratios, financial statements, discounted cash flows, etc.

Having audited Fortune 100 financial institutions, I understand how financial statement numbers are negotiated as opposed to discovered and revealed by the accounting/auditing process.

The markets seem largely to be a thermometer - not a barometer nor a scale for weighing - that mostly tells how hot or cold the buying/selling public is at any moment.

May 28 07:48 PM

[bcncv:]

Based on my previous career, I recently had a very similar debate to whether having a knowledge of military history made someone a better Army Officer. I actually think this is a perfect comparison.

The answer lies not in how much is known about the topic, but in an individuals ability to understand WHICH historical lessons can be applied. I know plenty of acedemic historians that would make horrible Army Officers. I also know plenty of excellent Officers that have very little knowledge of history. However, the best Officers know how to modify and adapt the lessons of history to fit the current situation.

I believe this applies to economists equally well.

May 28 07:53 PM

[debtacid:]

In this case, political history is more instructive. Start with The beginning of the fed in 1913, the 1929 crash, the new deal, bretton woods and the IMF in 1944, the great society, gold standard abandoned in 1971, Saving & loan housing bubble, tech bubble, and the current housing bubble. This crisis was caused by a long string of political failures, not economic.

May 28 08:08 PM

[reveigel@ms...:]

Economic history can be important, or it can be ignored. That seems to be the case when it comes to economics. Almost every action being taken today to correct a mess has been tried before and with disasterous results. Yet, we continue, and in essence are saying history is wrong. If you keep doing what has not worked in the past, but say it will be different this time, I call that stupidity. Many would say it is what politicians must do. Show the people that they care and are doing something about the problem. And because most people are economic illiterates they believe and accept those actions. Sadly today, many people are doing exactly what governments do.. If they have overspent and are in trouble, the way out is to spend more. The government has been a good teacher in a very poor way. And unless, and until the government admits it is the cause and insists on everyone, including members in government, to become literate in basic economics we will never recover, or if we do, will be back in another and larger mess sooner rather than later. Take this current financial mess, if the governments income and expense statement and balance sheet had been financially sound, the current problems would have had a minor impact. But when expenditures have been far greater than income and the outstanding debt is almost out of control, then additional programs that cause even larger imbalances will have very serious implications to the financial health of our Nation. This in not rocket science, just plain old common sense which is in short supply today. Will it change, can it change? Time will tell.

May 28 08:22 PM

[sidney:]

It is important to understand that academically speaking there is a civil war within the community divided across the Atlantic. The English variation of the theme is to house the economic historians in the history department thus freeing them from the shackles of the prevailing preferred economic models that would be imposed if housed within an economics department. Whereas in the USA the economic historians are typically housed within the economics departments and have had to force their students to back up such models as EMH, CAPM, Modern portfolio theory etc. based on rational behavior, perfect information, and normal behavior in markets etc. Within the USA there were a few excpeptions to this split betwee England and USA. Yale's history department stood out most as one that continued to house the economic historians within. Occasionally students of the Yale school such as Dennis M. P. McCarthy(Iowa State University) would land tenure in history departments outside of Yale and thus the Yale model would germinate outside occasionally. Dr. McCarthy is now emerits so no doubt Iowa State University opted to bring the next economic historians back into the economics department. THE MOST important classes I have EVER taken with respect to my appreciation of the big picture understanding of finance in economics were in fact tought by Dr. McCarthy; no offense to my economcs professors at ISU but DMPM was not limited in respect to reviewing real events by the models I was being tought in my economics classes. Instead he typically used multi-factor models discussing the signficance of the various fators on the economic growth(or decline) and comparing and contrasting the various economic history of cultures over time and places. I was somewhat naive in thinking I would be able to pursue economic history within a history department beyond the towers of ISU but much to my surprise I found the EH shackled by the economics department in the USA. I did not want to become a pseudo math PHD spouting out endless papers applying calculus to the review of economic data. Calculus has ruined economics in the sense that it could not handle the fractal relationships that an economic historian is free to observe, describe, and draw conclusions from. Instead Chaos theory, complexity theory, fuzzy logic should have been the basis upon which economics departments should have drawn upon thus linking up a typical qualitative approach of economic historians with the quantitative approach of economic study.

