The Roaring Twenties gave us the Modern World and one of the Greatest Economic Booms in History
When the steam engine hit the American farm it increased farm production. By mechanizing the farm fewer farmers could farm more land. Allowing American farmers to produce bumper crops. Creating a boom in farm exports. Especially during World War I. As Europeans farmers exchanged their plows for rifles Europe had no one to grow their food. So even though the mechanization of the American farm caused crop prices to fall the increase in sales volume brought in more farm revenue. Life was good for the American farmer. For businesses manufacturing all of that mechanized farm equipment. And the banks making loans to farmers so they could mechanize their farms.
The1920 presidential election pitted a progressive Democrat against a conservative Republican. The progressive promised to raise tax rates to pay down the war debt. Andrew Mellon, Warren Harding’s treasury secretary, found that high tax rates were counterproductive. They actually reduced tax revenue. As wealthy people invested their money out of the country to avoid high tax rates. So when Harding won the election they cut tax rates. With no need to shelter their income the wealthy invested their money in the United States. Pouring their money into the domestic economy caused great economic activity. Great returns on investment. And great income tax revenue. The wealthy paid almost three times as much in tax revenue. While the tax burden on the poor fell. And the national debt fell by one third.
Harding died in office but Calvin Coolidge continued his policies. He slashed government spending along with those tax cuts. Pulling the government out of the private sector economy. And the private sector economy responded. Creating a lot of jobs. Unemployment fell to as low as 2%. And living standards soared. For everyone. Not just those in the unions. In fact, this general rise in living standards weakened the unions. For you didn’t need to belong to a union to live well. It was the beginning of the modern world. Brought about by a burst of innovation and manufacturing that lasted 8 years. One of the greatest economic booms in history. Henry Ford’s moving assembly line made the car affordable for the working man. Auto registrations rose from 9 million in 1921 to 23 million by 1929. An increase of 156%. And keeping pace with the auto manufacturers were their suppliers. Metal, steel, paint, lumber, leather, cotton, glass, rubber, etc. And especially the oil industry. That made lubricating oils and greases. And the gasoline that powered all of these cars. With so many jobs per capita income increased from $522 in 1921 to $716 in 1929. An increase of 37%. With people earning more home ownership soared. And this boom in economic activity didn’t end there.
Herbert Hoover thought Government could better Manage the Economy than Messy Laissez-Faire Free Market Forces
Electric utilities were bringing the new electric power to industrial users and private homes during the Twenties. Industry was using 300% more electric power than they were in 1899. And it changed home life. As electric clothes irons, vacuum cleaners, clothes washers, toasters and refrigerators became common household items by the end of the Twenties. Households that had a telephone increased by 51% during the Twenties. People were watching movies. And saw the first talkies in the Twenties. The radio also became a household fixture with some 7.5 million radio sets sold by 1928. The economy was booming. The middle class was expanding. Consumer prices fell due to increases in productivity giving people more disposable income than they ever had before. Causing an increase in consumer spending. Allowing 1 in 5 Americans to own a car. And increasing the number of people who could afford to fly from 40,000 in 1920 to 417,000 in 1930. An increase of 943%. So Americans were buying a lot. But they were also saving a lot. And investing. Some 28% of American families owned stock. Something once the exclusive privilege of the rich. Wage earners were even buying life insurance policies to provide for their families in the event of their death. Things were happening in the United States during the Twenties. And the innovation and economic tsunami coming out of America had those in Europe worried. So worried that they were discussing forming a United States of Europe to compete with the American system.
But all was not good. During the Twenties those Europeans traded their rifles back for plows. Reducing the export market for American farmers. And when European governments threw up tariffs on America farm goods that export market disappeared. Putting great surpluses into the American market. Causing crop prices to fall further. Crashing farm incomes. Making some farmers unable to service their debt for all of that mechanized equipment they financed. And when they defaulted on their loans en masse banks in the farming regions failed. And when they did the money supply contracted. The Federal Reserve made no effort to stop this contraction. Which had a cooling effect. Tapping the breaks on an expanding economy.
Coolidge chose not to run for a second term. His successor, Herbert Hoover, was a progressive Republican. And was everything Coolidge was not. Hoover favored a big government perfecting the country. He was a professional bureaucrat. He loved bureaucracies. And he loved paperwork and forms. Which he wanted to bury private business in. He thought the government could manage the economy better than messy laissez-faire free market forces. Those very forces that created the Roaring Twenties. He wanted to partner government with business. With the emphasis on government. (As president he increased the size of the Commerce Department and deepened its reach into the private sector economy.)
The Smoot-Hawley Tariff caused Investors to Dump their Stocks causing the Stock Market Crash of 1929
The Federal Reserve misjudged the stock market. They thought it was nothing but speculation. Citing radio maker RCA’s stock price’s meteoric rise. So the Fed tapped the breaks further to cool this ‘speculative’ fervor. Further contracting the money supply. But this wasn’t speculation. The rate of growth in radio sales actually was greater than the rate of growth in the stock price. Making it more likely that the stock was undervalued. Not overvalued. But the Fed went ahead and contracted the money supply anyway. Making it difficult for business to get funding for continued growth. Despite there still being people out there who hadn’t bought a car, a house, electric appliances or a radio yet. And wanted to.
In 1929 a new tariff bill was moving through Congressional committees. The Smoot-Hawley Tariff. Which would raise taxes on imports by up to 30%. Which would greatly increase the cost of business. Because most if not all of American manufacturing used some imported raw materials. Which would increase their selling prices. Making them less competitive. Worse, if the U.S. slapped tariffs on imports it was certain their trading partners would respond with some retaliatory tariffs. Which would just shut down their export markets. Much like those tariffs shut down the export markets for American farmers. Then in the autumn of 1929 the Smoot-Hawley Tariff passed critical votes in committee. Sending the tariff bill on its way to becoming law. This was not good news for investors.
