Dr Wright
In the high school where I work I noticed pictures on the wall in a class room of moments in history. One picture says the American Revolution ended at Yorktown (somewhat untrue) and there was another that stated the Great Depression ended with FDR's social programs but I have read that World War II had an impact on the recovery, since you have wrote of the causes of it and other problems later in history could you comment on the recovery from the depression?.... signed (your cousin) DP
DP,
World War II rapidly brought the economy to full employment and beyond. It did not, repeat did not, bring the U.S. economy out of the Depression. FDR's social programs didn't either. What did the trick was loosening the gold standard (1 oz. gold to $35 from $20), which allowed the Fed to reflate the money supply, which lowered REAL (inflation adjusted) wages and interest rates, both of which had become far too high due to the deflation associated with the infamous bank panics and the stock market crash and subsequent decline in aggregate demand. 2H 1933 through 1936 were periods of strong growth (increases in per capita GDP). Unemployment decreased as well but more slowly. (As our beloved president recently noted, employment is a lagging indicator.) The unemployment rate would have been back near its normal low level by 1939, and certainly by 1941, even without the war had it not been for the so-called Roosevelt Recession of 1937-38, when FDR tried to balance the budget, in retrospect prematurely, and the Fed capriciously raised banks' reserve requirements for reasons only a central banker could "understand."
For more info., see a cute little volume I edited called Bailouts: Public Money, Private Profits due out from Columbia UP/SSRC shortly. It's only like 12 bucks on Amazon and my part of it is sort of a prequel to my Fubarnomics due out from Prometheus early next year.
Sunday, July 12, 2009
Monday, July 6, 2009
1929: The Sequel
This is the text of a webcast I did last week. To view the slides, etc:
http://www.complinet.com/connected/news-and-events/webcasts/great-crash/share/great-crash-slides.pdf
1929: The Sequel
By Robert E. Wright, Nef Family Chair of Political Economy, Augustana College SD
The Great Crash of 1929 did not literally repeat in 2008. As we will see, there is one crucial difference between the two episodes and it likely will be our savior. Nevertheless, striking similarities between the two crashes are evident. Foremost, as shown on slide 2, in both instances the economy was in recession BEFORE financial crisis struck and in that sense the financial system could not be said to CAUSE either economic downturn, only to exacerbate problems in the real economy like inventory gluts, softness in construction and real estate markets, and energy price spikes.
In both periods, the financial system proved to be EXTREMELY fragile due to the use of leverage, the purchase of speculative assets with borrowed money. In both periods the bursting of asset bubbles, real estate bubbles followed by corporate equities bubbles, led to the destructive processes illustrated on slide 3. When commercial and housing real estate markets softened in the 1920s and recently, corporate balance sheets weakened and mortgage default rates increased, which in turn increased asymmetric information, the great bane of financial institutions then and now.
In both crashes the “bank problems” listed second from the bottom were particularly potent. In the face of elevated default rates, damaged balance sheets, and high levels of uncertainty about future business conditions, banks raised the interest rates they charged some borrowers and stopped lending entirely to many others. That slowed business investment which led to further decreases in economic activity, even higher levels of default, and, ultimately, bank failures, and a massive degree of additional uncertainty.
Of course the crashes of 29 and “aught eight” are not identical. As Mark Twain once said, history rhymes rather than repeats. During the Depression, small banks bit the dust first, with the big ones staggering only in the later stages of the economy’s three-year death spiral. Today, it is the big boys who first fell but the pollution their crashing and burning creates is now suffocating smaller institutions. As summarized in slide 4, the changing but always inept nature of banking regulation explains why small banks gave way first during the Depression while big ones could not withstand last year’s crash. Prior to World War II, most Americans and their politicians possessed a morbid fear of large financial institutions. Andrew Jackson vetoed the re-charter of the Bank of the United States, pictured on slide 5, partly because he thought the institution had grown too large and powerful. Some 80 years later, a government fearful of the power accumulated by investment banker J.P. Morgan created a new central bank, the Federal Reserve System, but simultaneously tried to limit its influence by dividing it into 12 districts, also shown on slide 5. For similar reasons, throughout much of the nation regulators forbade banks to operate a branch across the street much less across state lines. As a result, most banks outside of the major money centers were tiny affairs that, even if conservatively run, were highly susceptible to local economic shocks. Places that allowed branch banking, including California and Canada, weathered the Depression much better than adjacent territories dominated by unit banks because they suffered many fewer failures.
That led regulators to conclude, erroneously, the bigger the better. In the years leading up to the current crisis, regulators not only allowed banks to grow large they actually strongly encouraged them to do so with the “Too Big to Fail” policy. Concocted in the aftermath of the Continental Illinois failure in 1984, TBTF policy promised that the government would prevent systemic financial crises by aiding the largest financial institutions should they face insolvency or bankruptcy. Because the government charged nothing for the guarantee and never made clear which companies were covered under it, many financiers used TBTF as an excuse for constant, rapid growth, mainly through the acquisition of smaller institutions. TBTF encouraged other types of excessive risk-taking as well by promising government aid in all events. Because risk and return are positively correlated, it essentially generated private profits with public money.
I am not, however, one of those folks who puts all the blame on the government. Properly understood, both the Depression and the current crisis are examples of a broader phenomenon I call “hybrid failures.” As slide 7 jokes, by this I do NOT mean a Prius that won’t start. Rather, as in slide 8, a hybrid failure is a combination of classic market failures like asymmetric information, asset bubbles, positive and negative externalities, and public goods INTRICATELY INTERTWINED with government failures like the creation of perverse incentives, misguided regulation, the inability to foresee and fix problems before they cause major economic disruptions, and implementing counterproductive bailouts.
Slide 9 summarizes the hybrid failures at the heart of both the 1929 and 2008 crashes. You’ll quickly perceive that they are identical. If we zoom in more closely, however, differences appear. The 1920s real estate bubble was not as big as the recent one shown in Slide 10. The stock market bubble of the 1920s, however, was much bigger than the fluff that survived the dotcom bust. We’ve already seen that very different yet equally misguided banking regulations played a role in both crises, as did the inability of the government to foresee the perverse incentives those regulations gave rise to. The most maddening thing about the “aught eight” debacle was that it was the 7th time in American history that regulators allowed mortgage originators to take full commissions upon closing and the 7th time that a mortgage securitization scheme exploded in our faces.
Finally, and most importantly, while fiscal stimulus, TARP, and other recent bailout attempts have hardly been unqualified successes to date they do not appear to be as disastrous as some of the policies implemented during the early stages of the Depression. The Smoot-Hawley tariff was extremely destructive and is unlikely to be repeated. We are also unlikely to repeat the creation of a bad bank, which works better when it has to liquidate numerous small institutions, as the Reconstruction Finance Corporation and the Resolution Trust Corporation did during the Depression and the Savings and Loan crisis, respectively.
We will also likely avoid creating anything like the National Industrial Recovery Act, the infamous blue eagle of which is pictured on slide 11. The NRA sought, luckily in vain, to INCREASE real wages when the economy desperately needed lower real wages. Wages stuck at high levels due to deflation and the unwillingness of workers to accept nominal wage cuts were of course the proximate cause of the very high levels of unemployment that disrupted America’s social, political, and financial systems during the Depression. Even at 10 percent, the unemployment rate today is much less than half of that experienced during the hard winter of 1932-33.
Moving on to slide 12, the only government policy during the New Deal with a demonstrably positive effect on the economy was the devaluation of the dollar and the de facto abandonment of the classical gold standard. Because it had to defend the nation’s gold stocks, the Depression-era Federal Reserve could not appreciably lower interest rates or increase money growth in the aftermath of the stock market crash. It did not even replace the money destroyed when thousands of banks failed, paying just pennies on the dollar to depositors. As a result, the money supply actually shrank and the price level declined dramatically, effectively increasing real wages and real interest rates. By greatly loosening the link to gold, Roosevelt allowed re-flation and decreased real interest rates, thereby fueling the expansion of 1933 to 1937.
Loss of the gold standard cost us our long term price anchor but gave us in exchange tremendous domestic monetary policy flexibility. Today’s Federal Reserve does not need to maintain gold stocks or the value of the dollar in international markets. It can, if it wishes, decrease interest rates to zero, print prodigious quantities of money, and lend it to whomever it sees fit. In fact, after the failure of Bear Stearns the Fed kept a pretty tight reign on the money supply in order to support the value of the dollar in international markets. After the failure of Lehman, by contrast, it let out all the stops and, as illustrated on slide 13, essentially implemented one-half of Alexander Hamilton and Walter Bagehot’s famous rule of central banking and lent freely to all who could post solid collateral. In addition to its traditional discount window, the Fed now lends via seven new so-called term facilities. The only disappointment is that it provides the funds very cheaply, rather than at the penalty rate espoused by Hamilton and Bagehot, thus subsidizing private concerns with public money and increasing moral hazard and hence the probability of future crises.
Clearly, the Fed wishes to avoid the melancholy scenes depicted on slide 14 -- the dust bowl, the breadlines, and the public health crises that characterized the Depression. Thanks largely to its efforts, the sequel to the Crash of 1929 will turn out to have a much happier ending, at least in the immediate term.
