The late bubble has been the
greatest on record and is the accumulated consequence of 95 years of Fed
stimulation. This shows up most directly as a 95% decline in the purchasing
power of the dollar, and indirectly as a series of business expansions
accompanied by increasingly unstable booms in asset prices. The latest boom
was in both tangible and financial assets culminated in a classic mania of
credit innovation. There have been a number of great bubbles, and the
prosperity has been so compelling to participants and governments that no one
person or agency deliberately ended the boom. Indeed there have been
well-documented examples of heroic efforts to restore the boom and then to
prevent the contraction - all in vain.
Every experiment in currency
depreciation ends with great market and political volatility, and the
transition to eventually severe contraction started in June, 2007 when the
yield curve reversed from inverted to steepening. This was soon followed by a
turn to credit spread widening, which confirmed that the financial world had
accomplished a classic reversal towards adversity.
With a number of examples
since the advent of modern markets in the late 1600s the instruction has been
that various passionate interests will attempt to resurrect the boom and,
ironically in ignoring such efforts, the severity of the contraction is
proportionate to the exuberance of the boom.
Keynes remains as a
charismatic interventionist economist, and inspired by the dislocations of
the early 1930s, thought that he had invented a way to end credit
contractions. But, because he was ignorant of market history he didn't know
that almost every century has an example of some intellectual having a
personal revelation about avoiding or prematurely ending a post-bubble
contraction. An early example occurred with the post-1618 bust, when in 1622
Missleden prescribed adding credit to a credit contraction.
The forever-esteemed editor of
The Economist, Walter Bagehot, wrote in 1873: "A panic in a word,
is a species of neuralgia, and according to the rules of science you must not
starve it. The holders of the cash reserve must be ready...to advance it most
freely for the liabilities of others."
In policymaking circles that
was and still is sound advice. No problems, if the right thing is done at the
right time. As expanded below, the subsequent period was described as
"The Great Depression" and it ran from 1873 to 1895.
Actually, the implementation
of such sound advice predates Bagehot, and had been implied by the Bank of
England in a report following the catastrophic end of the 1825 mania: "We
lent by every possible means and in modes we have never adopted before; we
took in stock on security, we purchased Exchequer bills, we made advances on
Exchequer bills, we not only discounted outright, but we made advances on
Exchequer bills of exchange to an immense amount, in short, by every possible
means...seeing the dreadful state in which the public were, we rendered every
assistance."
That records a mighty effort
by the senior central bank to prevent the subsequent general contraction that
endured from the climax of the bubble in 1825 until the mid 1840s.
At the height of the 1929
mania the Fed with its "elastic" currency was celebrated, as the
old system of the 1873 to 1895 "Great Depression" was condemned.
The following is by John Moody:
"The old breeder of
financial panics, the National Banking Law, which had been a menace to
American progress for two decades, has now been replaced by a modern,
scientific reserve system which embodied an elastic currency and an orderly
control of the money market."
In so many words,
"nothing could go wrong".
Ultimate confidence in the old
system prevailed as the 1873 bubble came under the usual credit changes that
signal a top. A leading New York paper, the Herald, editorialized:
"True, some great
event may prick the commercial bubble of the hour, and create convulsions;
but while the Secretary of the Treasury plays the role of banker for the
entire United States it is difficult to conceive of any condition of
circumstances which he cannot control. Power has been centralized in him to
an extent not enjoyed by the Governor of the Bank of England. He can issue
the paper representatives of gold, and count it as much as the yellow metal
itself. [He has] a greater influence than
is possessed by all the banking institutions of New York."
In so many words,
"nothing could go wrong".
Ironically, the editorial
contained some totems that are still deemed to have great power. Even today,
for some the terms "centralized", "banker for the U. S."
and "influence" provide considerable assurance. On the initial
panic into late September, the Herald editors extolled abiding confidence in
the Treasury System with "A crisis in our financial dealings has
been met and passed without loss of confidence... Here are growth,
understanding, [and] increased knowledge."
As it had done on previous
crises, the Treasury added liquidity and appeared to have avoided disaster.
Under similar pressures, today's Fed and Treasury have been injecting
liquidity and on the technical rebound into May such orthodoxy was
celebrated: "The policy response to financial asset deflation was
not only extremely fast, but extremely well coordinated. US policymakers
deserve the Nobel Prize."
Back to all the confidences
and issuance of liquidity in the early panics of the post-1873 contraction.
The usual business cycle prevailed, but the recessions were stronger than the
expansions. By 1884 leading economists began calling the prolonged
contraction as the "The Great Depression". Although it ended in
1895, it was still being analyzed as such until as late as 1939.
In order to preserve the
notion about an infallible Federal Reserve System, it has been expedient to
lay the blame on the Fed keeping too tight a policy during the post-1929
contraction. A couple of points suggest otherwise:
A Fed memorandum following the
1929 crash explained: "The drain upon bank reserves was met in the
classic way with a policy of free lending".
By free they meant liberal and
this was exemplified by George Harrison, who was head of the New York Fed. As
with today, the NY branch was huge compared to the whole Reserve System and
Harrison, in discounting freely, exceeded his authority by a factor of six
times. This was conventional theory and practice and as with a number of
examples did not prematurely end a post-bubble contraction.
It seems that part of the tout
at the top of the mania includes a celebration of whatever central banking or
treasury system that happens to be in place. This also has included
celebrating the treasury secretary as the "greatest since Alexander
Hamilton". The two best known have been Andrew Mellon and Robert Rubin.
Actually, each "earned" the accolade by merely being in office when
an era of financial innovation and mania brewed up. Mellon during the 1920s
and Rubin during the 1990s. On the mania that climaxed in 1720 John Law, as
the first really reckless central banker, was celebrated during the boom and
reviled during the bust.
Naturally, with the
recrimination and revulsion that goes with any post-bubble contraction the
prevailing system will be criticized during the contraction.
With the fullness of this
failure the first stage will likely be an ad hominem attack on the
personalities running the Fed and Treasury. Bernanke will be worked over for
not providing the exact interest rate change that would have prevented the
contraction. The rate change of the perfect amount made with perfect timing
only exists in the imagination of interventionist economists.
Eventually, the contraction
could become severe enough to prompt rigorous scrutiny. This would involve
examining the history of central banking - not for policy errors, but for
systemic inadequacy - through all of the great financial manias.
In the meantime, some old
advice about stock analysts seems applicable. "In a bull market who
needs them, and in a bear market who wants them?"
Considering the implacable
nature of credit, this applies to interventionist economists. In an expansion
who needs them, and in the consequent contraction who can afford them?
Heroic efforts in the past
have not reinvigorated the ultimate boom and have not prevented a severe
contraction.