It was all too much. The coming expansion of government regulation over the private sector economy. Higher taxes to pay for this bigger government. The contraction of the money supply. And then the Smoot-Hawley Tariff. Investors could read the writing on the wall. None of this would be good for business. It would just smother the economic growth of the Twenties. For if you increase businesses’ costs and decrease their markets you will slash their profits. Which will reduce the value of these companies. And reduce the value of their stock prices. As investors live by the adage of “buy low, sell high” they’d want to sell those stocks fast before the Smoot-Hawley Tariff sent their prices into a tailspin. Which they did. Causing a great selloff starting in October. That led to the Stock Market Crash of 1929.
Now contrast that with a true speculative bubble. The dot-com bubble. Where investors poured money into these dot-com companies eager to find the next Microsoft. Aided and abetted by the Federal Reserve that was keeping interest rates artificially low. To encourage all sorts of investment. Including ones driven by irrational exuberance. So investors were bidding those stock prices into the stratosphere. For companies that had no profits. For companies that didn’t have a product or service to sell. But these investors were looking with great anticipation at their future profits. Even though they really didn’t understand the Internet. They just knew that computers were involved. Which is what made Microsoft rich. Producing software to run on computers. And every investor was sure their dot-com was going to produce something to run on computers. Making that company rich. And their investors. But when the start-up capital ran out there were no earnings to replace it. And the speculative bubble burst beginning on March 11, 2000. And those highly overvalued stock prices began to fall back to earth. With the tech-laden NASDAQ losing 78% of its value before it was all over. Now THAT is a speculative bubble that the Federal Reserve should have tried to prevent. Not the economic boom of the Twenties where companies were building real things that real people were buying.
Tags: American farmer, Coolidge, crops prices, dot com bubble, dot.com, electric power, Federal Reserve, Harding, Hoover, jobs, living standards, mechanization, money supply, private sector economy, radio, Roaring Twenties, Smoot-Hawley Tariff, speculation, speculative bubble, stock, Stock Market Crash of 1929, stock price, stock prices, tariff, tax cuts, tax rates, tax revenue, Twenties
The Federal Reserve increased the Money Supply to Lower Interest Rates during the Roaring Twenties
Benjamin Franklin said, “Industry, perseverance, & frugality, make fortune yield.” He said that because he believed that. And he proved the validity of his maxim with a personal example. His life. He worked hard. He never gave up. And he was what some would say cheap. He saved his money and spent it sparingly. Because of these personally held beliefs Franklin was a successful businessman. So successful that he became wealthy enough to retire and start a second life. Renowned scientist. Who gave us things like the Franklin stove and the lightning rod. Then he entered his third life. Statesman. And America’s greatest diplomat. He was the only Founder who signed the Declaration of Independence, Treaty of Amity and Commerce with France (bringing the French in on the American side during the Revolutionary War), Treaty of Paris (ending the Revolutionary War very favorably to the U.S.) and the U.S. Constitution. Making the United States not only a possibility but a reality. Three extraordinary lives lived by one extraordinary man.
Franklin was such a great success because of industry, perseverance and frugality. A philosophy the Founding Fathers all shared. A philosophy that had guided the United States for about 150 years until the Great Depression. When FDR changed America. By building on the work of Woodrow Wilson. Men who expanded the role of the federal government. Prior to this change America was well on its way to becoming the world’s number one economy. By following Franklin-like policies. Such as the virtue of thrift. Favoring long-term savings over short-term consumption. Free trade. Balanced budgets. Laissez-faire capitalism. And the gold standard. Which provided sound money. And an international system of trade. Until the Federal Reserve came along.
The Federal Reserve (the Fed) is America’s central bank. In response to some financial crises Congress passed the Federal Reserve Act (1913) to make financial crises a thing of the past. The Fed would end bank panics, bank runs and bank failures. By being the lender of last resort. While also tweaking monetary policy to maintain full employment and stable prices. By increasing and decreasing the money supply. Which, in turn, lowers and raises interest rates. But most of the time the Fed increased the money supply to lower interest rates to encourage people and businesses to borrow money. To buy things. And to expand businesses and hire people. Maintaining that full employment. Which they did during the Roaring Twenties. For awhile.
The Roaring Twenties would have gone on if Herbert Hoover had continued the Harding/Mellon/Coolidge Policies
The Great Depression started with the Stock Market Crash of 1929. And to this date people still argue over the causes of the Great Depression. Some blame capitalism. These people are, of course, wrong. Others blamed the expansionary policies of the Fed. They are partially correct. For artificially low interest rates during the Twenties would eventually have to be corrected with a recession. But the recession did not have to turn into a depression. The Great Depression and the banking crises are all the fault of the government. Bad monetary and fiscal policies followed by bad governmental actions threw an economy in recession into depression.
A lot of people talk about stock market speculation in the Twenties running up stock prices. Normally something that happens with cheap credit as people borrow and invest in speculative ventures. Like the dot-com companies in the Nineties. Where people poured money into these companies that never produced a product or a dime of revenue. And when that investment capital ran out these companies went belly up causing the severe recession in the early 2000s. That’s speculation on a grand scale. This is not what happened during the Twenties. When the world was changing. And electrifying. The United States was modernizing. Electric utilities, electric motors, electric appliances, telephones, airplanes, radio, movies, etc. So, yes, there were inflationary monetary policies in place. But their effects were mitigated by this real economic activity. And something else.
President Warren Harding nominated Andrew Mellon to be his treasury secretary. Probably the second smartest person to ever hold that post. The first being our first. Alexander Hamilton. Harding and Mellon were laissez-faire capitalists. They cut tax rates and regulations. Their administration was a government-hands-off administration. And the economy responded with some of the greatest economic growth ever. This is why they called the 1920s the Roaring Twenties. Yes, there were inflationary monetary policies. But the economic growth was so great that when you subtracted the inflationary damage from it there was still great economic growth. The Roaring Twenties could have gone on indefinitely if Herbert Hoover had continued the Harding and Mellon policies (continued by Calvin Coolidge after Harding’s death). There was even a rural electrification program under FDR’s New Deal. But Herbert Hoover was a progressive. Having far more in common with the Democrat Woodrow Wilson than Harding or Coolidge. Even though Harding, Coolidge and Hoover were all Republicans.