Nevertheless, longer term, as indicated on slide 15, troubles loom. I was warning about the alarming growth of the national debt in 2007 and now of course am very concerned that the debt may cause interest rates to increase to levels that will hamper a robust recovery. Fears of a soft default or inflation are foremost as are concerns that foreigners will stop buying U.S. government bonds, at which point domestic crowding out may occur. I’m also concerned by the fact that the government has yet to price Too Big To Fail and other federal guarantees and backstops at anything close to market rates. That means, in effect, that the government is still subsidizing private risk taking with public money so it is only a matter of time before another financial crisis strikes. When and where it will occur I of course do not know but if the government doesn’t act decisively to force people to wager only their own money, I fear “The Great Crash III, They Did It Again” will be coming to an economy near you in the not-so-distant future.
I’m done. Thanks for your time and attention!
http://www.complinet.com/connected/news-and-events/webcasts/great-crash/share/great-crash-slides.pdf
1929: The Sequel
By Robert E. Wright, Nef Family Chair of Political Economy, Augustana College SD
The Great Crash of 1929 did not literally repeat in 2008. As we will see, there is one crucial difference between the two episodes and it likely will be our savior. Nevertheless, striking similarities between the two crashes are evident. Foremost, as shown on slide 2, in both instances the economy was in recession BEFORE financial crisis struck and in that sense the financial system could not be said to CAUSE either economic downturn, only to exacerbate problems in the real economy like inventory gluts, softness in construction and real estate markets, and energy price spikes.
In both periods, the financial system proved to be EXTREMELY fragile due to the use of leverage, the purchase of speculative assets with borrowed money. In both periods the bursting of asset bubbles, real estate bubbles followed by corporate equities bubbles, led to the destructive processes illustrated on slide 3. When commercial and housing real estate markets softened in the 1920s and recently, corporate balance sheets weakened and mortgage default rates increased, which in turn increased asymmetric information, the great bane of financial institutions then and now.
In both crashes the “bank problems” listed second from the bottom were particularly potent. In the face of elevated default rates, damaged balance sheets, and high levels of uncertainty about future business conditions, banks raised the interest rates they charged some borrowers and stopped lending entirely to many others. That slowed business investment which led to further decreases in economic activity, even higher levels of default, and, ultimately, bank failures, and a massive degree of additional uncertainty.
Of course the crashes of 29 and “aught eight” are not identical. As Mark Twain once said, history rhymes rather than repeats. During the Depression, small banks bit the dust first, with the big ones staggering only in the later stages of the economy’s three-year death spiral. Today, it is the big boys who first fell but the pollution their crashing and burning creates is now suffocating smaller institutions. As summarized in slide 4, the changing but always inept nature of banking regulation explains why small banks gave way first during the Depression while big ones could not withstand last year’s crash. Prior to World War II, most Americans and their politicians possessed a morbid fear of large financial institutions. Andrew Jackson vetoed the re-charter of the Bank of the United States, pictured on slide 5, partly because he thought the institution had grown too large and powerful. Some 80 years later, a government fearful of the power accumulated by investment banker J.P. Morgan created a new central bank, the Federal Reserve System, but simultaneously tried to limit its influence by dividing it into 12 districts, also shown on slide 5. For similar reasons, throughout much of the nation regulators forbade banks to operate a branch across the street much less across state lines. As a result, most banks outside of the major money centers were tiny affairs that, even if conservatively run, were highly susceptible to local economic shocks. Places that allowed branch banking, including California and Canada, weathered the Depression much better than adjacent territories dominated by unit banks because they suffered many fewer failures.
That led regulators to conclude, erroneously, the bigger the better. In the years leading up to the current crisis, regulators not only allowed banks to grow large they actually strongly encouraged them to do so with the “Too Big to Fail” policy. Concocted in the aftermath of the Continental Illinois failure in 1984, TBTF policy promised that the government would prevent systemic financial crises by aiding the largest financial institutions should they face insolvency or bankruptcy. Because the government charged nothing for the guarantee and never made clear which companies were covered under it, many financiers used TBTF as an excuse for constant, rapid growth, mainly through the acquisition of smaller institutions. TBTF encouraged other types of excessive risk-taking as well by promising government aid in all events. Because risk and return are positively correlated, it essentially generated private profits with public money.
I am not, however, one of those folks who puts all the blame on the government. Properly understood, both the Depression and the current crisis are examples of a broader phenomenon I call “hybrid failures.” As slide 7 jokes, by this I do NOT mean a Prius that won’t start. Rather, as in slide 8, a hybrid failure is a combination of classic market failures like asymmetric information, asset bubbles, positive and negative externalities, and public goods INTRICATELY INTERTWINED with government failures like the creation of perverse incentives, misguided regulation, the inability to foresee and fix problems before they cause major economic disruptions, and implementing counterproductive bailouts.
Slide 9 summarizes the hybrid failures at the heart of both the 1929 and 2008 crashes. You’ll quickly perceive that they are identical. If we zoom in more closely, however, differences appear. The 1920s real estate bubble was not as big as the recent one shown in Slide 10. The stock market bubble of the 1920s, however, was much bigger than the fluff that survived the dotcom bust. We’ve already seen that very different yet equally misguided banking regulations played a role in both crises, as did the inability of the government to foresee the perverse incentives those regulations gave rise to. The most maddening thing about the “aught eight” debacle was that it was the 7th time in American history that regulators allowed mortgage originators to take full commissions upon closing and the 7th time that a mortgage securitization scheme exploded in our faces.
Finally, and most importantly, while fiscal stimulus, TARP, and other recent bailout attempts have hardly been unqualified successes to date they do not appear to be as disastrous as some of the policies implemented during the early stages of the Depression. The Smoot-Hawley tariff was extremely destructive and is unlikely to be repeated. We are also unlikely to repeat the creation of a bad bank, which works better when it has to liquidate numerous small institutions, as the Reconstruction Finance Corporation and the Resolution Trust Corporation did during the Depression and the Savings and Loan crisis, respectively.
We will also likely avoid creating anything like the National Industrial Recovery Act, the infamous blue eagle of which is pictured on slide 11. The NRA sought, luckily in vain, to INCREASE real wages when the economy desperately needed lower real wages. Wages stuck at high levels due to deflation and the unwillingness of workers to accept nominal wage cuts were of course the proximate cause of the very high levels of unemployment that disrupted America’s social, political, and financial systems during the Depression. Even at 10 percent, the unemployment rate today is much less than half of that experienced during the hard winter of 1932-33.
Moving on to slide 12, the only government policy during the New Deal with a demonstrably positive effect on the economy was the devaluation of the dollar and the de facto abandonment of the classical gold standard. Because it had to defend the nation’s gold stocks, the Depression-era Federal Reserve could not appreciably lower interest rates or increase money growth in the aftermath of the stock market crash. It did not even replace the money destroyed when thousands of banks failed, paying just pennies on the dollar to depositors. As a result, the money supply actually shrank and the price level declined dramatically, effectively increasing real wages and real interest rates. By greatly loosening the link to gold, Roosevelt allowed re-flation and decreased real interest rates, thereby fueling the expansion of 1933 to 1937.
Loss of the gold standard cost us our long term price anchor but gave us in exchange tremendous domestic monetary policy flexibility. Today’s Federal Reserve does not need to maintain gold stocks or the value of the dollar in international markets. It can, if it wishes, decrease interest rates to zero, print prodigious quantities of money, and lend it to whomever it sees fit. In fact, after the failure of Bear Stearns the Fed kept a pretty tight reign on the money supply in order to support the value of the dollar in international markets. After the failure of Lehman, by contrast, it let out all the stops and, as illustrated on slide 13, essentially implemented one-half of Alexander Hamilton and Walter Bagehot’s famous rule of central banking and lent freely to all who could post solid collateral. In addition to its traditional discount window, the Fed now lends via seven new so-called term facilities. The only disappointment is that it provides the funds very cheaply, rather than at the penalty rate espoused by Hamilton and Bagehot, thus subsidizing private concerns with public money and increasing moral hazard and hence the probability of future crises.
Clearly, the Fed wishes to avoid the melancholy scenes depicted on slide 14 -- the dust bowl, the breadlines, and the public health crises that characterized the Depression. Thanks largely to its efforts, the sequel to the Crash of 1929 will turn out to have a much happier ending, at least in the immediate term.
Nevertheless, longer term, as indicated on slide 15, troubles loom. I was warning about the alarming growth of the national debt in 2007 and now of course am very concerned that the debt may cause interest rates to increase to levels that will hamper a robust recovery. Fears of a soft default or inflation are foremost as are concerns that foreigners will stop buying U.S. government bonds, at which point domestic crowding out may occur. I’m also concerned by the fact that the government has yet to price Too Big To Fail and other federal guarantees and backstops at anything close to market rates. That means, in effect, that the government is still subsidizing private risk taking with public money so it is only a matter of time before another financial crisis strikes. When and where it will occur I of course do not know but if the government doesn’t act decisively to force people to wager only their own money, I fear “The Great Crash III, They Did It Again” will be coming to an economy near you in the not-so-distant future.
I’m done. Thanks for your time and attention!
Saturday, June 27, 2009
Cap, Cap and Trade, or Tax
As I mentioned in a recent post, many FUBAR areas of the economy got that way because of decades (and sometimes centuries) of government interference followed by market response. I call these hybrid failures to stress my non-partisan approach to the problem. Most other analysts take ideologically-colored views. Those from the Left jump at the market failure part of the cycle while those on the Right emphasize the government failure part of it. Pollution and its control is certainly a hybrid failure.
Initially, pollution of any sort is, by definition, a type of market failure called a negative externality. The externality is the costs (cleanup, disease, environmental, etc.) imposed by the pollution on society, or rather on innocent victims within societies. Because polluters do not pay the costs of the pollution but reap the benefits they produce more than the socially optimum amount.