May 28 10:24 PM

[Windsun33:]

I would have to agree with that. If you look back, the vast majority of "crash and burn" scenarios have been caused by, or fueled by political considerations, not pure economics or capitalism.

You can see all the seeds of the present debacle in politicians pandering to constituents and/or special interests. And that will NEVER ever go away. I think one lesson to be learned from history is that a fully rational market is an oxymoron in a political environment. In the long run, markets are mostly rational - but that may take years to play out if there is a lot of media/political noise causing a distorted view of what is actually happening.

On May 28 08:08 PM debtacid wrote:

> In this case, political history is more instructive. Start with The
> beginning of the fed in 1913, the 1929 crash, the new deal, bretton
> woods and the IMF in 1944, the great society, gold standard abandoned

May 28 11:58 PM

[MGA_1:]

Economic history is important, but, it can be viewed through a variety of economic prisms. This downturn came as a surprise to many, BUT, not all. Check out the Austrian school of economics - to me its economics that actually makes sense. In 1928 Von Mises actually predicted there would be a bust - he didn't know the exact timing but said it was coming and would probably be bad. Pretty apt description of the great depression. There are economist from this school who accurately foresaw this downturn and invested appropriately. I follow these guys to get and idea what's coming down the pike - even though I may not like it. Here's two of my favorites:
Peter Schiff
Tom Woods
Two guys not directly associated with the school, but who nailed the downturn:
Jim Rogers
Marc Faber
None of these guys are without their foibles, but hey... probably better than Cramer, right?

May 29 12:34 AM

[Tom Colangelo:]

How dumb can investors get when they get excited by this kind of news this morning???

Futures up on the good news!!!

THE GOOD NEWS:
The negative 5.7% estimate for real seasonally adjusted gross domestic product was slightly stronger than the first estimate of a 6.1% decline released a month ago.

THE BAD NEWS:
1] The U.S. economy contracted violently again in the first quarter, falling at a revised 5.7% annual rate after sinking 6.3% in the fourth quarter, the Commerce Department reported Friday in its second estimate of quarterly gross domestic product.
2] Business investment declined at a record rate during the quarter.
3] Investments in housing fell at the fastest pace in 29 years.
4] Domestic demand fell at the fastest rate in 29 years.
5] Exports fell at the fastest pace in 38 years.

May 29 08:58 AM

[andypandy:]

Who controls the past now controls the future
Who controls the present now controls the past
Who controls the past now controls the future
Who controls the present now?

Now testify
Testify
It's right outside our door
Now testify
Testify
It's right outside our door

May 29 09:29 AM

[Glen L.:]

The author and both of his "historians" appear to be Keynesians. They never met a central banker they didn't love. Keynes' General Theory is the biggest pile of shinola ever written, but Bernanke today is applying its insane fallacious economics, plus the errors of Friedman and Schwartz, to the current debacle, making the crisis far, far worse than it needs to be.

Learning economic history - true history, not that written by the same crooks who caused the Great Depression and every downturn before and after - is absolutely vital. Kudos to the commenters who mentioned Austrian economics and von Mises, you're on the right track. Read also Murray Rothbard's "America's Great Depression" if you want to learn who caused it and how (the Federal Reserve, with easy credit). Read Tom Woods' "Meltdown" for a clear, concise, and brilliant exposition of the causes of the current crisis (same culprits, same policies).

History is being repeated because we never learned its lessons. Will Keynes and his idiot theory finally be tossed in the dustbin when this is all over? Based on many of the comments here, as well as the article, I have my doubts.