Activist Intervention into Market Forces turned a Recession into the Great Depression
One of the things that happened in the Twenties was a huge jump in farming mechanization. The tractor allowed fewer people to farm more land. Producing a boom in agriculture. Good for the people. Because it brought the price of food down. But bad for the farmers. Especially those heavily in debt from mechanizing their farms. And it was the farmers that Hoover wanted to help. With an especially bad policy of introducing parity between farm goods and industrial goods. And introduced policies to raise the cost of farm goods. Which didn’t help. Many farmers were unable to service their loans with the fall in prices. When farmers began to default en masse banks in farming communities failed. And the contagion spread to the city banks. Setting the stage for a nation-wide banking crisis. And the Great Depression.
One of the leading economists of the time was John Maynard Keynes. He even came to the White House during the Great Depression to advise FDR. Keynes rejected the Franklin/Harding/Mellon/Coolidge policies. And the policies favored by the Austrian school of economics (the only people, by the way, who actually predicted the Great Depression). Which were similar to the Franklin/Harding/Mellon/Coolidge policies. The Austrians also said to let prices and wages fall. To undo all of that inflationary damage. Which would help cause a return to full employment. Keynes disagreed. For he didn’t believe in the virtue of thrift. He wanted to abandon the gold standard completely and replace it with fiat money. That they could expand more freely. And he believed in demand-side solutions. Meaning to end the Great Depression you needed higher wages not lower wages so workers had more money to spend. And to have higher wages you needed higher prices. So the employers could pay their workers these higher wages. And he also encouraged continued deficit spending. No matter the long-term costs.
Well, the Keynesians got their way. And it was they who gave us the Great Depression. For they influenced government policy. The stock market crashed in part due to the Smoot Hawley Tariff then in committee. But investors saw the tariffs coming and knew what that would mean. An end to the economic boom. So they sold their stocks before it became law. Causing the Stock Market Crash of 1929. Then those tariffs hit (an increase of some 50%). Then they doubled income tax rates. And Hoover even demanded that business leaders NOT cut wages. All of this activist intervention into market forces just sucked the wind out of the economy. Turning a recession into the Great Depression.
Tags: Andrew Mellon, Austrian, bank failures, banking crises, banks, Benjamin Franklin, capital, capitalism, capitalists, cheap credit, Coolidge, depression, economic activity, economic growth, expansionary policies, farm, farmers, farming, FDR, Federal Reserve, Founding Fathers, Franklin, frugality, full employment, gold standard, Great Depression, Harding, Herbert Hoover, Hoover, industry, interest rates, John Maynard Keynes, Keynes, Keynesians, laissez faire capitalism, mechanization, Mellon, monetary policy, money, money supply, perseverance, prices, real economic activity, recession, Roaring Twenties, speculation, tariff, the Fed, wages, Warren Harding, Woodrow Wilson
Dot-Com Companies used Venture Capital and Proceeds from their IPOs to pay their Expenses as they had no Revenue
The economy in the Nineties boomed. President Bill Clinton and the Democrats say it was their policies of higher taxes on the rich that made it all happen. At least that’s the argument you hear today in their arguments for returning to the Clinton era taxes on the wealthy. Because it gave us the incredible economic explosion of the Nineties. And balanced the federal budget. But was the economy really that good? No. It wasn’t. A lot of bad things happened in the Nineties. Including something we’re still suffering from today. The Subprime Mortgage Crisis. Which gave us the Great Recession.
The Clinton administration told lenders to approve more mortgages for poor and minority applicants or face action from his justice department. Lenders were not approving these applicants for reasons like lack of income and a poor credit history. Common of people who lived in poorer sections of town because they didn’t have the income and credit history to move to a less poor section of town. To avoid action from Clinton’s justice department lenders turned to subprime lending to qualify the unqualified. To help these lenders unload these toxic mortgages off of their balance sheets the federal government’s GSEs Fannie Mae and Freddie Mac bought them and resold them to unsuspecting investors. And we all know how well that turned out. A great housing bubble blowing up. Subprime Mortgage Crisis. And the Great Recession.
The Nineties also gave us the dot-com bubble. A lot of Internet start-up companies with soaring stock prices for products they never sold. They had no revenues. But speculators were so anxious to get in on the next Microsoft that they ran up these stock prices into the stratosphere. And with nothing to sell these dot-coms used venture capital and proceeds from their initial public offerings (IPOs) to pay their expenses. Giving away what they had for free. Hoping to build brand awareness. And to figure out a way to actually make money on the Internet. Even cities joined in the speculation. Spending tax dollars to build high-tech infrastructure to attract the dot-coms to their cities. And businesses came to their cities. Built buildings. Filled them with employees earning good money. It was the dawn of the new high-tech, Internet-based world. But when all of the investor money ran out they still didn’t have anything to sell to pay their bills. The bubble burst. People lost their jobs en masse. And all those new buildings sat empty in cities burdened with debt and a shrunken tax base. While students who went to college to get degrees to let them join the dot-com world found no one was hiring when they graduated. As few were hiring during the ‘dot-com’ stock market crash and recession of 2000-2002.
Enron Cooked their Books to Overstate Sales and Assets and Underreport Liabilities
Enron came of age in the Nineties. They were in the electricity and natural gas business. In both distribution and generation. They were also into other businesses. Too many to list. But the energy business took off in the Nineties thanks to deregulation. And Enron became a darling of the stock market. With its stock price rising about 300% during the Nineties. The value of its stock was worth about 70 times earnings. Meaning that investors saw nothing but further growth in Enron. Why? Because the Clinton administration was taxing the rich at higher tax rates? Not quite. It’s because they cooked their books.
Investors like to see strong earnings. Lots of assets on the balance sheet. With not so much debt (i.e., liabilities). So Enron strived to give investors what they wanted. By the aforementioned cooking of their books. Using mark-to-market accounting. As opposed to historical cost accounting. Where you buy an asset. You post it to the balance sheet for the value you paid for it. Then forget about it. Mark-to-market, on the other hand, notes the ‘fair value’ of those assets. If an asset grows in value a company adjusts it books to reflect the current, higher value. Making their books more attractive to investors. To look better on the liability side they created a lot of shell companies and special purpose entities. Posting liabilities on these off-balance-sheet companies instead of their own books. The combination of higher asset values and underreporting of liabilities made Enron look very strong financially. And strong revenue growth just made investors drool.