The U.S. government reacted to this market failure by capping or limiting the emission of various types of nasties. Polluters responded by weighing the net costs (costs minus benefits) of compliance and cheating so, ultimately, the effectiveness of the cap-only system was a function of the government's diligence monitoring compliance and prosecuting cheaters. Over time, the government's zeal fluctuated. High levels of enforcement were unsustainable due to budget constraints and regulatory capture. In short, politicians found it in their own interest to spend public monies in other, more salient areas in order to garner votes and in order to attract campaign contributions from polluters.
Cap and trade is a modest improvement over straight caps because it offers polluters a third option: selling some or all of their pollution quotas to other polluters who value them more highly. That should induce polluters with a relatively low cost of pollution reduction to sell permits to polluters with a relatively high cost of pollution reduction. That should spur more compliance and a better use of resources. Of course political decisions still rule the system as the government will decide the size of the cap and the distribution of permits. Polluters will try to get an unfair proportion of permits and also to get the overall cap enlarged. And again politicians will see compliance as a drain on public resources that might be better spent elsewhere (like paying down the national debt ... yeah right!).
A tax, on the other hand, gives the government an incentive to enforce compliance, the payment of the tax. Cheating can and will occur but the IRS will try earnestly to minimize it. The government no longer directly decides how much pollution will be allowed but rather sets the tax rate. The market then determines how much pollution is cost effective at that rate. Roughly speaking, the higher the tax, the lower the tolerable quantity of pollution. Presumably, the government will try to maximize its revenue, so it won't increase the tax to the point of eliminating all pollution and hence all its revenue but at the same time it won't be easily swayed by calls for suboptimally low taxes either.
Finally, it would be technically possible to use such a tax to reduce pollution abroad as well by embedding the tax in tariffs. (That may run afoul of the WTO in which case I say then change WTO rules.) That will keep the playing field level and also dissuade polluters from outsourcing or outright moving to other countries to avoid the tax. Cheap imports from China won't look so cheap anymore.
As I noted in One Nation Under Debt, it would behoove us to find a politically tolerable tax to replace the tariffs that paid off the first national debt. A tax on pollution of various sorts might well fit the bill. Most people agree less carbon, mercury, PCBs, etc. would be a good thing. More taxes is a bad thing but if a pollution tax were tied to reductions in income taxes, even if they were less than 1 to 1 reductions, it could work politically, esp. if pushed by some popular, silver-tongued leader.
Initially, pollution of any sort is, by definition, a type of market failure called a negative externality. The externality is the costs (cleanup, disease, environmental, etc.) imposed by the pollution on society, or rather on innocent victims within societies. Because polluters do not pay the costs of the pollution but reap the benefits they produce more than the socially optimum amount.
The U.S. government reacted to this market failure by capping or limiting the emission of various types of nasties. Polluters responded by weighing the net costs (costs minus benefits) of compliance and cheating so, ultimately, the effectiveness of the cap-only system was a function of the government's diligence monitoring compliance and prosecuting cheaters. Over time, the government's zeal fluctuated. High levels of enforcement were unsustainable due to budget constraints and regulatory capture. In short, politicians found it in their own interest to spend public monies in other, more salient areas in order to garner votes and in order to attract campaign contributions from polluters.
Cap and trade is a modest improvement over straight caps because it offers polluters a third option: selling some or all of their pollution quotas to other polluters who value them more highly. That should induce polluters with a relatively low cost of pollution reduction to sell permits to polluters with a relatively high cost of pollution reduction. That should spur more compliance and a better use of resources. Of course political decisions still rule the system as the government will decide the size of the cap and the distribution of permits. Polluters will try to get an unfair proportion of permits and also to get the overall cap enlarged. And again politicians will see compliance as a drain on public resources that might be better spent elsewhere (like paying down the national debt ... yeah right!).
A tax, on the other hand, gives the government an incentive to enforce compliance, the payment of the tax. Cheating can and will occur but the IRS will try earnestly to minimize it. The government no longer directly decides how much pollution will be allowed but rather sets the tax rate. The market then determines how much pollution is cost effective at that rate. Roughly speaking, the higher the tax, the lower the tolerable quantity of pollution. Presumably, the government will try to maximize its revenue, so it won't increase the tax to the point of eliminating all pollution and hence all its revenue but at the same time it won't be easily swayed by calls for suboptimally low taxes either.
Finally, it would be technically possible to use such a tax to reduce pollution abroad as well by embedding the tax in tariffs. (That may run afoul of the WTO in which case I say then change WTO rules.) That will keep the playing field level and also dissuade polluters from outsourcing or outright moving to other countries to avoid the tax. Cheap imports from China won't look so cheap anymore.
As I noted in One Nation Under Debt, it would behoove us to find a politically tolerable tax to replace the tariffs that paid off the first national debt. A tax on pollution of various sorts might well fit the bill. Most people agree less carbon, mercury, PCBs, etc. would be a good thing. More taxes is a bad thing but if a pollution tax were tied to reductions in income taxes, even if they were less than 1 to 1 reductions, it could work politically, esp. if pushed by some popular, silver-tongued leader.
Friday, June 26, 2009
Obama's Health Insurance Proposal: You Didn't Know
If you like Obama's proposal to create a government health insurer don't feel bad. You didn't know. You didn't know that every major FUBAR (Fouled Up, ahem, Beyond All Recognition) or hyper-dysfunctional area of the economy -- health care, marriage, retirement, construction, higher education, mortgages, etc. -- has followed the same general pattern:
The market for some good doesn't work as well as some people would like. (Unsurprisingly, the FUBAR areas are characterized by asymmetric information, externalities, etc., i.e., information is imperfect so the markets are as well.) Some people can't afford to buy the good, some people get less value than they thought they would, etc. Politicians get wind of the problem and try to win over voters by trying to fix the problem with taxes or regulations. The intervention, however, actually makes matters worse, "necessitating" additional government interference. Eventually, as in the case of intercity passenger rail, private businesses are driven from the market entirely, leaving behind a bloated, inefficient, highly-subsidized government entity like Amtrak, or the public school system.
If the government is serious about helping to improve the value of health care services, it needs to help to promote competition. That means forcing doctors to disclose stats on how well they perform and encouraging businesses to collate, compare, and disseminate the information. It needs to divorce health insurance from employment by ending biz tax deductions on premium payments and encourage the development of individual policies by deregulating policy forms. But most of all, we need a system whereby doctors' compensation is based on their performance, not their time. The easiest way to do that is to develop a system where people pay when they are healthy but don't pay when they are sick. That will encourage doctors to focus on prevention and on outcomes, rather than inputs, as presently. Med mal would also be transformed as docs who messed up would be responsible for the patient until s/he recovered. A system of true competition -- competition on what is most important to people, the value proposition (trade off between cost and benefit) -- would quickly reduce quackery, unnecessary tests, and so forth.
Obama's government health insurer would do nothing to promote competition but would simply pump more money into the current health care system, allowing costs to soar higher still.
You didn't know. But now you do ... what are you going to do about it?
The market for some good doesn't work as well as some people would like. (Unsurprisingly, the FUBAR areas are characterized by asymmetric information, externalities, etc., i.e., information is imperfect so the markets are as well.) Some people can't afford to buy the good, some people get less value than they thought they would, etc. Politicians get wind of the problem and try to win over voters by trying to fix the problem with taxes or regulations. The intervention, however, actually makes matters worse, "necessitating" additional government interference. Eventually, as in the case of intercity passenger rail, private businesses are driven from the market entirely, leaving behind a bloated, inefficient, highly-subsidized government entity like Amtrak, or the public school system.
If the government is serious about helping to improve the value of health care services, it needs to help to promote competition. That means forcing doctors to disclose stats on how well they perform and encouraging businesses to collate, compare, and disseminate the information. It needs to divorce health insurance from employment by ending biz tax deductions on premium payments and encourage the development of individual policies by deregulating policy forms. But most of all, we need a system whereby doctors' compensation is based on their performance, not their time. The easiest way to do that is to develop a system where people pay when they are healthy but don't pay when they are sick. That will encourage doctors to focus on prevention and on outcomes, rather than inputs, as presently. Med mal would also be transformed as docs who messed up would be responsible for the patient until s/he recovered. A system of true competition -- competition on what is most important to people, the value proposition (trade off between cost and benefit) -- would quickly reduce quackery, unnecessary tests, and so forth.
Obama's government health insurer would do nothing to promote competition but would simply pump more money into the current health care system, allowing costs to soar higher still.
You didn't know. But now you do ... what are you going to do about it?
Keynote Speech at Augustana College, Sioux Falls, South Dakota, 3 June 2009
"Rebounding from Leveraged Asset Bubbles"
By Robert E. Wright, Nef Family Chair of Political Economy, Augustana College
I have good news, bad news, devastating news, and hopeful news. The good news is that the recession will end. The bad news is that I can’t predict when it will do so and I don’t think anyone else can either. The devastating news is that the economy may improve for a short time before plunging again into recession. The hopeful news is that the nation’s long-term economic outlook remains very good indeed.
Thank you!
Thank you!
Just kidding. That was my opening joke. I’m sure you’d like to know how I came to those conclusions. I know the recession will end eventually because they always do. According to the National Bureau of Economic Research or NBER, the United States since 1857 has suffered through 32 recessions including the one that began in December 2007. The longest to date lasted from October 1873 until March 1879, a total of 65 months. The Great Depression proper lasted a mere 43 months, from August 1929 until March 1933, but was quite deep. Since World War II the American economy has contracted 10 times and never for more than 16 months, as in the 1973-75 and 1981-82 downturns.
