October 30, 2008

Sometime soon George Bush may want to review Herbert Hoover’s 1932 acceptance speech and pluck phrases from it that might calm angry Americans.  In rationalizing his interventionism, Hoover said:  

nothing has ever been devised in our history which has done more for . . . “the common run of men and women.” Some of the reactionary economists urged that we should allow the liquidation to take its course until we had found bottom . . . . We determined that we would not follow the advice of the bitter-end liquidationists and see the whole body of debtors of the United States brought to bankruptcy and the savings of our people brought to destruction. [p. 187]

Had Hoover followed the advice of the “bitter-end liquidationists,” one of whom was Treasury Secretary Andrew Mellon, the economy would likely have recovered by 1932, and we might’ve been spared the Roosevelt holocaust.  Mellon, though ever the interventionist during the 1920s, at least understood that a bust should be allowed to break.  In stark contrast to the current secretary, Mellon correctly wanted to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate” to “purge the rottenness” from the system.   

But Hoover overruled Mellon, and backed by other members of his administration, intervened heavily into the economy.  Hans Sennholz describes Hoover ’s so-called “laissez-faire” approach:

[ Hoover ] prodded the Federal Reserve to renew many of the money illusions of the 1920s.  The New York Federal Reserve Bank soon lowered its discount rate, 1/2% at a time, from 4 1/2% on February 6, 1930 , to 2% by the end of 1931.  It cut its buying–rate for ninety-day acceptances to 1 3/4%.  Trying desperately to reignite the boom, the System bought government securities on a grand scale, $729.467 million in 1930 and $816.96 million in 1932. [pp. 11-12]

Hoover also engaged in massive deficit spending, curtailed foreign imports, and pressured businessmen to maintain price and wage rates.  Out of concern for “the common run of men and women,” Hoover ’s policies left 25 percent of them out of work by August, 1932.

Bush won’t have as many unemployed calling for his head, but others have reason for concern.  Since the DJIA reached an all-time high on October 9, 2007 , $8.4 trillion has disappeared from the value of U.S. stocks, and $2 trillion has evaporated from the nation’s retirement accounts. 

Stable prices and booms

Though Hoover was a pioneer among presidents in getting the government to “do something” about a depression, he was no maverick.  He had the support of distinguished court economists who promoted the idea that stable prices were the key to lasting prosperity.  

Common sense tells us that if we walk into a store and find prices consistently lower than they had been, we are better off, other things equal, because our money buys more.  As Rothbard wrote, “Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the stand of living of all consumers.  Forcible propping up of the price level prevents this spread of higher living standards.” [p. 40]  

While the concept “stable price level” may not sound menacing, the mechanism for achieving it was.   The theory’s proponents, which included such economics luminaries as Irving Fisher and John Maynard Keynes, weren’t too concerned with price stability when prices tended to rise during a boom, especially if prices were rising on the stock market where they were heavily invested.  The price stability priests were mostly concerned with falling prices during a bust, and for that they relied on government’s creature, the central bank.  Falling prices, in fact, were regarded as the cause of depressions.  Using enlightened “monetary policy,” central banks needed to keep prices from falling to keep economies from collapsing.

Yale and Harvard go boom and bust

Yale professor Irving Fisher helped popularize the view that the “new era” economy of the 1920s would last indefinitely.  With the exception of stocks and real estate, prices were fairly level, and since the mainstream definition of inflation was and still is “a general and progressive increase in prices,” the 1920s were and still are said to be a period of inconsequential inflation.  Rothbard tells us that  

Fisher was particularly critical of the minority of skeptical economists who warned of overexpansion in the stock and real estate markets due to cheap money, and even after the stock market crash, Fisher continued to insist that prosperity, particularly in the stock market, was just around the corner. [p. 449]

Beginning in 1923 Fisher wrote a syndicated column, carried by leading newspapers, in which he discussed relevant economic issues of the day.  Fisher’s column was Yale’s answer to the Harvard Economic Service.  An NBER research paper says that Fisher’s  

predictions in the period before and after the crash, were no closer to the mark than those of his Harvard brethren.

“In two months I expect to see the stock market much higher than today,” Fisher said on October 15, 1929 .  Economist Hernán Cortés Douglas tells us that  

Days after the crash [on October 29], the Harvard Economic [Service] informed its subscribers: "A severe depression such as 1920-21 is outside the range of probability. We are not facing a protracted liquidation."  