Enron traded. They bought and sold products and services. Providing risk management for its clients. Think of an airline buying a contract for jet fuel for one year to lock in low prices. How you record this transaction on your books depends on what you’re buying and selling. If you’re a stock broker you record only your fees as revenue. Not the value of the stock. If you’re a retailer you record the value of what you sell as revenue. Enron recorded their trading like a retailer would. Which greatly increased their revenues from these trades. They also used mark-to-market accounting on future revenue streams. Instead of using the retailer method of recording sales and costs for a period they would calculate the value of a contract for future sales and record them as current revenue. Pulling future revenues into the current accounting period. This sent revenues soaring. Increasing some 700-800% during the Nineties. Much of which was a house of cards built upon shady accounting practices. Long story short, they couldn’t keep cooking the books. And the house of cards collapsed. The stock price fell back to earth. And landed with a thud. Becoming worthless. People went to prison. Workers lost their jobs. And their pensions. Valued at some $2 billion (though they got a little of that back). Shareholders lost some $74 billion. Their accountant, Arthur Andersen, went out of business for their involvement. And Enron went bankrupt. The biggest bankruptcy ever. Until WorldCom.
The Obama Administration borrowed Accounting Practices from Enron and WorldCom to Score Obamacare
WorldCom became a telecommunications titan by buying other companies. And then with the largest merger in U.S. history when it merged with MCI Communications in 1997. It was huge. And it posted huge sales. Accordingly, its stock price rose. As the dot-com bubble burst WorldCom’s stock price fell. As did a lot of telecoms. To prop up their falling stock price they, too, turned to shady accounting practices. Inflating both revenues and assets. And like Enron they couldn’t keep up the scam. And the fallout was similar to Enron. Only bigger. Interestingly, they even had the same accountant.
But it’s just not corporations playing with their accounting practices. Even the government gets into the action. Case in point Obamacare. The magic number for the cost of Obamacare over 10 years was a trillion dollars. The same cost of the Iraq War and the War in Afghanistan. As the wars end Obamacare takes over that spending. Making it ‘revenue neutral’. Well, health care for everyone without adding any new government spending would be hard to say ‘no’ to. So how do you keep it below the cost of these wars? You borrow accounting practices from Enron and WorldCom.
The original CBO scoring of Obamacare came in at $940 billion. They based this on the data the Obama administration gave them. Which included 10 years of new taxes (or spending transferred from war spending to Obamacare spending). But only 6 years of benefits. So that $940 billion only covered 6 years of Obamacare in that 10 year period. Greatly underreporting the costs of the program. No one knew it at the time. Because they fast-tracked this bill through Congress before anyone had a chance to read its two thousand pages. So they had their CBO scoring below a trillion. And with some shady backroom deals, voila. Obamacare became law. CBO has since revised their number to $1.76 trillion that includes 9 years of benefits. Bringing it to about $2 trillion if you cover all ten years. And closer to $3 trillion if you put back the $741 billion or so taken from Medicare. So the government cooked the books to conceal the true costs of Obamacare. With the true cost being approximately 300% more than they promised the American people it would cost. This $2 trillion scam is greater than the Enron and WorldCom scams. But the government suffers no fallout for their gross misrepresentation like Enron and WorldCom did. Because when they do it it’s just politics.
Tags: accounting period, accounting practices, assets, CBO, CBO scoring, Clinton, Clinton administration, cooked their books, dot com bubble, Enron, Great Recession, housing bubble, Internet, IPOs, liabilities, mark-to-market accounting, Nineties, Obamacare, revenue, speculation, stock prices, subprime lending, subprime mortgage crisis, underreporting of liabilities, WorldCom
When Spain came to the New World they Brought Home a lot of Gold and Silver and Turned it into Coin
Our first banks were goldsmiths’ vaults. They locked up people’s gold or other valuable metals (i.e., specie) in their vaults and issued these ‘depositors’ receipts for their specie. When a depositor presented their receipt to the goldsmith he redeemed it for the amount of specie noted on the receipt. These notes were as good as specie. And a lot easier to carry around. So these depositors used these notes as currency. People accepted them in payment. Because they could take them to the goldsmith and redeem them for the amount of specie noted on the receipt.
The amount of specie these first bankers kept in their vaults equaled the value of these outstanding notes. Meaning their bank reserves were 100%. If every depositor redeemed their notes at the same time there was no problem. Because all specie that was ever deposited was still in the vault. So there was no danger of any ‘bank runs’ or liquidity crises.
When Spain came to the New World they brought home a lot of gold and silver. And turned it into coin. Or specie. The Spanish dollar entered the American colonies from trade with the West Indies. As the British didn’t allow their colonies to coin any money of their own the Spanish dollar became the dominate money in circulation in commerce and trade in the cities. (Which is why the American currency unit is the dollar). While being largely commodity money in the rural parts of the country. Tobacco in Virginia, rice in the south, etc. Paper money didn’t enter into the picture until Massachusetts funded some military expeditions to Quebec. Normally the soldiers in this expedition took a portion of the spoils they brought back for payment. But when the French repulsed them and they came back empty handed the government printed paper money backed by no specie. For there was nothing more dangerous than disgruntled and unpaid soldiers. The idea was to redeem them with future taxation. But they never did.
Thomas Jefferson believed that the Combination of Money and Politics was the Source of all Evil in Government
During the American Revolutionary War the Americans were starving for specie. They were getting some from the French but it was never enough. So they turned to printing paper money. Backed by no specie. They printed so much that it became worthless. The more they printed the more they devalued it. And the fewer people would take it in payment. Anyone paying in these paper Continentals just saw higher and higher prices (while people paying in specie saw lower prices). Until some just refused to accept them. Giving rise to the expression “not worth a Continental.” And when they did the army had to take what they needed from the people. Basically giving them an IOU and telling the people good luck in redeeming them.