Well, until the current recession that is. Fact is, recessions differ considerably in ferocity and duration due to their underlying causes. Recessions caused by small, one-off shocks, temporary inventory gluts, and unleveraged asset bubbles tend to come and go quickly. Recessions stemming from leveraged asset bubbles, by contrast, tend to be long and nasty and until last year the United States hadn’t faced one since the early 1930s.
Bubbles originate in a soapy mixture of new technology and expected future demand of unprecedented proportions. Sometimes they are puffed up by the child’s breath of cheap credit, sometimes not. By their very nature they are unstable, sparkling and glistening as they magically float upward. Then they suddenly pop, leaving only toxins behind.
If a bubble is unleveraged, if in other words buyers of the inflated asset used their own money to speculate, the cleanup is relatively easy. In China’s Yunnan province a bubble in a special type of tea called Pu’er recently burst. The local farmers’ aspirations were shattered and their cash flows crimped but their balance sheets remained intact. They complain, for example, of owning fancy automobiles that they cannot afford to put gasoline into and having to shift production to corn and rice. Because they were largely free of debt, however, they still have their farms, much improved during the boom, and can sell their fuel-less cars for cash. By the way, I don’t mean to pick on the Chinese here; American farmers did not invent the agricultural bubble – and neither did the Dutch with their tulip mania – but they have concocted more than their fair share of them. I detail an early U.S. beet sugar bubble in my book One Nation Under Debt.
In any event, what saved the farmers was that they did not have access to easy, cheap credit. Low interest rate loans on easy terms can turn run of the mill asset bubbles into dangerous leveraged ones by decreasing the total cost of assets. To borrow $10,000 for a year to buy a car at 10% simple interest will cost $1,000, raising the total cost of the car to $11,000. At 1%, the same loan will cost only $100, making the car’s total cost, excluding taxes and so forth, only $10,100. Lower total cost, in turn, raises the quantity demanded.
Interest rates affect the total cost of some assets more than others. They have very little direct effect on toothpaste, food, and other inexpensive items but they deeply influence the total cost of more expensive goods, things that people typically borrow to purchase. They have an especially powerful effect on real estate, which is relatively fixed in supply. Low interest rates bring down the total cost of owning land, increasing demand, but the supply does not change appreciably. That means prices can only go in one direction, up. The same analysis applies to real estate improvements, like houses and strip malls, although their supply will eventually increase as new construction projects are completed. Of course if interest rates increase the process reverses and real estate prices sag, all else constant.
If investors believe that interest rates will remain low for an extended period, or if they think that some new technology or change in market conditions will make an asset permanently more valuable, they begin to get very excited. They will start to borrow money to buy the asset with the sole intention of reselling it soon afterward at a profit. In other words, they increase leverage to engage in speculation. Some people call this greed but it is really just business, trying to buy low and sell high, or in the case of bubbles to buy high and sell yet higher.
What makes speculation dangerous is the leverage or borrowing part. Playing with leverage is like playing with fire. If all goes well, fire is a great friend that helps us to stay warm, cook our food, and frighten away dangerous critters. If it gets out of control, however, it can burn both speculators and their lenders and, it seems, the entire economic forest.
Speculators employ leverage to increase their returns by risking other people’s money. That is fantastic on the way up but when asset prices begin to slide, as they always eventually do, lenders get nervous and begin to ask for their money back and limit further lending. Most borrowers can repay only by selling the asset they borrowed to buy. They desperately try to unload but buyers are few because prices are no longer soaring and easy loans are no longer to be had. That realization causes a panic, a moment when everybody must sell and few can or want to buy. Prices then plummet, triggering additional calls, and yet more selling. Speculators cannot sell assets quickly enough, or for a high enough price, to repay their loans so banks and other lenders begin to suffer defaults. In turn their lenders -- other banks, depositors, holders of commercial paper -- begin to wonder if financial institutions are still creditworthy and call or restrict their lending. That is what brought down Bear Stearns, Lehman Brothers, AIG and other seemingly invincible financial giants.
Some financial economists, of the rational expectations/efficient markets ilk, argue that asset bubbles are impossible. In their models, which is to say in their minds, they are correct: speculators do not overpay for assets on the expectation of selling out to a bigger sucker and sophisticated financial institutions do not make loans to such speculators. But in the real world, bubbles clearly do occur. Another group of financial economists, the behavioralists, attribute bubbles to human irrationality. People tend to launch themselves over cliffs like legendary lemmings and to make decisions based on emotions instead of cold, hard logic. It is difficult to dispute the existence of excitable morons, even -- or should I say especially? -- on Wall Street. The efficient markets proponents counter that the presence of irrational traders does not mean that markets, which aggregate the individual decisions of many participants, will be irrational. In the limit, one rational trader will ensure proper prices.
The sanguine expectations of the efficient markets crowd, however, meet a difficult reception in many real world markets. Key to their belief that one smart uber-trader can drive prices to their rational value is the ability to “short” the asset or, in other words, to profit at the expense of investors who pay too much for it. In many markets regularly troubled by bubbles, including agricultural, real estate, and mortgage markets, shorting is impossible or at least very expensive. Proponents of efficient markets also fail to see that what is rational for corporations’ stockholders and what is rational for their hired managers can be very different things.
Regardless of their position on bubbles, most economists agree that the economy is in quite a pickle at present. The largest financial institutions lost most of their capital making bad loans of various types. That put the economy into recession, which made it difficult for the banks to recapitalize and also pressured marginal industries, like automobile manufacturing, consumer electronics retailing, and others. Unable to obtain private sector loans, companies in those industries have been going bankrupt. Additional bad loans hurt already crippled financial institutions and layoffs decrease consumption, further deepening the recession.
That is the same sort of nasty downward spiral that helped to make the Depression so depressing, culminating in Rose of Sharon Joad’s suckling of a starving man. (That, by the way, refers to the final scene in Steinbeck’s book The Grapes of Wrath, not the Henry Fonda movie version.) Thankfully for us, we have thus far avoided the worst part of the Depression, a bout of serious sustained deflation. When the prices of everything decrease month after month, quarter after quarter, and year after year, businesses find it difficult to make long term investments. Nobody wants to buy high and sell low.
Currently, prices are holding pretty steady and the economy is clearly trying to reverse course. Leading economic indicators, including initial jobless claims, new manufacturing orders, building permits, consumer sentiment, the spread between 10-year Treasuries and the federal funds rate, and the growth of the money supply have improved in recent months, in the sense of being less bad, but they are still giving signals that are far from unequivocal. Moreover, an unexpected economic shock like the resurgence of the swine flu or the failure of a major depository institution could quickly nip any tentative recovery in the bud.
If we’re lucky and no shocks strike, the rapid expansion of the Fed’s balance sheet to over $2.2 trillion will eventually stimulate economic activity. As Milton Friedman once famously pointed out, however, monetary policy works only with “long and variable lags.” In other words, nobody knows when more money will lead to more output and, again, any number of unexpected shocks could further delay recovery.
Even more disturbing, the recovery, when it comes, might be short-lived. America has suffered through at least five double-dip recessions, in 1837-39, 1890-93, 1910-13, 1929-37, and 1980-81. All stemmed from the same basic cause, government meddling. Our time, my voice, and your patience preclude a detailed examination of each of those episodes but I would like to take a few minutes to describe how the federal government snuffed the life out of the recovery that began in April 1933. By April 1937, the economy was almost back to its 1929 highs but a balanced federal budget and several unexpected increases in the reserves that the Federal Reserve required banks to hold sent it spiraling back into recession. It recovered in just 13 months this time, over a year before Hitler invaded Poland I might add, but later conflation of the two recessions in the American psyche extended the Great Depression over the entire 1930s and created the pernicious myth that Hitler and Tojo saved capitalism.
Truth is, the government’s policies not only caused the Roosevelt Recession of 1937-38, they postponed the recovery and diminished its vigor. Myths that Herbert Hoover believed in laissez faire to the contrary notwithstanding, the government actively interfered with market mechanisms in the early 1930s, prompting FDR of all people to claim that Hoover was “leading the country down the path to socialism.”
The first Hoover bailout attempt was called the Smoot-Hawley Tariff Act. Enacted in June 1930, the act imposed the highest tariffs, or taxes on imported goods, in U.S. history. It was named after the two jokers, who happened to be U.S. legislators, who concocted it. Republican Willis Hawley hailed from Oregon’s 1st Congressional District, which he had served in the House of Representatives since 1907. Ironically, before turning to politics Hawley had taught history and economics at Willamette for about 16 years. Apparently, he knew little of either subject. Ridiculously persistent legends to the contrary notwithstanding, America’s industrial revolution began late in the eighteenth century, not after the Civil War, and owed little to tariff protection. Reed Smoot was a Republican from Utah and, judging from the photographs I’ve seen of him, a total nerd. By the 1930s, however, he was a powerful nerd, having served in the Senate since 1903. He almost wasn’t allowed his seat because he was a Mormon, and an apostle of the Latter Day Saints at that. He was eventually allowed in, however, because he had only one wife and purportedly did not take the Mormon “oath of vengeance” against the U.S. government, which had treated Mormons rather roughly in the 1840s and 1850s. Whether he took the oath or not, the tariff he co-sponsored did take a terrible toll on America. Not that he was solely responsible for the economic carnage that followed. It was the entire government’s call, and it made the wrong one.
Reed Smoot and Willis Hawley got their just desserts in 1932, when they both lost re-election bids. Although many Americans thought the act would be beneficial, 1,028 economists had opposed it, as had Henry Ford, who called it “an economic stupidity,” GM director Graeme Howard, who predicted it would cause the “most severe depression ever experienced,” and investment banker Thomas W. Lamott, who termed it, and I quote: “asinine.”
