Those Who Do Not Understand History

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Benjamin M. Anderson’s Economics and the Public Welfare: A Financial and Economic History of the United States, 1914—1946, first appeared in 1949. Anderson was in a unique position to observe, record, and analyze this history. He had three professions: professor, practicing economist, and writer-journalist. For 20 years (1920—1939), he was economist for the Chase National Bank. "During these years, he was in intimate contact with bankers, investment bankers, brokers, and industrialists throughout the world, with the Federal reserve System and with foreign central banks, with government officials and leading journalists of many countries, as well as with academic students in the United States and abroad." In real time, Anderson published his insights in the Chase Economic Bulletin. He was not a distant observer of events but an active participant who knew personally many of the participants.

I recommend highly the entire book for those seeking deeper knowledge of these matters. One may not always agree with Anderson in every instance, but one will always find his comments thought-provoking as one considers our times.

We know that Austrian economics has no place in the economic knowledge and policies of our financial and economic leaders: our establishment. Apparently, neither does the kind of economics steeped in keen observation and experience of practice that we find in Anderson. Adherence to Keynesian orthodoxy leaves no room for either von Mises or Anderson. Their wisdom has been rejected. The contrast between Anderson’s statements and well-known attitudes expressed by our leaders, past and present, is startling. Even a cursory reading would have taught them the lessons needed to avoid the current economic and financial tragedy. If they did read him, they rejected his wisdom in favor of fallacious doctrines. Or they lacked the courage to stand up for proper policies. Or our educational system is so bankrupt that it has considerably dumbed down our leadership. Or our system is so corrupt that it no longer attracts men with the capacity to manage it properly, while thwarting and corrupting many men who might do the right things.

All quotations are from Anderson’s book. Occasional comments of mine are in brackets.

"Not all the countries had safely balanced budgets. France, though enormously strong financially, in 1914 had had chronically unbalanced budgets for many years. The balance in Russia and Italy was precarious." (p. 23.)

"But always the statesmen of these countries winced under criticism, and none of them boasted of their achievements in unbalancing the budgets or termed the deficit u2018investments’… But, in general, the great countries held their own gold. They relied upon themselves to meet their international obligations in gold." (p. 24.)

"There was no such thing in prewar days as the kind of international cooperation which we saw in the 1920s, under which a dangerous boom was prolonged and turned into an almost uncontrollable inflation through the cooperation of the Bank of England and the Federal Reserve System of the United States." (p. 24.)

"All the Continental belligerents, victors and vanquished, had unbalanced budgets, and were borrowing and spending far more than the tax revenues collected; and all of them had currencies which, lacking gold redemption and increasing steadily in volume, were fluctuating violently and depreciating rapidly. There was a great need for the balancing of budgets and for the stabilization of currencies with gold." (p. 115.)

"The purchase of approximately $500 million worth of government securities by the Federal Reserve banks…The total deposits of the member banks increased from $28,270,000,000 on March 31, 1924, to $32,457,000,000 on June 30, 1925, an increase of over $4 billion…This additional bank credit was not needed by commerce and it went preponderantly into securities: in part into direct bond purchases by the banks and in part into stock and bond collateral loans. It went also into real estate mortgages purchased by banks and in part into installment finance paper. This immense expansion of credit, added to the ordinary sources of capital, created the illusion of unlimited capital…" (pp. 127—28.)

"Those who see history only from the outside easily convince themselves that impersonal social forces are overwhelming and that individual men in strategic places make little difference. But this is not true. The handling of Federal Reserve policy by Strong and Crissinger in the years 1924—27 led to ghastly consequences from which we have not yet recovered. Competent and courageous men occupying their positions would have avoided the mistakes which these men made." (p. 130.)

"There is no need whatever to be doctrinaire in objecting to the employment of bank credit for capital purposes, so long as the growth of this is kept proportionate to the growth of the industry of the country…But when in the period 1924—29 there came an extraordinary spurt of this kind of employment of bank funds, and when commercial loans began going down in the banks at the same time that the stock market loans and bank holdings of bonds were mounting rapidly, the careful observer grew alarmed. And when in addition there came a startling increase of several hundred percent in bank holdings of real estate mortgages, the thing seemed extremely ominous." (p. 135.)

"The first lesson of a young banker should be to learn the difference between a mortgage and a bill of exchange." (pp. 135—36.)

"The great bank credit expansion of the 1920s took the form of time deposits to a greater extent than demand deposits." (p. 139.)

"The theory that cheap money is essential for business revival and business activity received a pretty sharp test in this period [1926] I think. The British, with much lower rates, and with rates held unduly low on the theory that cheap money was necessary for good business, went through a prolonged stagnation, with high unemployment. The Germans, more flexible, making the necessary adjustments in wages and other costs, endured both high interest rates and cruelly high taxation, but still did business and made money, with very full employment. Cheap money plays no such dominating role as Keynes and Hawtrey and their followers would have us believe." (pp. 162—63.)

"And the British banks, instead of permitting a liquidation of credit — something that would have been inevitable in the United States, where we had 20,000 independent unit banks — were able, by virtue of the high degree of concentration of the British banking system, to prevent liquidation. They extended credit on a great scale…England by credit expansion held the fort and continued the rigidities." (p. 175.) [Fast forward and replace British banks by American big banks.]