Skip ahead to the War of 1812 and the Americans had the same problem. They needed money. So they turned to the printing presses. With the aid of the Second Bank of the United States (BUS). America’s second central bank. Just as politically contentious as the First Bank of the United States. America’s first central bank. The BUS was not quite like those early bankers. The goldsmiths. Whose deposits were backed by a 100% specie reserve. The BUS specie reserve was closer to 10%. Which proved to be a problem because their bank notes were redeemable for specie. Which people did. And because they did and the BUS was losing so much of its specie the government legislated the suspension of the redemption of bank notes for specie. Which just ignited inflation. With the BUS. And the state banks. Who were no longer bound by the requirement to redeem bank notes for specie either. Enter America’s first economic boom created by monetary policy. A huge credit expansion that created a frenzy of borrowing. And speculation.
When more dollars are put into circulation without a corresponding amount of specie backing them this only depreciated the dollar. Making them worth less, requiring more of them to buy the same stuff they did before the massive inflation. This is why prices rise with inflation. And they rose a lot from 1815 to 1818. Real estate prices went up. Fueling that speculation. Allowing the rich to get richer by buying land that soared in value. While ordinary people saw the value of their currency decline making their lives more difficult. Thanks to those higher prices. The government spent a lot of this new money on infrastructure. And there was a lot of fraud. The very reason that Thomas Jefferson opposed Alexander Hamilton’s first Bank of the United States. The combination of money and politics was the source of all evil in government. And fraud. According to Jefferson, at least. Everyone was borrowing. Everyone was spending. Which left the banks exposed to a lot of speculative loans. While putting so much money into circulation that they could never redeem their notes for specie. Not that they were doing that anyway. Bank finances were growing so bad that the banks were in danger of failing.
Most Bad Recessions are caused by Easy Credit by a Central Bank trying to Stimulate Economic Activity
By 1818 things were worrying the government. And the BUS. Inflation was out of control. The credit expansion was creating asset bubbles. And fraud. It was a house of cards that was close to collapsing. So the BUS took action. And reversed their ruinous policies. They contracted monetary policy. Stopped the easy credit. And pulled a lot of those paper dollars out of circulation. It was the responsible thing to do to save the bank. But because they did it after so much inflation that drove prices into the stratosphere the correction was painful. As those prices had a long way to fall.
The Panic of 1819 was the first bust of America’s first boom-bust cycle. The first depression brought on by the easy credit of a central bank. When the money supply contracted interest rates rose. A lot of those speculative loans became unserviceable. With no easy credit available anymore the loan defaults began. And the bank failures followed. Money and credit of the BUS contracted by about 50%. Businesses couldn’t borrow to meet their cash needs and went bankrupt. A lot of them. And those inflated real estate prices fell back to earth. As prices fell everywhere from their artificial heights.
It was America’s first depression. But it wouldn’t be the last. Thanks to central banking. And boom-bust cycles. We stopped calling these central banking train wrecks depressions after the Great Depression. After that we just called them recessions. And real bad recessions. Most of them caused by the same thing. Easy credit by a central bank to stimulate economic activity. Causing an asset bubble. That eventually pops causing a painful correction. The most recent being the Great Recession. Caused by the popping of a great real estate bubble caused by the central bank’s artificially low interest rates. That gave us the subprime mortgage crisis. Which gave us the greatest recession since the Great Depression. Just another in a long line of ‘real bad’ recessions since the advent of central banking.
Tags: asset bubbles, Bank of the United States, bank reserves, bankers, boom-bust cycles, bus, central bank, coin, commodity money, Continental, credit expansion, currency, depositor, depression, easy credit, economic boom, fraud, gold, gold and silver, goldsmith, Great Depression, Great Recession, higher prices, inflation, interest rates, monetary policy, money, money and politics, money supply, Panic of 1819, paper money, printing paper money, recessions, silver, Spanish dollar, specie, speculation, speculative loans, Thomas Jefferson, vaults
Week in Review
The Chinese housing market isn’t what it was. Which can be quite the problem considering the housing boom was 13% of China’s GDP (see China new home prices slide for sixth consecutive month posted 4/18/2012 on BBC News Business).
Property prices in China have fallen for a sixth consecutive month amid government efforts to control prices and curb speculation.
New home prices in 46 out of 70 Chinese cities fell between February and March. Meanwhile prices were lower than a year ago in 38 cities.
There have been fears of the formation of asset bubbles in China…
The booming housing industry supported China’s expansion in recent years, with real estate investment making up 13% of the nation’s gross domestic product in 2011…
“The ultimate goal of the property tightening is to drive down prices but maintain growth in construction and investment.”
Hey, this kind of sounds familiar. Prior to 2008, the U.S. housing market was red hot. People were being approved for mortgages they didn’t have a chance in hell of being able to repay. And house flippers were walking in and getting mortgages for zero down. Fixing them up and putting them back on the market. The subprime mortgage made both of these possible. And the government was doing everything within its power to put as many people in houses as possible. Keeping interest rates artificially low. And having their GSEs Fannie Mae and Freddie Mac buy up toxic subprime mortgages from banks and unloading them onto unsuspecting investors in the guise of ‘safe’ mortgage-backed securities. The economy was booming. Then the housing bubble burst. As did the economy.
The lesson here is the same the Japanese learned in the Nineties. If you put your housing market on government steroids (artificially low interest rates, laws to force lenders t make bad loans, loan guarantees, etc.) it will crash and burn one day. And if you keep building houses you will lower prices on homes already built. The houses people are paying mortgages on. And if you build enough new houses the value of the older houses will be less than the mortgage they’re paying. Especially after the bubble bursts. And you see how well that worked out in the U.S. Suffice it to say President Obama is not running for reelection on his economic record.
