They’re like plate tectonics in the field of geology. An earthquake can often be quite a serious event. But one earthquake is just an indication of the presence of a fault, if not a complex fault system. And that fault system may be part of a vastly larger structural zone at the edge of a shifting continent.

When it comes to major changes, you have to keep something clear. Earthquakes don’t move continents. In the big scheme of things, moving continents cause earthquakes. Something similar occurs with economic events.

The Great Depression, Hooverism and the New Deal

For example, the Great Depression in the U.S. is associated with the administration of President Herbert Hoover. The term “Hooverism” is commonly used to describe government mismanagement of the economy while things slide from bad to worse.

But the truth is that the market excesses that led to the stock market crash in October 1929 (only seven months after Hoover took office) occurred in the mid- to late 1920s, with Calvin Coolidge in the White House. And many of the monetary excesses of the 1920s had their roots in excess U.S. spending by the Wilson administration during the “Great War,” as World War I was called before there was a second.

And looking back at the 1930s, the growth of big government in the U.S. is associated with the presidency of Franklin Roosevelt.

True enough, the New Deal was a Roosevelt campaign slogan.

But Roosevelt’s plan to close the banks after his inauguration was drawn up during the last six months of the Hoover administration. And many of the great public works projects of Roosevelt, such as the Tennessee Valley Authority or construction of dams on Western rivers like the Colorado or Columbia, were drawn up under the Hoover administration. (Why do you think that they eventually renamed Boulder Dam after Herbert Hoover?)

Reaganism and Thatcherism

Much later, the seeds of Reaganism were planted during the preceding administration of President Jimmy Carter, who appointed Paul Volker to run the Federal Reserve. Indeed, it was Volker’s sharp increases in interest rates that broke the backs of the Vietnam-era inflation and the stagflation of the 1970s.

Volker’s policies allowed the Reagan-era tax cuts and supply-side policies to gain traction. Without Carter’s appointment of Volker, we would probably never have heard the term “Reaganism” or “Reaganomics.” The economic boom of the 1980s might never have occurred.

And let’s take a look at Britain’s “Thatcherism.” This concept has become almost synonymous with strong growth monetarism in the U.K. Looking back, Margaret Thatcher is often credited with defeating British inflation and ending an era of heavy-handed government spending and control.

Of course, there is no denying the important and bold policies that Margaret Thatcher pursued. Or Thatcher’s good fortune to be prime minister during the early and successful exploitation of the oil resources of the North Sea.

But monetarism in the U.K. dates from 1976, three years before Thatcher came into office as prime minister. That was when a Labor government accepted a loan from the International Monetary Fund, paving the way for Britain to prosper under Thatcher.

Deep Roots, Visible in Hindsight

The point to keep in mind is that major economic trends do not just appear and disappear with the coming and going of politicians in office. (We should be so lucky!) The roots of things are usually quite deep, perhaps apparent only in hindsight.

Thus, you want to be careful of assuming that the upcoming U.S. presidential election will usher in some new era of economic policy. Epic changes in economic trends do not simply appear when voters dismiss one bunch of politicians and ask a new bunch to do things differently. In many respects, the dice are already loaded for whichever of the two candidates prevails on Election Day. Sure they’ll count the votes on that “first Tuesday,” but in many respects the fix is already in.

It is not overstating the case to say that large-scale change tends to happen abruptly — and not uncommonly — when the previous policies collapse under their own weight. As history shows, it is often the politicians on their way out (for example, Hoover or Carter — and G.W. Bush when we eventually look back on these months) are forced to change things once it becomes clear they have failed.

Monetary Excess, Tectonic Policy Shifts

The excess credit creation by the U.S. over the past 10 years has been a policy failure of historic proportions. We witnessed serial bubbles in technology, dot-coms, housing and now energy and commodities. These bubbles were related to horrible distortions within the larger financial system.

Thus, within the past year, the lame-duck Bush administration has presided over a huge expansion of the government’s role in finance. The Bear Stearns bailout inaugurated a sea of change in policy. Now investment banks, not just commercial banks, may borrow directly from the Federal Reserve.

More recently, Fannie Mae and Freddie Mac failed. So did Lehman Brothers, winding up in bankruptcy court. Indeed, the entire model of investment banking is history. Now we see the U.S. Treasury attempting to administer a $700 billion bailout of Wall Street banks. What’s next?

Perhaps this is not quite the scope of FDR’s New Deal. Then again, the New Deal was about building roads, bridges and dams, not bailing out failed banks.

But the new government intervention to bail out large financial players signals a remarkable change in national economic policy. And it has not come about at the behest of the voters. Indeed, when the voters have a say, they reject the bailouts. It’s only raw politics that led to the recent bailout bill in Congress.

This new set of government guarantees to investment banks will be difficult — perhaps impossible — to reverse. Thus, the new situation will simply be “the way things are” when either President McCain or President Obama takes office.

What will this mean to the future of the U.S. dollar? Among other things, it means that the federal government will be spending tens or hundreds of billions of dollars to bail out bad investments by investment banks and other entities like Fannie and Freddie. And in turn, the government will not be spending dollars to fix national infrastructure like roads, bridges or water or energy systems.

And long term, it is probably bad for the value of the dollar. Which is why you should be sure to preserve some of your savings and purchasing power in precious metals like gold and silver.