May 29 09:55 AM

[Gregman2:]

Would it be safe to characterize many of the republican conservatives
(i.e. Senator Bob Corker) as "liquidationist"? You raise a really great point, which is that one of the two schools now debating is that of the liquidationists, which I had forgotten was headed by Mellon. Thanks for this.

May 29 12:20 PM

[John Lounsbury:]

Felix - - -

You have opened a can of worms here. As User 353732 wrote:

"Much economic"history" is a selective presentation of a compendium of facts, episodes and anecdotes linked by a synthetic dramatic narrative heavily influenced by the ideological predilections (and often covert agenda) of the writer."

Everybody has a model of some sort (mathematical or conceptual) and interprets history through that lense. By definition, a model with n variables will have shortcomings in describing an essentially infinitely variable universe. We have to be careful in what we say or it will affect what we think. If x has been followed by y ten times in a row, we often say that x produces y. That gives us a flase confidence, which is often later betrayed.

The correct statement is that the occurence of x is correlated with the subsequent occurence of y, based on ten samples. More sophisticated statisticians will transalate that into a confidence level that the correlation can be projected onto the universe.

Too many have drawn conclusions about what was done wrong and what was done right during past economic periods, like the Great Depression, without recognizing that they are failing to recognize such things as correlations with limited confidence levels. Sometimes conclusions are drawn about cause and effect when what really happened was coincidence.

This article has messages far beyond the words actually written. Looking at the excellent comment stream, I think many of these messages are being recognized.

May 29 12:54 PM

[John Lounsbury:]

I have gone back and reread all the comments here. This is a truly well presented comment stream, with a cross section of opinions.

I do not understand how any of these comments deserved a thumbs down rating - they are all well written and cover a diversity of opinion. If you are voting thumbs down because of a difference of opinion, shame on you for being closed minded. If your mind is already made up, what benefit do you get from reading a discussion such as this.

Only the most ignorant man has nothing left to learn.

May 29 01:10 PM

[morph366:]

User 353732 has the most radical take on this which is the subjectivity of facts and the impossibility of perceiving history as it really is rather than through the lens of a political or ideological bias.
Noam Chomsky is the expert on this and well worth reading

May 29 02:13 PM

[Jade Queen:]

I want to add Ron Paul to those who saw what was coming and helped to connect and prepare those who got the message. If his Federal Reserve transparency initiative passes, the federal government will be shaken up. He has gotten a lot of airplay recently, though he still seems off the radar in many spots where I would expect to hear more.

May 29 03:10 PM

[Fred Voetsch:]

Studying history is vital and then you need to be objective eough and fact based enough to see when we have gone completely out-of-whack.

We are out-of-whack on a historical basis. That does not mean the end of the world but it does mean tremendous opportunity for those who know the facts.

May 29 03:50 PM

[Fred Voetsch:]

On May 29 08:58 AM Tom Colangelo wrote:
> THE BAD NEWS:
> 1] The U.S. economy contracted violently again in the first quarter,
> falling at a revised 5.7% annual rate after sinking 6.3% in the fourth
> quarter, the Commerce Department reported Friday in its second estimate
> of quarterly gross domestic product.
> 2] Business investment declined at a record rate during the quarter.
>
> 3] Investments in housing fell at the fastest pace in 29 years.
>
> 4] Domestic demand fell at the fastest rate in 29 years.
> 5] Exports fell at the fastest pace in 38 years.


In a typical business-cycle recession all of that bad news would suggest a great time to buy. The vast majority of investors just simply can't accept that this is a generational shift in valuation and that the stock market won't simply go back up as it has always done in the(ir) past.

Just when they finally give in and give up will be the time to go long.

May 29 03:55 PM

[TradingHelp...:]

If you don't learn from history, what can you learn from? The future? Exactly.

May 31 05:08 PM

[Charles Pet...:]

I think Bernanke realizes that this event is unique when compared to other financial crises. I doubt he is using historical examples as his only guide.

May 31 05:58 PM