In 1932, Hoover attempted yet another major bailout, this time of distressed banks, by creating the Reconstruction Finance Corporation or RFC. Unlike the tariff hike, the RFC was not outright destructive and after a rocky start may have marginally helped the recovery by speeding up the resolution of failed banks. Nevertheless, it did not stem the waves of bank failures that repeatedly shocked the economy and further decreased the all-important money supply.
Opinions regarding subsequent bailouts, generally termed “the New Deal,” were also mixed. Some economists and businesses opposed all or most of them but others, followers of John Maynard Keynes and kindred spirits, supported them. The basic notion was that the government could increase output almost at will by borrowing and spending. Government spending, proponents hoped, would stop the cycle of unemployment, default, and bank failure plaguing the economy.
Did the rash of government spending programs cooked up by the Roosevelt administration pull the economy out of recession? The timing is right: Roosevelt took office in late March 1933 and in his first 100 days he induced Congress to pass numerous spending measures. Even more spending came in subsequent years. Government deficit spending, however, was simply too small to have had much effect. The economy recovered because the money supply grew after Roosevelt devalued the dollar. That decreased real wages and real interest rates, which increased investment by making some businesses profitable again.
Some economists argue that increasing government spending cannot really help the economy, Keynes and his many minions to the contrary notwithstanding. Remember the tax rebate checks the government sent you in 2001 and 2008? What did they do for the economy, as opposed to your wallet? Exactly zero. Oh, I was happy to cash both checks and spend the manna, as I am sure you were too. And businesses were happy to serve us meals, sell us televisions, and so forth. Knowing that the windfall was temporary, however, none of them invested in new facilities or hired new employees. And most people realized that government borrowing today means higher taxes tomorrow, which of course mutes the effects of the stimulus. The rebate checks were therefore little more than a fart in a bottle. They didn’t last very long or smell very good.
So Little Orphan Annie was right: the New Deal was more political bunk than economic funk. Rather than depicting the New Deal as the economy’s savior in the mid-1930s, it’s more accurate to say that the economy managed to bounce back despite the bungling interference of the Roosevelt and Hoover administrations. That is not to say, of course, that the New Deal’s relief programs should not have been implemented. If anything, they should have been extended. Relief redistributes resources rather than increasing the size of the economy but it is the right thing to do during systemic downturns, when people are laid low through no fault of their own. Too bad the government botched many of its relief efforts by waging turf and ideology wars against state and private relief organizations like the Fraternal Order of Eagles and the nation’s schools of philanthropy.
New Deal programs that created public goods also should be immune from imputation. Public goods are things of value that the government must produce if society is to enjoy them because no individual or business would have an incentive to create them. Technically, pure public goods are non-excludable and non-rivalrous, meaning that no one can be excluded from using the good and consumption of the good by one person does not reduce its availability for others. National defense is the classic example, as is protection of life, liberty, and property more generally.
Most New Deal programs, however, did not supply public goods. Worse, they hurt the economy by unwisely allocating resources. Some of the New Deal dollars that did not merely redistribute wealth, in other words, may have actually destroyed wealth by using real resources to create goods that nobody at the time wanted for what they cost to create. To the extent that the programs used resources that would have been wasted due to the uncertain business climate, they were better than nothing. Of course the government itself helped to create, perpetuate, and even amplify the uncertainty that plagued the business environment.
The Federal Deposit Insurance Corporation or FDIC, which insured the retail deposits of solvent banks beginning in 1934, was a great boon even before it began operations because its mere announcement induced depositors to stop running on their banks. That helped to keep the money supply from disintegrating and hence was crucial to the recovery that began in April 1933. Ever since, the FDIC has effectively prevented classic bank runs, like that in It’s a Wonderful Life. It has not, however, stemmed the tide of so-called silent bank runs, where creditors simply refuse to roll over short term loans to banks. It also lulls depositors to sleep, which allows bankers to take on additional risks without fearing the wrath of depositors. The FDIC’s twin, the Federal Savings and Loan Insurance Corporation (FSLIC), was one of the key causes of the Savings and Loan crisis of the 1980s for precisely that reason. Most economists agree that aside from its initial success in stabilizing the banking system in the 1930s, the FDIC’s net contribution to the economy has been approximately zero. Due to the existence of the insurance, bank runs are less likely but bank risk taking is higher.
Given the initial effectiveness of the FDIC, it is ironic that the Roosevelt administration opposed its creation. Its intransigence led to a great compromise of dubious merit. The advocates of deposit insurance, led by Henry B. Steagall, a Democratic congressman from Alabama, joined forces with advocates of the separation of commercial from investment banking, led by Virginia Democratic Senator Carter Glass. The compromise, officially known as the Banking Act of 1933, created the FDIC and also, in a section colloquially known as Glass-Steagall, forbade banks from engaging in both investment banking activities, like issuing securities, and commercial banking activities such as accepting deposits and making loans. The major fear was that risky investment banking activities endangered the safety of deposits and hence the solvency of the insurance fund. Of course that potential problem would have been mitigated if the FDIC had charged risk-based premiums, to wit if it charged riskier banks proportionally more to insure their deposits. It would later do so but not effectively, likely because the intricacies involved boggled its staff. For a variety of reasons, government regulators have been slow to use market based signals of financial institution risk-taking.
The Gramm-Leach-Bliley Act of 1999 officially repealed the Glass-Steagall prohibition, about a decade after the Federal Reserve had rendered it a dead letter by allowing bank holding companies to acquire investment bank subsidiaries and about four decades after financial innovations and regulatory arbitrage had greatly weakened the “Chinese Wall” separating the two types of banking activity. The law never made much sense because commercial bankers who want to take big risks can do so in numerous ways regardless of their ability or inability to underwrite securities. Glass-Steagall was thus akin to trying to reduce the murder rate by banning baseball bats but allowing an open trade in assault rifles. Tellingly, few other countries adopted similar prohibitions and many actually encouraged the development of so-called universal banks that engaged in securities underwriting, loan making, and deposit taking. Some commentators blamed the Panic of 2008 on the repeal of Glass-Steagall but when pressed most admitted that they invoked the law merely as an example of the need for re-regulation. In other words, they did not know what they were talking about.
The new Securities and Exchange Commission or SEC also had a dubious impact on the U.S. financial system and economy, one that I will spare you today. Suffice it to say that someone had to take the fall for the Depression and the government was not about to blame itself or its creature, the Federal Reserve. Securities market participants were the best scapegoats because few people understood what they did but most maintained deep prejudices against them. Americans, nay all human beings, innately distrust and envy great wealth. Likely a residue of life in poor, zero sum economies, where the rich truly became so at the expense of their neighbors, our instinctive repulsion has largely been overcome by education in the rich, positive sum economies of North America, Western Europe, and East Asia. People in those places, in other words, realize that wealthy individuals and large corporations usually create new wealth, not steal existing property. In a crisis, however, people often revert to emotion or instinct and back politicians and policies that they wouldn’t under normal circumstances.
Thus emboldened, the Roosevelt administration forged ahead and created another federal bureaucracy that does little more than lull investors to sleep. Chronically short of funds, the SEC was a nearsighted and nearly toothless securities market policeman. Unfortunately, investors believed the SEC was bigger, stronger, and smarter than it actually was. So, much like the FDIC, the SEC’s biggest effect was to reduce private monitoring. Investors began to act like people who leave their doors unlocked when they vacation because they believe the town cop will watch their house and automobile as if they were his own. When they return home to all of their property, they attribute it to police vigilance rather than blind luck. If robbed, they are shocked and wonder how anything like that could ever happen.
Finally, some New Deal bailouts were simply wrongheaded, attacking the wrong problems in the right way, or methodologically flawed, attacking the right problems in the wrong way. One doesn’t kill zombies with a stake to the heart or sunlight – well, except I Am Legend zombies -- or destroy vamps with a bullet to the brain. But that didn’t stop the government from trying to support farm prices, which had dropped precipitously in the latter half of the 1920s, from $1.30 to $.44 per bushel of wheat and $113 to $29 per bale of cotton. Initially, the government’s policy was the height of economic and political folly, destroying crops in the field and six million young pigs fattening for market. The correct policy, of course, would have been for the government to buy the food with borrowed or new money and distribute it to the needy. In subsequent years, U.S. agricultural policy was made only slightly less destructive by paying farmers not to grow crops or raise livestock in the first place. Farmers gladly took animals and acres out of production, cashed their government checks, and increased yields per acre on the rest of their farms by investing more heavily in tractors, fertilizer, better seeds, and so forth. That kept output high and prices low, a fact that even cocksure Agricultural Adjustment Administration bureaucrats eventually conceded. Soon, farmers captured the AAA, turning their ostensible regulators into prisoners who did their bidding in Congress. Unsurprisingly, agricultural subsidies remain with us to this day.
Perhaps the worst of the New Deal’s bailouts was the National Industrial Recovery Act. In July 1933, Roosevelt announced the new program, noting that it was designed to increase hourly wages and keep prices up by means of the collusion of government-sanctioned cartels. To induce companies and consumers to join the effort, the administration created a Blue Eagle emblem, a spread winged raptor clutching an industrial cog in one claw and three lightening bolts in the other, over the phrase “We Do Our Part.” Roosevelt explained that “in war in the gloom of attack, soldiers wear a bright badge to be sure that comrades do not fire on comrades. Those who cooperate in this program must know each other at a glance. That bright badge is the Blue Eagle.” After the beloved president’s speech, the Blue Eagle emblem quickly gained notoriety. Hollywood hotties Martha Virginia “Toby” Wing and Frances Drake, for example, sunburned the emblem onto their backs, though of course not in blue.