Until we meet again,
Byron W. King
October 8, 2008

Root Causes Behind the Politics was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“I consider you one of the dozen or so finest economists of all times and countries, and, if I did not know that, my work in the history of economic analysis which I hope to complete in the current year would have brought the fact home to me.”

Irving Fisher remains immensely important in the history of economic thought, and of economic policy. He was the most influential of academic economists in the period of the Great Depression. He had been an important influence on the English economist, John Maynard Keynes, with whom he corresponded. During the slump Fisher had access to President Roosevelt and helped to influence the President’s response to the Depression.

In the early 1930s there was the same feeling that now exists that the experts have been taken by surprise and do not know how to respond. It is a mark of Fisher’s stature that he always had a rational proposal — and many of them still seem to have good sense behind them. Even on his deathbed, he did not hesitate to write a letter of warning to President Truman, who had succeeded Roosevelt, against the dangers of deflation. “I am in hospital, but so far as facts have reached me, the talk in Washington is to the effect of lower prices, which are sure to lead to disaster” (Letter dated March 21, 1947; Irving Fisher died April 30, 1947).

With Franklin Roosevelt it is seldom possible to know whose advice he took. He flattered almost every adviser by praising his work. The notes that Fisher took after his meetings with the President suggest that he was — like everyone else — overwhelmed with Roosevelt’s charm. Nevertheless, Fisher provided some of the arguments that supported Roosevelt’s own preference for a reflationary policy. It was Roosevelt who told Fisher, at their meeting on September 6, 1934, he wanted to get all the unemployed at work as soon as possible and estimated that it would cost “five billion dollars to provide for the five million men for one year.”  Roosevelt rather naively asked Fisher “how the money could be obtained.”

After Britain came off the gold standard in 1931, Fisher sent one of his letters to the British Prime Minister, Ramsay MacDonald. It contains one particularly telling sentence: “The irony of the present situation is that the world is being put deeper and deeper into debt by its very struggles to get out.”

That certainly strikes a note in the week of the U.S. nationalisation of Fannie Mae and Freddie Mac, at a cost of $5.4 trillion, which has to be added to the existing liabilities of the Federal Government. In 1934, President Roosevelt talked of public expenditure rising by $4 billion, in 2008 President Bush has increased U.S. exposure by $5 trillion — a thousand times as much.

Irving Fisher’s objective was stable money. He was the author of the equation of exchange, which states that MV = PT (Money x Velocity = Price x Transactions). He thought that a commodity-based standard would be the most stable substitute for the gold standard.

In terms of the economic debates of the 1930s, the nationalisation of Fannie Mae and Freddie Mac is a potentially inflationary commitment of the U.S. Government. It transfers $5 trillion of liabilities to the public sector, or, as they were already in the public sector, it acknowledges and guarantees those liabilities.

The early opinion polls suggest that many American taxpayers are concerned that the $5 trillion will eventually land on them. It is, in any case, a huge experiment, an economic experiment on the scale of CERN. Other nations may observe it with awe. I think Irving Fisher would certainly have supported it.

Regards,
Lord William Rees-Mogg
September 11, 2008

Bailout of Fannie and Freddie was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The peculiarity of the Great Depression of 1929-33 was that the American economy proved not to be self-stabilizing, although some other major economies of the period, including the British, did recover spontaneously in the early 1930s. Indeed, for Britain, the 1930s, with industrial expansion in automobiles and extensive building of houses, was a record decade.

However, recovery in the United States was later and weaker. When one compares Franklin Roosevelt’s first term, from 1933-37, the performance of the U.S. New Deal was not as good as that of Germany, rearming under Hitler, or of the United Kingdom, building cars and houses under Stanley Baldwin and Neville Chamberlain.

This is important, because there appear to be two types of depression, one of which is much stronger and longer lasting than the other. Panics, like those of 1907 or 1987, are steep, but relatively brief; great depressions can last for a decade or more. As Irving Fisher observed — prematurely — “The Depression out of which we are now (I trust) emerging is an example of a debt-deflation depression of the most serious sort.”

He argues, “The debts of 1929 were the greatest known, both nominally and really, up to that time. They were great enough not only to “rock the boat,” but to start it capsizing. By March 1933, liquidation had reduced the debt about 20%, but had increased the dollar about 75%, so that the real debt — that is, the debt as measured in terms of commodities — was increased about 40%.”

Obviously, the combination of the need for debt liquidation with falling prices means that debt has to be redeemed in money that is harder to earn. By contrast, debt can be liquidated by currency inflation, as happened in the 1970s. The relationship between the level of U.S. debt and the level of the U.S. dollar, therefore, becomes critical. Fortunately, the dollar has been very weak, allowing excess debt to be repaid in depreciating dollars. The length of the Japanese depression after 1990 must have been affected by the high relative price of the yen, so that debts in the 1990s were being repaid in terms of a high-value currency.

Irving Fisher argues that the “big bad actors” in the Great Depression were “debt disturbances and price level disturbances.” In 2008, we certainly have debt disturbances, though these are more important in the housing market than in the stock market. However, the global economy is, on balance, in an inflationary stage, with energy prices very high and the dollar weak. China is experiencing significant inflation, and commodity prices are high, if somewhat nervous.

This is a relatively favorable situation, in that the global authorities have to deal with debt and inflation, rather than debt and deflation. As inflation helps to liquidate excess debt, these conditions are more likely to generate panics than great depressions. At any rate, one can hope so.

Regards,
Lord William Rees-Mogg
March 31, 2008

Lessons of the Great Depression was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.