Tags: asset bubbles, Chinese, home prices, housing bubble, housing industry, housing market, mortgages, speculation
Because of the Unpredictable Human Element in all Economic Exchanges the Austrian School is more Laissez-Faire
Name some of the great inventions economists gave us. The computer? The Internet? The cell phone? The car? The jumbo jet? Television? Air conditioning? The automatic dishwasher? No. Amazingly, economists did not invent any of these brilliant inventions. And economists didn’t predict any of these inventions. Not a one. Despite how brilliant they are. Well, brilliant by their standard. In their particular field. For economists really aren’t that smart. Their ‘expertise’ is in the realm of the social sciences. The faux sciences where people try to quantify the unquantifiable. Using mathematical equations to explain and predict human behavior. Which is what economists do. Especially Keynesian economists. Who think they are smarter than people. And markets.
But there is a school of economic thought that doesn’t believe we can quantify human activity. The Austrian school. Where Austrian economics began. In Vienna. Where the great Austrian economists gathered. Carl Menger. Ludwig von Mises. And Friedrich Hayek. To name a few. Who understood that economics is the sum total of millions of people making individual human decisions. Human being key. And why we can’t reduce economics down to a set of mathematical equations. Because you can’t quantify human behavior. Contrary to what the Keynesians believe. Which is why these two schools are at odds with each other. With people even donning the personas of Keynes and Hayek to engage in economic debate.
Keynesian economics is more mainstream than the Austrian school. Because it calls for the government to interfere with market forces. To manipulate them. To make markets produce different results from those they would have if left alone. Something governments love to do. Especially if it calls for taxing and spending. Which Keynesian economics highly encourage. To fix market ‘failures’. And recessions. By contrast, because of the unpredictable human element in all economic exchanges, the Austrian school is more laissez-faire. They believe more in the separation of the government from things economic. Economic exchanges are best left to the invisible hand. What Adam Smith called the sum total of the millions of human decisions made by millions of people. Who are maximizing their own economic well being. And when we do we maximize the economic well being of the economy as a whole. For the Austrian economist does not believe he or she is smarter than people. Or markets. Which is why an economist never gave us any brilliant invention. Nor did their equations predict any inventor inventing a great invention. And why economists have day jobs. For if they were as brilliant and prophetic as they claim to be they could see into the future and know which stocks to buy to get rich so they could give up their day jobs. When they’re able to do that we should start listening to them. But not before.
Low Interest Rates cause Malinvestment and Speculation which puts Banks in Danger of Financial Collapse
Keynesian economics really took off with central banking. And fractional reserve banking. Monetary tools to control the money supply. That in the Keynesian world was supposed to end business cycles and recessions as we knew them. The Austrian school argues that using these monetary tools only distorts the business cycle. And makes recessions worse. Here’s how it works. The central bank lowers interest rates by increasing the money supply (via open market transactions, lowering reserve requirements in fractional reserve banking or by printing money). Lower interest rates encourage people to borrow money to buy houses, cars, kitchen appliances, home theater systems, etc. This new economic activity encourages businesses to hire new workers to meet the new demand. Ergo, recession over. Simple math, right? Only there’s a bit of a problem. Some of our worst recessions have come during the era of Keynesian economics. Including the worst recession of all time. The Great Depression. Which proves the Austrian point that the use of monetary policy to end recessions only makes recessions worse. (Economists debate the causes of the Great Depression to this day. Understanding the causes is not the point here. The point is that it happened. When recessions were supposed to be a thing of the past when using Keynesian policies.)
The problem is that these are not real economic expansions. They’re artificial ones. Created by cheap credit. Which the central bank creates by forcing interest rates below actual market interest rates. Which causes a whole host of problems. In particular corrupting the banking system. Banks offer interest rates to encourage people to save their money for future use (like retirement) instead of spending it in the here and now. This is where savings (or investment capital) come from. Banks pay depositors interest on their deposits. And then loan out this money to others who need investment capital to start businesses. To expand businesses. To buy businesses. Whatever. They borrow money to invest so they can expand economic activity. And make more profits.
But investment capital from savings is different from investment capital from an expansion of the money supply. Because businesses will act as if the trend has shifted from consumption (spending now) to investment (spending later). So they borrow to expand operations. All because of the false signal of the artificially low interest rates. They borrow money. Over-invest. And make bad investments. Even speculate. What Austrians call malinvestments. But there was no shift from consumption to investment. Savings haven’t increased. In fact, with all those new loans on the books the banks see a shift in the other direction. Because they have loaned out more money while the savings rate of their depositors did not change. Which produced on their books a reduction in the net savings rate. Leaving them more dangerously leveraged than before the credit expansion. Also, those lower interest rates also decrease the interest rate on savings accounts. Discouraging people from saving their money. Which further reduces the savings rate of depositors. Finally, those lower interest rates reduce the income stream on their loans. Leaving them even more dangerously leveraged. Putting them at risk of financial collapse should many of their loans go bad.
Keynesian Economics is more about Power whereas the Austrian School is more about Economics
These artificially low interest rates fuel malinvestment and speculation. Cheap credit has everyone, flush with borrowed funds, bidding up prices (real estate, construction, machinery, raw material, etc.). This alters the natural order of things. The automatic pricing mechanism of the free market. And reallocates resources to these higher prices. Away from where the market would have otherwise directed them. Creating great shortages and high prices in some areas. And great surpluses of stuff no one wants to buy at any price in other areas. Sort of like those Soviet stores full of stuff no one wanted to buy while people stood in lines for hours to buy toilet paper and soap. (But not quite that bad.) Then comes the day when all those investments don’t produce any returns. Which leaves these businesses, investors and speculators with a lot of debt with no income stream to pay for it. They drove up prices. Created great asset bubbles. Overbuilt their capacity. Bought assets at such high prices that they’ll never realize a gain from them. They know what’s coming next. And in some darkened office someone pours a glass of scotch and murmurs, “My God, what have we done?”
The central bank may try to delay this day of reckoning. By keeping interest rates low. But that only allows asset bubbles to get bigger. Making the inevitable correction more painful. But eventually the central bank has to step in and raise interest rates. Because all of that ‘bidding up of prices’ finally makes its way down to the consumer level. And sparks off some nasty inflation. So rates go up. Credit becomes more expensive. Often leaving businesses and speculators to try and refinance bad debt at higher rates. Debt that has no income stream to pay for it. Either forcing business to cut costs elsewhere. Or file bankruptcy. Which ripples through the banking system. Causing a lot of those highly leveraged banks to fail with them. Thus making the resulting recession far more painful and more long-lasting than necessary. Thanks to Keynesian economics. At least, according to the Austrian school. And much of the last century of history.