"There are many objections to widespread branch banking. We should preserve competitive banking. Banks should be under pressure all the time to meet their engagements at the clearing house every day, so that the banker may be compelled to keep his bank liquid, to hold slow [long-dated] paper to a minimum, and to limit bank credit to proper bankable transactions. When, however, five hundred to a thousand banking offices are under the jurisdiction of a single central office, there is no such pressure on the individual offices; and if there can be concerted policy among a few great central offices, the competitive pressure is so greatly lessened that unsound policies can be carried very far." (p. 176.) [See Bank of America and Citigroup, among others. Our authorities have encouraged branch banking.]

"Confined to minor countries, it constituted a safe enough device, but if the effort were made to universalize the gold exchange standard, it is obvious that insolvable problems would arise…the process would lead to a violent break in money rates as surplus reserves piled up in every money market, making possible an unlimited expansion of bank credit…" (p. 179.) [Major countries of the world today do not even have a gold exchange standard in which reserves are foreign currencies convertible into gold. They have reserves of foreign currencies inconvertible into gold.]

"The speculators lost their heads. To too great an extent, the investment bankers did. American investment banking had a long and honorable record…They had been critical of the credits they extended…They had been concerned about their reputations. They tried hard not to put out unsound issues, if only because they wished to be able to sell other issues in later years to the same investors…But with the great flood of cheap money, and with insatiable demand for stocks and bonds, their perspective and their credit standard began to relax as early as 1925. And with the renewal of cheap money in 1927 perspective was badly lost and credit standards suffered a great deal." (p. 212.)

"Short selling is one of the most wholesome factors in the broad and active stock market. The bear, selling stocks short when they go too high, tends to hold them down, and that same bear, in order to take his profits, must buy stocks when they break. Short covering is thus one of the most helpful influences in a bad market break." (p. 216.)

"If we had taken our medicine in 1929 and early 1930, we should have had a severe depression. There were a good many unsound points in the credit structure, and they would have had to be liquidated or readjusted…there were weak points in the banking system where there were excessive holdings of illiquid bonds, or where there were large loans to customers on collateral inadequately diversified, liquidation of which would break the market. There were weak points in the real estate mortgage situation based on very exaggerated real estate prices…" (p. 224.)

"But the administration in Washington was dead set against any such readjustment. It turned instead to frantic governmental economic planning…President Hoover called together in Washington the leaders in business, in railroads, and others, to urge upon them the policies of not cutting prices, not cutting wages, increasing capital outlay, and the like. This was the personal conduct of business by the back seat driver which is the essence of the New Deal…" (p. 225.)

"Almost immediately following the stock market crash, there was an ominous downward movement in the prices of many raw materials and basic foods — the great staples of international trade." (p. 225.)

"Early 1930 saw also a renewal of artificially cheap money." (p. 227.)

"We renewed in 1930 many of the illusions which the stock market crash of 1929 should have dispelled." (p. 228.)

"An examination of the curve for production shows a strong upward trend movement following the open market purchases of government securities by the Federal Reserve banks in 1924, as well as a strong upward movement in the stock market, and the same thing is true in 1927. In 1930, however, although the stock market and the issue of new securities responded to the renewal of cheap money, the curve for production makes no response at all…The jaded economic organism could no longer respond to financial stimulus." (p. 229.)

"There is no need in human life so great as that men should trust one another and should trust their government, should believe in promises, and should keep promises in order that future promises may be believed in and in order that confident cooperation may be possible. Good faith — personal, national, and international — is the first prerequisite of decent living, of the steady going on of industry, of governmental financial strength, and of international peace…The President’s course in connection with the gold standard and in connection with the Thomas Amendment, represented an act of absolute bad faith…It was dishonor." (pp. 315—16.)

[1913] "It was an era of good faith. Men believed in promises. Men believed in the promises of government. Treaties were serious matters. In financial matters the good faith of governments and central banks was taken for granted…No country took pride in debasing its currency as a clever financial expedient." (pp. 21—22.)

"The world was incredibly shocked in 1914 when Bethmann-Hollweg, chancellor of Germany, characterized the treaty guaranteeing the neutrality of Belgium as a u2018scrap of paper.’" (p. 22.) [Attributed to George W. Bush: "Stop throwing the Constitution in my face. It's just a goddamned piece of paper!"]

"On January 4, 1934, the President announced the great spending program in his budget message…The late unlamented CWA, the leaf-raking and snow-shoveling program, was part of this expenditure. A multitude of other things were involved in it. The government loan organizations were pressed to lend more money. The all-important thing was to get money, borrowed money, out of the Treasury, to make prosperity." (p. 350.)

"An evaluation of this spending program and its effect upon business is not difficult…If we attribute all of the business history of the ensuing ten months to the government’s spending program, the record is very disappointing. Business rallied from the 72 index number of November 1933 to 86 in May 1934. Then the curve turned sharply downward and by September 1934 it had dropped to 71…in September, moreover, there came a grave disturbance in the government bond market and a grave concern regarding the government’s credit." (pp. 350—51.)