After repeated forecasts of optimism, the Harvard Economic Service folded in 1932.  Fisher’s professional reputation gradually collapsed.  Fisher’s son estimates his father lost $10 million during the Depression (roughly $140 million in 2008 dollars).  Yale had to buy Fisher’s house and rent it back to him to keep him from being evicted.  When he died in 1947 he left an estate so small it wasn’t even taxed.

Interestingly, the authors of the NBER paper applied “modern statistical techniques” to analyze the data Fisher and the Harvard service used in their forecasts.  The result: “The statistical findings mirror the verbal pronouncements' systematic overprediction of economic activity.”  Translated: Today’s economics mainstream is equally clueless about booms and busts.  Both Fisher and Harvard were correct in being wrong, the paper concludes.  

Keynes was no less a forecasting bungler.  An avid speculator, he saw nothing but good times ahead during the boom:  

He met the Swiss banker, Felix Somary and was begging Somary to give him some great stock picks. When Somery said he couldn't recommend any stocks right now because he was expecting a crash, Keynes responded infamously, "We will not see another crash in our lifetimes."

(Somary once said, correctly: “the state alone is responsible for inflation: inflation without government . . . is impossible.”)

Keynes lost a fortune but went bargain-hunting in the early 1930s, putting aside his loathing of the barbarous relic and buying up gold stocks and managing money for insurance companies.  He recovered handsomely until he was wiped out again when an incipient recovery collapsed in 1937.  When he died of a heart attack in April, 1946 he had once more accumulated an impressive fortune.  

“The injection of fiat funds falsifies interest rates”  

Ludwig von Mises and F. A. Hayek were among the few economists to forecast the Crash.  Their crystal ball was the economic theory they had developed, known today as the Austrian Theory of the Trade Cycle.  It says bank credit expansion based on money created out of nothing generates booms that eventually go bust.  Activities that were profitable when money was made cheap are revealed as unsustainable when low-interest loans are no longer available.  Roger Garrison explains:  

Mises showed that an artificially low rate of interest, maintained by credit expansion, misallocates capital, making the production process too time-consuming in relation to the temporal pattern of consumer demand. As time eventually reveals the discrepancy, markets for both capital goods and consumer goods react to undo the misallocation [p. 8].  

The market reaction is the bust phase of the business cycle, as producers attempt to bring production in alignment with actual consumer demands.  Hans Sennholz has written,

Economic booms and busts occur in every case of fiat expansion, whether the expansion is one percent or hundredths of a percent.  The magnitude of expansion . . . merely determines the severity of the maladjustment and the necessary readjustment.

Even if most prices should decline while monetary authorities expand credit at a modest rate, the injection of fiat funds falsifies interest rates and thereby causes erroneous investment decisions.” [p. 38]

“Credit expansion” is another name for a policy of inflation.  Inflation creates “the illusion of profits,” as Mises noted in Socialism; inflation “discourages saving, and thereby prevents the formation of fresh capital.”  It is this “rottenness” – inflation – that must be extirpated along with all the bad bets, but since Fisher and Keynes, it is considered the cure.  Hayek, Joseph Salerno tells us, “placed the blame for ‘the exceptional severity and duration of the depression’ squarely on central banks' . . . ‘experiment’ in ‘forced credit expansion,’ first to stabilize prices in the 1920s and then to combat the depression in the early 1930s.”  

Government has tried countless ways to sustain its Fed-induced booms and avoid the painful but necessary corrections.  Its track record has been an unmitigated disaster, unless inflating the economy out of a crisis for a bigger one later is regarded as success.   Yet the idea persists that intervention works, that if a mountain of facts show otherwise it’s always possible the intervention was too little, too late.

From the Establishment’s perspective, the fatal flaw of Austrian economics is the job it accords government, which is none at all.  But free markets are markets free from intervention, which means today’s government not only has a job, but a crucial one: It should bow out of our economic lives altogether.  That’s the “something” government should do.  

In the beginning  

In his 1874 book, A History of American Currency, William Graham Sumner notes that in early America certain tribes on Long Island Sound had a circulating medium, and this fact marked their superiority to other tribes known to the settlers.  The circulating medium consisted of polished beads of two kinds, one white, made from a periwinkle shell, and the other black, made from a clam shell.  “They regarded one black bead as worth two white.  This money was called wampumpeag, or wampum, or peag.”  For these tribes, it was the perfect money.  Like other commodity monies, it “was a product of labor, and subject to demand and supply.”  

The colonists used wampum to trade with the Indians.  Then they used it to trade with each other.  Then, to mark their superiority, they began to counterfeit it – which brings us to the beginning of our current crisis.