The Austrian school believes the market should determine interest rates. Not central bankers. They’re not big fans of fractional reserve banking, either. Which only empowers central bankers to cause all of their mischief. Which is why Keynesians don’t like Austrians. Because Keynesians, and politicians, like that power. For they believe that they are smarter than the people making economic exchanges. Smarter than the market. And they just love having control over all of that money. Which comes in pretty handy when playing politics. Which is ultimately the goal of Keynesian economics. Whereas the Austrian school is more about economics.
Tags: asset bubbles, Austrian economics, Austrian school, Austrian school of economics, bad debt, banking, banking system, business cycle, businesses, central banking, cheap credit, consumption, credit, debt, depositors, deposits, economic activity, economic exchanges, Economics, economists, fractional reserve banking, free market, Great Depression, Hayek, human behavior, income stream, inflation, interest rates, investment, investment capital, Keynes, Keynesian, Keynesian economists, loan, malinvestment, market forces, market interest rates, mathematical equations, monetary tools, money supply, predict human behavior, prices, quantify, recessions, savings, savings accounts, savings rate, speculation, unquantifiable, workers
Week in Review
If there’s anything that tells us not to take mainstream economists or the United Nations or the International Monetary Fund or other global organizations seriously it’s this (see Economists Call for Crop-Trading Limits to Curb Volatility by Alan Bjerga posted 10/10/2011 on Bloomberg Businessweek).
Hundreds of economists including scholars from Oxford University and the University of California, Berkeley, are asking the Group of 20 nations to impose limits on speculative positions in food commodities to curb volatility in crop prices…
Research sponsored by the United Nations, International Monetary Fund and other global organizations suggest speculation in crop futures by index funds and large banks may cause price spikes that can put grocery costs out of reach for poorer people. Global regulation of speculators has been a goal of French President Nicolas Sarkozy during his term as leader of the G-20 this year.
What’s the common thread in all these organizations? They’re all Keynesian tax and spend big world government. And, surprise, surprise, they want more control over the world’s economies.
Have we learned nothing from the Nixon’s price controls of the Seventies? Price controls make scarce things scarcer. Did rent control make more low-income housing available? No. Did price controls make gasoline more available? No. Why? Because market prices match supply to demand. And when you mess with the market price mechanism, you mess with supply and demand. Resulting in shortages. Such as low-income housing and gasoline during the Seventies.
Messing with prices doesn’t make scarce things less scarce. So why do it? Because that’s what Keynesian tax and spend big world government does. It’s not about the economy. It’s about power. Their power. And they want more.
The 2008 spike in gasoline prices is an example of this pricing mechanism. The run up that peaked in July 2008 was due to a fall in OPEC production, not speculation (see Federal Reserve Bank of Dallas Clearly Explains Why Speculation Didn’t Drive Oil Prices in 2008 by Kay McDonald posted 10/14/2011 on big agriculture picture). The high gas prices in 2008 just made sure that a scarce resource was available for those who really needed it. People drove less over the summer. Which made a scarce resource available for those who really needed it. The result? No gas shortages. And no gas lines. Like in the Seventies.
Tags: economists, economy, G-20, gasoline prices, Keynesian, market prices, price controls, price mechanism, price spikes, speculation, speculators, supply and demand, Tax and spend
WHAT GAVE BIRTH to the Federal Reserve System and our current monetary policy? The Panic of 1907. Without going into the details, there was a liquidity crisis. The Knickerbocker Trust tried to corner the market in copper. But someone else dumped copper on the market which dropped the price. The trust failed. Because of the money involved, a lot of banks, too, failed. Depositors, scared, created bank runs. As banks failed, the money supply contracted. Businesses failed. The stock market crashed (losing 50% of its value). And all of this happened during an economic recession.
So, in 1913, Congress passed the Federal Reserve Act, creating the Federal Reserve System (the Fed). This was, basically, a central bank. It was to be a bank to the banks. A lender of last resort. It would inject liquidity into the economy during a liquidity crisis. Thus ending forever panics like that in 1907. And making the business cycle (the boom – bust economic cycles) a thing of the past.
The Fed has three basic monetary tools. How they use these either increases or decreases the money supply. And increases or decreases interest rates.
They can change reserve requirements for banks. The more reserves banks must hold the less they can lend. The less they need to hold the more they can lend. When they lend more, they increase the money supply. When they lend less, they decrease the money supply. The more they lend the easier it is to get a loan. This decreases interest rates (i.e., lowers the ‘price’ of money). The less they lend the harder it is to get a loan. This increases interest rates (i.e., raises the ‘price’ of money).
The Fed ‘manages’ the money supply and the interest rates in two other ways. They buy and sell U.S. Treasury securities. And they adjust the discount rate they charge member banks to borrow from them. Each of these actions either increases or decreases the money supply and/or raises or lowers interest rates. The idea is to make money easier to borrow when the economy is slow. This is supposed to make it easier for businesses to expand production and hire people. If the economy is overheating and there is a risk of inflation, they take the opposite action. They make it more difficult to borrow money. Which increases the cost of doing business. Which slows the economy. Lays people off. Which avoids inflation.
The problem with this is the invisible hand that Adam Smith talked about. In a laissez-faire economy, no one person or one group controls anything. Instead, millions upon millions of people interact with each other. They make millions upon millions of decisions. These are informed decisions in a free market. At the heart of each decision is a buyer and a seller. And they mutually agree in this decision making process. The buyer pays at least as much as the seller wants. The seller sells for at least as little as the buyer wants. If they didn’t, they would not conclude their sales transaction. When we multiply this basic transaction by the millions upon millions of people in the market place, we arrive at that invisible hand. Everyone looking out for their own self-interest guides the economy as a whole. The bad decisions of a few have no affect on the economy as a whole.