Due to the government’s call for consumers to boycott firms that refused to join the NIRA, companies at first clamored to join to enjoy the right to put the eagle on their advertising and products and thus avoid their customers’ wrath. The government, however, announced the program before enough emblems were available so it had to outsource their printing to private companies. It also had to allow exempt companies, like sole proprietorships, to display the emblem so they would not be mistakenly boycotted. It allowed companies that were noncompliant to join and at first did not have a compliance division. Even after its establishment, the compliance division took only 564 cases to court out of the 155,102 complaints it received. Soon, the Lincoln, Nebraska compliance board quit in disgust. Only about a third of the businesses under its jurisdiction sporting the Blue Eagle faced complaints but it lacked the resources to force the businesses to comply or to give up their emblems. Soon after, most of the Lowell, Massachusetts board quit for the same reasons.
The NIRA’s laughable execution was surpassed only by the inanely insane economic theory underlying the program. The poor little eagle and the program it symbolized were doomed from the start. As noted previously, the biggest problem facing the economy was that wages were already too high. Driving them higher would simply create more unemployment, a far cry from Roosevelt’s claim that the Blue Eagle was a “badge of honor … in the great summer offensive against unemployment.” The government’s reasoning was backwards. It believed that high wages created prosperity but in reality, as banker Albert Wiggin noted, “it is not true that high wages make for prosperity. Instead, prosperity makes high wages.” Moreover, the price level was almost entirely a function of the money supply, not of market structure. Instead of supporting prices across the board, in other words, the NIRA’s cartels merely caused relative prices to change. They also injured consumers dull witted or patriotic enough to shop only where the Blue Eagle kept prices of specific goods artificially high.
Thankfully, most American consumers and businesses were not so daft. Especially given the program’s well known enforcement difficulties, the public soon felt justified ignoring emblems and seeking the best bargains. After the initial flurry of activity, the Blue Eagle died quickly and painlessly. The Supreme Court drove the final nails into its little coffin by declaring it unconstitutional.
Auto manufacturer Henry Ford was the first major public critic of the NIRA, refusing to sign the industry code in August although his company had long since far exceeded the guidelines. Ford was an advocate of efficiency wages, or paying workers extremely well but expecting much from them in return, so he already paid much more than the guideline minimum wage. Apparently, however, he disliked the code’s recognition of workers’ right to unionize. He called the eagle a “Roosevelt buzzard” and ignored a cartoon showing him cutting off his own nose with a pair of scissors labeled “non-participation.” Tellingly, the government continued to buy his company’s automobiles anyway. American citizens must have followed their Uncle Sam because Ford lost no market share during the Blue Eagle’s brief life. Smaller fry began to take heart and stand up to the big blue buzzard too. In Hagerstown, Maryland, for example, gasoline station owner Herman Mills publicly fought the NIRA, vowing to take his case all the way to the Supreme Court on the grounds that it eliminated legitimate competition.
The government was astute enough to sidestep Mr. Mills but soon fell afoul the Schechter Brothers, purveyors of kosher chickens in Brooklyn. They bought the birds wholesale, alive, and kept them alive until a customer picked one for dinner, at which point a shochtim would ritually slaughter it if he believed it fit for human consumption. The brothers were also fierce competitors, eager to hold their own against larger rivals by cutting prices when necessary. Those practices, however, ran contrary to the NIRA codes and unusually vigilant inspectors let the Schechters know it. Eventually, the NIRA dragged them into court. Fearful that their very Jewishness was on trial, the chicken men fought like the dickens. They made it to the Supreme Court and won by showing the codes were as un-American as they were unconstitutional.
The short of all this is that another major threat to recovery is the Obama administration and the Democratically-controlled Congress. An attempt to reform healthcare, Social Security, or the tax system could energize our nation’s latent entrepreneurial talents or it could turn into our generation’s NIRA. Regulatory reformation could be salutary but could also spark a “strike of capital” the likes of which have not been seen since the 1930s. Massive fiscal stimulus added to aggressive money supply growth may spur growth but could just as easily unleash inflationary pressures too intense for the Fed to combat.
The biggest threat of all, though, may be something much more prosaic, UNCERTAINTY. We don’t fear fear itself, we sweat what schemes our politicians might concoct to win the next election. The natural response to uncertainty is timidity. Better to hold onto what one already has than to aim for the stars, most people conclude. That’s exactly what makes uncertainty so economically dangerous. I’m going to counter that, however, and propose that small business owners in Sioux Falls do not have as much to worry about as they may think. Where ever governments adequately protect life, liberty, and property economies trend upward over time. America’s long-term prosperity rests on the solid foundation of relatively non-predatory government, a modern financial system, open access entrepreneurship, and capable corporate management. We still have property rights in this country, a judicial system that for all its faults will protect us from government encroachments, and arguably the best system of federalism in the world. You may not trust the politicos in Washington – I sure as heck don’t – but the men and women in “Peer” provide us with a buffer. Their power is limited but thankfully we’re not facing a Hitler, Stalin, or Pol Pot in Washington.
And we’re not facing the antichrist either, as some bloggers contend. Maybe I’m wrong about that but if I am then nothing matters anyway. So you might as well attend the conference today and formulate safe ways to improve or expand your business tomorrow, or next week, or next month. Don’t wait for the economy to improve … collectively, you ARE the economy. Instead, have faith in your country and its ability to rebound. Due to its roots in a leveraged asset bubble the current recession is a formidable foe. But we’ve been through worse before, far worse in fact.
So let’s get back to work!
This time I’m really done. Thank you.
By Robert E. Wright, Nef Family Chair of Political Economy, Augustana College
I have good news, bad news, devastating news, and hopeful news. The good news is that the recession will end. The bad news is that I can’t predict when it will do so and I don’t think anyone else can either. The devastating news is that the economy may improve for a short time before plunging again into recession. The hopeful news is that the nation’s long-term economic outlook remains very good indeed.
Thank you!
Thank you!
Just kidding. That was my opening joke. I’m sure you’d like to know how I came to those conclusions. I know the recession will end eventually because they always do. According to the National Bureau of Economic Research or NBER, the United States since 1857 has suffered through 32 recessions including the one that began in December 2007. The longest to date lasted from October 1873 until March 1879, a total of 65 months. The Great Depression proper lasted a mere 43 months, from August 1929 until March 1933, but was quite deep. Since World War II the American economy has contracted 10 times and never for more than 16 months, as in the 1973-75 and 1981-82 downturns.
Well, until the current recession that is. Fact is, recessions differ considerably in ferocity and duration due to their underlying causes. Recessions caused by small, one-off shocks, temporary inventory gluts, and unleveraged asset bubbles tend to come and go quickly. Recessions stemming from leveraged asset bubbles, by contrast, tend to be long and nasty and until last year the United States hadn’t faced one since the early 1930s.
Bubbles originate in a soapy mixture of new technology and expected future demand of unprecedented proportions. Sometimes they are puffed up by the child’s breath of cheap credit, sometimes not. By their very nature they are unstable, sparkling and glistening as they magically float upward. Then they suddenly pop, leaving only toxins behind.
If a bubble is unleveraged, if in other words buyers of the inflated asset used their own money to speculate, the cleanup is relatively easy. In China’s Yunnan province a bubble in a special type of tea called Pu’er recently burst. The local farmers’ aspirations were shattered and their cash flows crimped but their balance sheets remained intact. They complain, for example, of owning fancy automobiles that they cannot afford to put gasoline into and having to shift production to corn and rice. Because they were largely free of debt, however, they still have their farms, much improved during the boom, and can sell their fuel-less cars for cash. By the way, I don’t mean to pick on the Chinese here; American farmers did not invent the agricultural bubble – and neither did the Dutch with their tulip mania – but they have concocted more than their fair share of them. I detail an early U.S. beet sugar bubble in my book One Nation Under Debt.
In any event, what saved the farmers was that they did not have access to easy, cheap credit. Low interest rate loans on easy terms can turn run of the mill asset bubbles into dangerous leveraged ones by decreasing the total cost of assets. To borrow $10,000 for a year to buy a car at 10% simple interest will cost $1,000, raising the total cost of the car to $11,000. At 1%, the same loan will cost only $100, making the car’s total cost, excluding taxes and so forth, only $10,100. Lower total cost, in turn, raises the quantity demanded.
Interest rates affect the total cost of some assets more than others. They have very little direct effect on toothpaste, food, and other inexpensive items but they deeply influence the total cost of more expensive goods, things that people typically borrow to purchase. They have an especially powerful effect on real estate, which is relatively fixed in supply. Low interest rates bring down the total cost of owning land, increasing demand, but the supply does not change appreciably. That means prices can only go in one direction, up. The same analysis applies to real estate improvements, like houses and strip malls, although their supply will eventually increase as new construction projects are completed. Of course if interest rates increase the process reverses and real estate prices sag, all else constant.
If investors believe that interest rates will remain low for an extended period, or if they think that some new technology or change in market conditions will make an asset permanently more valuable, they begin to get very excited. They will start to borrow money to buy the asset with the sole intention of reselling it soon afterward at a profit. In other words, they increase leverage to engage in speculation. Some people call this greed but it is really just business, trying to buy low and sell high, or in the case of bubbles to buy high and sell yet higher.