"Keynes was a dangerously unsound thinker." (p. 384.)

Our leaders are appallingly ignorant in their adherence to discredited Keynesian doctrines. Why is this the case? My oldest brother has asked me an excellent question: "How in the world did the education system, educating individuals who would become economists, bankers, financiers, etc., fail so miserably?"

I do not know. I can only speculate and make a few observations that may be pertinent. I think one reason is that economists emulated physicists and the fame and premier role of physics in the natural sciences. They imported an excessive amount of mathematics and modeling into economics. Mathematical models provide the illusions of understanding and sophistication. They make it seem that anything non-mathematical is vague, possibly mistaken, and inferior. Economists tend to ignore the fact that mathematical models in economics are based upon unreal assumptions, sometimes contradictory assumptions, and often unstated assumptions that are both unreal and contradictory. Formalized hand-waving displaces the informal, even when the informal is correct. Economists tend to believe the results of their mathematical models. The formalism itself seems to dispel proper doubt. They love or are bewitched by the beauty of the symbols, even if they are disconnected from economic reality.

The mathematical economists succeeded in pushing everyone else aside and becoming first in the pecking order. They owned the prestigious journals, publications, and the promotion process. It is easier to demonstrate mathematical skills and secure promotion than it is to demonstrate skills in economics that do not use math.

Modeling took over. History was accorded a low status. Econometrics came in, which is another mathematical tool. The testing of theories, due to the influence of positive economics, became important. Econometrics is beset with a huge number of problems that have always been buried and ignored. Business history and finance have no place in the usual economics curriculum.

The imitation of physics and math is symbolized by the success of Paul Samuelson. His text became standard, despite numerous fallacies and poor ideas. It sold in the millions and was used everywhere for decades. Keynesianism absolutely took over, in part because it was mathematized in the hands of his followers. No matter that the models made no sense.

The government provided ample job markets for economists trained in these ways.

As true as all of that may be, it still does not get at the deep roots of such a thing. There is something more when whole generations go into a certain mode of thought and perpetuate it, something philosophical, psychological, sociological, and ideological. We have to remember that the 1930s saw the rise of fascism and that its offshoots occurred in the US and England too. Somehow university intellectuals in many, many fields got swept along into ideologies, right across the board, in schools of religion, journalism, law, economics, and sociology. The universities to this day reflect the ideological shifts.

The result of all this is that we get people who are educated fools. Their education is narrow and biased. Its products place far too much weight on some things that seem definite to them while rejecting others that seem indefinite to them by not being expressed in the language of math. Ben Bernanke has been a publishing economist with a high reputation. But it does not stop him from being a dyed-in-the-wool Keynesian. It would appear that our leaders, both in government and central banking, are ignorant of economic history or else draw the wrong lessons from it after they get done relying on econometrics applied to unrealistic models using imperfect data. This does not mean that the country will necessarily collapse, but it does mean that they are delaying the adjustments that would restore the things that are now out of balance or out of equilibrium.

Those who know Alan Greenspan personally are in a far better position than I to understand what makes him tick and why he did what he did. He bears a very, very heavy responsibility for our present troubles, in my opinion.

His speeches contain economics fallacies. He seems to have been a coward in the job. There were FED officials under him making warnings, but he did little or nothing actively to restrain the "irrational exuberance" that he made note of. He did not take away the punch bowl; he poured high-proof vodka into it. William McChesney Martin was far better as a FED chairman who was willing to restrain the banking system.

To me it appears that Greenspan got old, tired, and senile in the job. He lost the vigor needed. He became too comfortable and cynical. He lacked the guts to rein in and go against the banks.

He himself unleashed the overly easy money that Anderson explains in detail led to problems in the 20s. Greenspan came to believe that easy money solved recessions. And the mild 1990 and 1994 recessions made him believe it. He didn’t understand the system’s imbalances. He didn’t understand the big picture. He focused on his favorite data series.

He didn’t care about regulating the banks. In the existing system that is essential. One cannot be thinking free market when we do not have one, but instead have inconvertible currencies, a central bank, deposit insurance, a forced currency, large dominating banks, and central banks across the world that have used foreign currencies as reserves.

Greenspan kowtowed to the government. He undermined FED independence. He also expanded its role — that was his biggest and most fatal error. An economist like Anderson who believes in proper government and in central banking sees the latter as having two main proper roles: (a) meeting seasonal needs for credit, and (b) lending during crises. If the central bank attempts to smooth the economy, which is what Greenspan did, the troubles begin. If it targets the price level or inflation, troubles ensue.

Greenspan attempted to find the easy money way out of recessions. He boasted that it was easy. He got hubris. Why did a man who once advocated gold do that? I don’t know. Was it to satisfy Capitol Hill? To be popular? To be The Maestro? Was it to be rewarded by prestigious honors, to hobnob with notables and be recognized as one?

Who was there to sit on Alan Greenspan? He became unaccountable.

The system breeds these kinds of men, this kind of pride, this misdirection and mismanagement, this ignorance of history, and these kinds of errors. We pay for it.

Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York.

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