Now replace the invisible hand with government and what do you get? A managed economy. And that’s what the Fed does. It manages the economy. It takes the power of those millions upon millions of decisions and places them into the hands of a very few. And, there, a few bad decisions can have a devastating impact upon the economy.
TO PAY FOR World War I, Woodrow Wilson and his Progressives heavily taxed the American people. The war left America with a huge debt. And in a recession. During the 1920 election, the Democrats ran on a platform of continued high taxation to pay down the debt. Andrew Mellon, though, had done a study of the rich in relation to those high taxes. He found the higher the tax, the more the rich invested outside the country. Instead of building factories and employing people, they took their money to places less punishing to capital.
Warren G. Harding won the 1920 election. And he appointed Andrew Mellon his Treasury secretary. Never since Alexander Hamilton had a Treasury secretary understood capitalism as well. The Harding administration cut tax rates and the amount of tax money paid by the ‘rich’ more than doubled. Economic activity flourished. Businesses expanded and added jobs. The nation modernized with the latest technologies (electric power and appliances, radio, cars, aviation, etc.). One of the best economies ever. Until the Fed got involved.
The Fed looked at this economic activity and saw speculation. So they contracted the money supply. This made it hard for business to expand to meet the growing demand. When money is less readily available, you begin to stockpile what you have. You add to that pile by selling liquid securities to build a bigger cash cushion to get you through tight monetary times.
Of course, the economy is NOT just monetary policy. Those businesses were looking at other things the government was doing. The Smoot-Hartley tariff was in committee. Across the board tariff increases and import restrictions create uncertainty. Business does not like uncertainty. So they increase their liquidity. To prepare for the worse. Then the stock market crashed. Then it got worse.
It is at this time that the liquidity crisis became critical. Depositors lost faith. Bank runs followed. But there just was not enough money available. Banks began to fail. Time for the Fed to step in and take action. Per the Federal Reserve Act of 1913. But they did nothing. For a long while. Then they took action. And made matters worse. They raised interest rates. In response to England going off the gold standard (to prop up the dollar). Exactly the wrong thing to do in a deflationary spiral. This took a bad recession to the Great Depression. The 1930s would become a lost decade.
When FDR took office, he tried to fix things with some Keynesian spending. But nothing worked. High taxes along with high government spending sucked life out of the private sector. This unprecedented growth in government filled business with uncertainty. They had no idea what was coming next. So they hunkered down. And prepared to weather more bad times. It took a world war to end the Great Depression. And only because the government abandoned much of its controls and let business do what they do best. Pure, unfettered capitalism. American industry came to life. It built the war material to first win World War II. Then it rebuilt the war torn countries after the war.
DURING THE 1980s, in Japan, government was partnering with business. It was mercantilism at its best. Japan Inc. The economy boomed. And blew great big bubbles. The Keynesians in America held up the Japanese model as the new direction for America. An American presidential candidate said we must partner government with business, too. For only a fool could not see the success of the Japanese example. Japan was growing rich. And buying up American landmarks (including Rockefeller Center in New York). National Lampoon magazine welcomed us to the 90s with a picture of a Japanese CEO at his desk. He was the CEO of the United States of America, a wholly owned subsidiary of the Honda Motor Company. The Japanese were taking over the world. And we were stupid not to follow their lead.
But there was no invisible hand in Japan. It was the hand of Japan Inc. It was Japan Inc. that pursued economic policies that it thought best. Not the millions upon millions of ordinary Japanese citizens. Well, Japan Inc. thought wrong.
There was collusion between Japanese businesses. And collusion between Japanese businesses and government. And corruption. This greatly inflated the Japanese stock market. And those great big bubbles finally burst. The powerful Japan Inc. of the 1980s that caused fear and trembling was gone. Replaced by a Japan in a deflationary spiral in the 1990s. Or, as the Japanese call it, their lost decade. This once great Asian Tiger was now an older tiger with a bit of a limp. And the economy limped along for a decade or two. It was still number 3 in the world, but it wasn’t what it used to be. You don’t see magazine covers talking about it owning other nations any more. (In 2010, China took over that #3 spot. But China is a managed economy. Will it suffer Japan’s fate? Time will tell.)
The Japanese monetary authorities tried to fix the economy. Interest rates were zero for about a decade. In other words, if you wanted to borrow, it was easy. And free. But it didn’t help. That huge economic expansion wasn’t real. Business and government, in collusion, inflated and propped it up. It gave them inflated capacity. And prices. And you don’t solve that problem by making it easier for businesses to borrow money to expand capacity and create jobs. That’s the last thing they need. What they need to do is to get out of the business of managing business. Create a business-friendly climate. Based on free-market principles. Not mercantilism. And let that invisible hand work its wonders.
MONETARY POLICY CAN do a lot of things. Most of them bad. Because it concentrates far too much power in too few hands. The consequences of the mistakes of those making policy can be devastating. And too tempting to those who want to use those powers for political reasons. As we can see by Keynesian ‘stimulus’ spending that ends up as pork barrel spending. The empirical data for that spending has shown that it stimulates only those who are in good standing with the powers that be. Never the economy.
Sound money is important. The money supply needs to keep pace with economic expansion. If it doesn’t, a tight money supply will slow or halt economic activity. But we have to use monetary policy for that purpose only. We cannot use it to offset bad fiscal policy that is anti-business. For if the government creates an anti-business environment, no amount of cheap money will encourage risk takers to take risks in a highly risky and uncertain environment. Decades were lost trying.
No, you don’t stimulate with monetary policy. You stimulate with fiscal policy. There is empirical evidence that this works. The Mellon tax cuts of the Harding administration created nearly a decade of strong economic growth. The tax cuts of JFK were on pace to create similar growth until his assassination. LBJ’s policies were in the opposite direction, thus ending the economic recovery of the JFK administration. Ronald Reagan’s tax cuts produced economic growth through two decades.
THE EVIDENCE IS there. If you look at it. Of course, a good Keynesian won’t. Because it’s about political power for them. Always has been. Always will be. And we should never forget this.
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