What makes speculation dangerous is the leverage or borrowing part. Playing with leverage is like playing with fire. If all goes well, fire is a great friend that helps us to stay warm, cook our food, and frighten away dangerous critters. If it gets out of control, however, it can burn both speculators and their lenders and, it seems, the entire economic forest.
Speculators employ leverage to increase their returns by risking other people’s money. That is fantastic on the way up but when asset prices begin to slide, as they always eventually do, lenders get nervous and begin to ask for their money back and limit further lending. Most borrowers can repay only by selling the asset they borrowed to buy. They desperately try to unload but buyers are few because prices are no longer soaring and easy loans are no longer to be had. That realization causes a panic, a moment when everybody must sell and few can or want to buy. Prices then plummet, triggering additional calls, and yet more selling. Speculators cannot sell assets quickly enough, or for a high enough price, to repay their loans so banks and other lenders begin to suffer defaults. In turn their lenders -- other banks, depositors, holders of commercial paper -- begin to wonder if financial institutions are still creditworthy and call or restrict their lending. That is what brought down Bear Stearns, Lehman Brothers, AIG and other seemingly invincible financial giants.
Some financial economists, of the rational expectations/efficient markets ilk, argue that asset bubbles are impossible. In their models, which is to say in their minds, they are correct: speculators do not overpay for assets on the expectation of selling out to a bigger sucker and sophisticated financial institutions do not make loans to such speculators. But in the real world, bubbles clearly do occur. Another group of financial economists, the behavioralists, attribute bubbles to human irrationality. People tend to launch themselves over cliffs like legendary lemmings and to make decisions based on emotions instead of cold, hard logic. It is difficult to dispute the existence of excitable morons, even -- or should I say especially? -- on Wall Street. The efficient markets proponents counter that the presence of irrational traders does not mean that markets, which aggregate the individual decisions of many participants, will be irrational. In the limit, one rational trader will ensure proper prices.
The sanguine expectations of the efficient markets crowd, however, meet a difficult reception in many real world markets. Key to their belief that one smart uber-trader can drive prices to their rational value is the ability to “short” the asset or, in other words, to profit at the expense of investors who pay too much for it. In many markets regularly troubled by bubbles, including agricultural, real estate, and mortgage markets, shorting is impossible or at least very expensive. Proponents of efficient markets also fail to see that what is rational for corporations’ stockholders and what is rational for their hired managers can be very different things.
Regardless of their position on bubbles, most economists agree that the economy is in quite a pickle at present. The largest financial institutions lost most of their capital making bad loans of various types. That put the economy into recession, which made it difficult for the banks to recapitalize and also pressured marginal industries, like automobile manufacturing, consumer electronics retailing, and others. Unable to obtain private sector loans, companies in those industries have been going bankrupt. Additional bad loans hurt already crippled financial institutions and layoffs decrease consumption, further deepening the recession.
That is the same sort of nasty downward spiral that helped to make the Depression so depressing, culminating in Rose of Sharon Joad’s suckling of a starving man. (That, by the way, refers to the final scene in Steinbeck’s book The Grapes of Wrath, not the Henry Fonda movie version.) Thankfully for us, we have thus far avoided the worst part of the Depression, a bout of serious sustained deflation. When the prices of everything decrease month after month, quarter after quarter, and year after year, businesses find it difficult to make long term investments. Nobody wants to buy high and sell low.
Currently, prices are holding pretty steady and the economy is clearly trying to reverse course. Leading economic indicators, including initial jobless claims, new manufacturing orders, building permits, consumer sentiment, the spread between 10-year Treasuries and the federal funds rate, and the growth of the money supply have improved in recent months, in the sense of being less bad, but they are still giving signals that are far from unequivocal. Moreover, an unexpected economic shock like the resurgence of the swine flu or the failure of a major depository institution could quickly nip any tentative recovery in the bud.
If we’re lucky and no shocks strike, the rapid expansion of the Fed’s balance sheet to over $2.2 trillion will eventually stimulate economic activity. As Milton Friedman once famously pointed out, however, monetary policy works only with “long and variable lags.” In other words, nobody knows when more money will lead to more output and, again, any number of unexpected shocks could further delay recovery.
Even more disturbing, the recovery, when it comes, might be short-lived. America has suffered through at least five double-dip recessions, in 1837-39, 1890-93, 1910-13, 1929-37, and 1980-81. All stemmed from the same basic cause, government meddling. Our time, my voice, and your patience preclude a detailed examination of each of those episodes but I would like to take a few minutes to describe how the federal government snuffed the life out of the recovery that began in April 1933. By April 1937, the economy was almost back to its 1929 highs but a balanced federal budget and several unexpected increases in the reserves that the Federal Reserve required banks to hold sent it spiraling back into recession. It recovered in just 13 months this time, over a year before Hitler invaded Poland I might add, but later conflation of the two recessions in the American psyche extended the Great Depression over the entire 1930s and created the pernicious myth that Hitler and Tojo saved capitalism.
Truth is, the government’s policies not only caused the Roosevelt Recession of 1937-38, they postponed the recovery and diminished its vigor. Myths that Herbert Hoover believed in laissez faire to the contrary notwithstanding, the government actively interfered with market mechanisms in the early 1930s, prompting FDR of all people to claim that Hoover was “leading the country down the path to socialism.”
The first Hoover bailout attempt was called the Smoot-Hawley Tariff Act. Enacted in June 1930, the act imposed the highest tariffs, or taxes on imported goods, in U.S. history. It was named after the two jokers, who happened to be U.S. legislators, who concocted it. Republican Willis Hawley hailed from Oregon’s 1st Congressional District, which he had served in the House of Representatives since 1907. Ironically, before turning to politics Hawley had taught history and economics at Willamette for about 16 years. Apparently, he knew little of either subject. Ridiculously persistent legends to the contrary notwithstanding, America’s industrial revolution began late in the eighteenth century, not after the Civil War, and owed little to tariff protection. Reed Smoot was a Republican from Utah and, judging from the photographs I’ve seen of him, a total nerd. By the 1930s, however, he was a powerful nerd, having served in the Senate since 1903. He almost wasn’t allowed his seat because he was a Mormon, and an apostle of the Latter Day Saints at that. He was eventually allowed in, however, because he had only one wife and purportedly did not take the Mormon “oath of vengeance” against the U.S. government, which had treated Mormons rather roughly in the 1840s and 1850s. Whether he took the oath or not, the tariff he co-sponsored did take a terrible toll on America. Not that he was solely responsible for the economic carnage that followed. It was the entire government’s call, and it made the wrong one.
Reed Smoot and Willis Hawley got their just desserts in 1932, when they both lost re-election bids. Although many Americans thought the act would be beneficial, 1,028 economists had opposed it, as had Henry Ford, who called it “an economic stupidity,” GM director Graeme Howard, who predicted it would cause the “most severe depression ever experienced,” and investment banker Thomas W. Lamott, who termed it, and I quote: “asinine.”
In 1932, Hoover attempted yet another major bailout, this time of distressed banks, by creating the Reconstruction Finance Corporation or RFC. Unlike the tariff hike, the RFC was not outright destructive and after a rocky start may have marginally helped the recovery by speeding up the resolution of failed banks. Nevertheless, it did not stem the waves of bank failures that repeatedly shocked the economy and further decreased the all-important money supply.
Opinions regarding subsequent bailouts, generally termed “the New Deal,” were also mixed. Some economists and businesses opposed all or most of them but others, followers of John Maynard Keynes and kindred spirits, supported them. The basic notion was that the government could increase output almost at will by borrowing and spending. Government spending, proponents hoped, would stop the cycle of unemployment, default, and bank failure plaguing the economy.
Did the rash of government spending programs cooked up by the Roosevelt administration pull the economy out of recession? The timing is right: Roosevelt took office in late March 1933 and in his first 100 days he induced Congress to pass numerous spending measures. Even more spending came in subsequent years. Government deficit spending, however, was simply too small to have had much effect. The economy recovered because the money supply grew after Roosevelt devalued the dollar. That decreased real wages and real interest rates, which increased investment by making some businesses profitable again.
Some economists argue that increasing government spending cannot really help the economy, Keynes and his many minions to the contrary notwithstanding. Remember the tax rebate checks the government sent you in 2001 and 2008? What did they do for the economy, as opposed to your wallet? Exactly zero. Oh, I was happy to cash both checks and spend the manna, as I am sure you were too. And businesses were happy to serve us meals, sell us televisions, and so forth. Knowing that the windfall was temporary, however, none of them invested in new facilities or hired new employees. And most people realized that government borrowing today means higher taxes tomorrow, which of course mutes the effects of the stimulus. The rebate checks were therefore little more than a fart in a bottle. They didn’t last very long or smell very good.
So Little Orphan Annie was right: the New Deal was more political bunk than economic funk. Rather than depicting the New Deal as the economy’s savior in the mid-1930s, it’s more accurate to say that the economy managed to bounce back despite the bungling interference of the Roosevelt and Hoover administrations. That is not to say, of course, that the New Deal’s relief programs should not have been implemented. If anything, they should have been extended. Relief redistributes resources rather than increasing the size of the economy but it is the right thing to do during systemic downturns, when people are laid low through no fault of their own. Too bad the government botched many of its relief efforts by waging turf and ideology wars against state and private relief organizations like the Fraternal Order of Eagles and the nation’s schools of philanthropy.
New Deal programs that created public goods also should be immune from imputation. Public goods are things of value that the government must produce if society is to enjoy them because no individual or business would have an incentive to create them. Technically, pure public goods are non-excludable and non-rivalrous, meaning that no one can be excluded from using the good and consumption of the good by one person does not reduce its availability for others. National defense is the classic example, as is protection of life, liberty, and property more generally.
