1992, Christina Romer published an article titled "What
Ended the Great Depression?" in The Journal of Economic
History. In her introduction, Roper explains how America recovered
from the Great Depression:
paper examines the role of aggregate-demand stimulus in ending
the Great Depression. Plausible estimates of the effects of fiscal
and monetary changes indicate that nearly all the observed
recovery of the U.S. economy prior to 1942 was due to monetary
expansion [emphasis mine]. A huge gold inflow in the
mid- and late 1930s swelled the money stock and stimulated
the economy by lowering real interest rates and encouraging
investment spending and purchases of durable goods. That monetary
developments were crucial to the recovery implies that self-correction
played little role in the growth of real output between 1933 and
is now the chair of President Obama's Council of Economic Advisors
and was the co-author the administration’s economic recovery plan.
In Romer, Fed
Chairman Ben Bernanke has a willing accomplice in his quest to print
money, errr…I mean engage in quantitative easing. Like Romer,
Bernanke is an expert on the Great Depression. Like Romer, Bernanke
believes that the solution to our current economic ills lies in
devaluing the dollar through monetary expansion. After all, Bernanke
promised Milton Friedman that the Fed would never again refrain
from providing liquidity during a downturn like it did during the
It seems as
if Romer, Bernanke, et al. are proposing something new and revolutionary
— inflate the money supply and devalue the currency. Genius! But
there is a big problem. This solution is neither new nor revolutionary.
Although it has never before had as fancy a euphemism as "quantitative
easing," the practice of monetary devaluation is ancient and
is standard government operating procedure. Unfortunately, it has
also proven a disaster everywhere it has been implemented.
Romans tried it. The result was the implosion of Western civilization;
a hole out of which it took a millennium for Europe to climb.
tried it. Twice, in fact. The first time, in the early 18th century,
resulted in a classic speculative bubble. Fortunes were made and
then lost in the blink of an eye. The second time, after their revolution,
was even worse. In order to combat price inflation — which was causing
rioting and civil unrest — the government imposed price controls.
Shortages ensued causing more rioting and civil unrest. The French
finally gave up and instituted a gold standard.
tried it after World War One. Their experience was much worse than
the French experience but the outcome wasn't quite as bad as the
Romans — the Weimar inflation contributed to the rise of National
Socialism and the subsequent deaths of over 72 million people. Okay,
maybe it was a bad as the Romans.
have also tried it. As have the Poles, the Hungarians, the Greeks,
the Chinese, the Argentineans, the Brazilians, the Chileans, and
the Yugoslavians. Oh, and the Zimbabweans are trying it right now.
All of these
episodes ended in catastrophe. Of course, the American experience
will be different, right? After all, folks like Romer and Bernanke
Minister Karl Helfferich was an expert on money, too, and even he
could not resist the temptation to crank up the printing press:
follow the good counsel of stopping the printing of notes would
mean refusing to economic life the circulating medium
necessary for transactions, payments of salaries and wages,
etc. It would mean that in a very short time the entire public,
and above all the Reich, could no longer pay merchants, employees,
or workers. In a few weeks, besides the printing of notes,
factories, mines, railways, and post offices, national and
local government, in short, all national and economic life would
As it turned
out, it was the continued printing of money — and not the cessation
— that caused all of these things to occur. But we know better now,
No matter what
the epoch, the laws of economics remain constant. Prices are information.
They relay to entrepreneurs where to best allocate resources in
order to satisfy consumer demand. Because it is a society's medium
of exchange, money has a universal price; generally, everything
is priced in terms of money. Distort the price of money and you
throw the entire system into disarray causing what Austrian economists
call malinvestment. Resources flow into areas that they should not
and away from areas where they should, not because entrepreneurs
have lost the ability to make sound decisions, but because the information
upon which they rely to make those decisions is corrupted.
Romer and Bernanke
are playing a dangerous game. They are also operating under false
premises. First of all, the Great Depression was not caused by a
"lack of aggregate demand" but by the malinvestment brought
on by the Fed's monetary inflation of the 1920s. The reason the
depression lasted so long was that the government refused to allow
the malinvestment to liquidate.
As for the
asset and price deflation of the Great Depression, this was not
the result of the Fed's failure expand the money supply but a result
of a drop in the velocity of money — the rate at which money exchanges
hands. As Murray Rothbard has illustrated in America's
Great Depression, bank reserves actually increased throughout
the Great Depression. However, banks were leery of lending, fearing
bank runs and failure. The demand for money was high as people sought
safety by holding onto cash; saving and not spending. All of this
meant that the price of commodities other than money dropped as
people would rather hold onto their money than spend it.
is much similar to what we face today. Unfortunately, because Bernanke
believes that the Great Depression could have been avoided if the
Fed had inflated aggressively, he has readied an inflationary tsunami.
The only thing holding this tidal wave of dollars back is that much
of it is still sitting in bank reserves and the velocity of money
is still low. Count on Romer and the government to do everything
and anything necessary to change that.
believes that once the economy takes off again, he will be able
to remove the "excess liquidity" from the system by selling
the Fed's assets. Unfortunately, he faces a big problem. Much of
the increase in the Fed's balance sheet is the result of the Fed
removing toxic assets from the banking system. Ummm, they are called
toxic for a reason; no one wants them. To whom then is Bernanke
going to sell them?
the Obama administration, following Romer's advice, is going to
have to fund its profligate spending somehow. U.S. treasuries —
government debt — were once considered the safest investment in
the world. Now, because of the massive debt the federal government
is accruing, no one is buying. According to the Treasury
International Capital System, capital is now
flowing out of the U.S. That leaves one buyer for trillions
of dollars of new debt — the Fed. In other words, not only will
Bernanke not be able to sell the government debt the Fed already
owns, he is going to have to buy oodles and gobs more.
and Bernanke are right. Perhaps printing money is the solution.
Perhaps this one time the laws of economics will prove malleable.
And perhaps donkeys will fly.
is any guide, I'm betting on the donkeys.