Most New Deal programs, however, did not supply public goods. Worse, they hurt the economy by unwisely allocating resources. Some of the New Deal dollars that did not merely redistribute wealth, in other words, may have actually destroyed wealth by using real resources to create goods that nobody at the time wanted for what they cost to create. To the extent that the programs used resources that would have been wasted due to the uncertain business climate, they were better than nothing. Of course the government itself helped to create, perpetuate, and even amplify the uncertainty that plagued the business environment.
The Federal Deposit Insurance Corporation or FDIC, which insured the retail deposits of solvent banks beginning in 1934, was a great boon even before it began operations because its mere announcement induced depositors to stop running on their banks. That helped to keep the money supply from disintegrating and hence was crucial to the recovery that began in April 1933. Ever since, the FDIC has effectively prevented classic bank runs, like that in It’s a Wonderful Life. It has not, however, stemmed the tide of so-called silent bank runs, where creditors simply refuse to roll over short term loans to banks. It also lulls depositors to sleep, which allows bankers to take on additional risks without fearing the wrath of depositors. The FDIC’s twin, the Federal Savings and Loan Insurance Corporation (FSLIC), was one of the key causes of the Savings and Loan crisis of the 1980s for precisely that reason. Most economists agree that aside from its initial success in stabilizing the banking system in the 1930s, the FDIC’s net contribution to the economy has been approximately zero. Due to the existence of the insurance, bank runs are less likely but bank risk taking is higher.
Given the initial effectiveness of the FDIC, it is ironic that the Roosevelt administration opposed its creation. Its intransigence led to a great compromise of dubious merit. The advocates of deposit insurance, led by Henry B. Steagall, a Democratic congressman from Alabama, joined forces with advocates of the separation of commercial from investment banking, led by Virginia Democratic Senator Carter Glass. The compromise, officially known as the Banking Act of 1933, created the FDIC and also, in a section colloquially known as Glass-Steagall, forbade banks from engaging in both investment banking activities, like issuing securities, and commercial banking activities such as accepting deposits and making loans. The major fear was that risky investment banking activities endangered the safety of deposits and hence the solvency of the insurance fund. Of course that potential problem would have been mitigated if the FDIC had charged risk-based premiums, to wit if it charged riskier banks proportionally more to insure their deposits. It would later do so but not effectively, likely because the intricacies involved boggled its staff. For a variety of reasons, government regulators have been slow to use market based signals of financial institution risk-taking.
The Gramm-Leach-Bliley Act of 1999 officially repealed the Glass-Steagall prohibition, about a decade after the Federal Reserve had rendered it a dead letter by allowing bank holding companies to acquire investment bank subsidiaries and about four decades after financial innovations and regulatory arbitrage had greatly weakened the “Chinese Wall” separating the two types of banking activity. The law never made much sense because commercial bankers who want to take big risks can do so in numerous ways regardless of their ability or inability to underwrite securities. Glass-Steagall was thus akin to trying to reduce the murder rate by banning baseball bats but allowing an open trade in assault rifles. Tellingly, few other countries adopted similar prohibitions and many actually encouraged the development of so-called universal banks that engaged in securities underwriting, loan making, and deposit taking. Some commentators blamed the Panic of 2008 on the repeal of Glass-Steagall but when pressed most admitted that they invoked the law merely as an example of the need for re-regulation. In other words, they did not know what they were talking about.
The new Securities and Exchange Commission or SEC also had a dubious impact on the U.S. financial system and economy, one that I will spare you today. Suffice it to say that someone had to take the fall for the Depression and the government was not about to blame itself or its creature, the Federal Reserve. Securities market participants were the best scapegoats because few people understood what they did but most maintained deep prejudices against them. Americans, nay all human beings, innately distrust and envy great wealth. Likely a residue of life in poor, zero sum economies, where the rich truly became so at the expense of their neighbors, our instinctive repulsion has largely been overcome by education in the rich, positive sum economies of North America, Western Europe, and East Asia. People in those places, in other words, realize that wealthy individuals and large corporations usually create new wealth, not steal existing property. In a crisis, however, people often revert to emotion or instinct and back politicians and policies that they wouldn’t under normal circumstances.
Thus emboldened, the Roosevelt administration forged ahead and created another federal bureaucracy that does little more than lull investors to sleep. Chronically short of funds, the SEC was a nearsighted and nearly toothless securities market policeman. Unfortunately, investors believed the SEC was bigger, stronger, and smarter than it actually was. So, much like the FDIC, the SEC’s biggest effect was to reduce private monitoring. Investors began to act like people who leave their doors unlocked when they vacation because they believe the town cop will watch their house and automobile as if they were his own. When they return home to all of their property, they attribute it to police vigilance rather than blind luck. If robbed, they are shocked and wonder how anything like that could ever happen.
Finally, some New Deal bailouts were simply wrongheaded, attacking the wrong problems in the right way, or methodologically flawed, attacking the right problems in the wrong way. One doesn’t kill zombies with a stake to the heart or sunlight – well, except I Am Legend zombies -- or destroy vamps with a bullet to the brain. But that didn’t stop the government from trying to support farm prices, which had dropped precipitously in the latter half of the 1920s, from $1.30 to $.44 per bushel of wheat and $113 to $29 per bale of cotton. Initially, the government’s policy was the height of economic and political folly, destroying crops in the field and six million young pigs fattening for market. The correct policy, of course, would have been for the government to buy the food with borrowed or new money and distribute it to the needy. In subsequent years, U.S. agricultural policy was made only slightly less destructive by paying farmers not to grow crops or raise livestock in the first place. Farmers gladly took animals and acres out of production, cashed their government checks, and increased yields per acre on the rest of their farms by investing more heavily in tractors, fertilizer, better seeds, and so forth. That kept output high and prices low, a fact that even cocksure Agricultural Adjustment Administration bureaucrats eventually conceded. Soon, farmers captured the AAA, turning their ostensible regulators into prisoners who did their bidding in Congress. Unsurprisingly, agricultural subsidies remain with us to this day.
Perhaps the worst of the New Deal’s bailouts was the National Industrial Recovery Act. In July 1933, Roosevelt announced the new program, noting that it was designed to increase hourly wages and keep prices up by means of the collusion of government-sanctioned cartels. To induce companies and consumers to join the effort, the administration created a Blue Eagle emblem, a spread winged raptor clutching an industrial cog in one claw and three lightening bolts in the other, over the phrase “We Do Our Part.” Roosevelt explained that “in war in the gloom of attack, soldiers wear a bright badge to be sure that comrades do not fire on comrades. Those who cooperate in this program must know each other at a glance. That bright badge is the Blue Eagle.” After the beloved president’s speech, the Blue Eagle emblem quickly gained notoriety. Hollywood hotties Martha Virginia “Toby” Wing and Frances Drake, for example, sunburned the emblem onto their backs, though of course not in blue.
Due to the government’s call for consumers to boycott firms that refused to join the NIRA, companies at first clamored to join to enjoy the right to put the eagle on their advertising and products and thus avoid their customers’ wrath. The government, however, announced the program before enough emblems were available so it had to outsource their printing to private companies. It also had to allow exempt companies, like sole proprietorships, to display the emblem so they would not be mistakenly boycotted. It allowed companies that were noncompliant to join and at first did not have a compliance division. Even after its establishment, the compliance division took only 564 cases to court out of the 155,102 complaints it received. Soon, the Lincoln, Nebraska compliance board quit in disgust. Only about a third of the businesses under its jurisdiction sporting the Blue Eagle faced complaints but it lacked the resources to force the businesses to comply or to give up their emblems. Soon after, most of the Lowell, Massachusetts board quit for the same reasons.
The NIRA’s laughable execution was surpassed only by the inanely insane economic theory underlying the program. The poor little eagle and the program it symbolized were doomed from the start. As noted previously, the biggest problem facing the economy was that wages were already too high. Driving them higher would simply create more unemployment, a far cry from Roosevelt’s claim that the Blue Eagle was a “badge of honor … in the great summer offensive against unemployment.” The government’s reasoning was backwards. It believed that high wages created prosperity but in reality, as banker Albert Wiggin noted, “it is not true that high wages make for prosperity. Instead, prosperity makes high wages.” Moreover, the price level was almost entirely a function of the money supply, not of market structure. Instead of supporting prices across the board, in other words, the NIRA’s cartels merely caused relative prices to change. They also injured consumers dull witted or patriotic enough to shop only where the Blue Eagle kept prices of specific goods artificially high.
Thankfully, most American consumers and businesses were not so daft. Especially given the program’s well known enforcement difficulties, the public soon felt justified ignoring emblems and seeking the best bargains. After the initial flurry of activity, the Blue Eagle died quickly and painlessly. The Supreme Court drove the final nails into its little coffin by declaring it unconstitutional.
Auto manufacturer Henry Ford was the first major public critic of the NIRA, refusing to sign the industry code in August although his company had long since far exceeded the guidelines. Ford was an advocate of efficiency wages, or paying workers extremely well but expecting much from them in return, so he already paid much more than the guideline minimum wage. Apparently, however, he disliked the code’s recognition of workers’ right to unionize. He called the eagle a “Roosevelt buzzard” and ignored a cartoon showing him cutting off his own nose with a pair of scissors labeled “non-participation.” Tellingly, the government continued to buy his company’s automobiles anyway. American citizens must have followed their Uncle Sam because Ford lost no market share during the Blue Eagle’s brief life. Smaller fry began to take heart and stand up to the big blue buzzard too. In Hagerstown, Maryland, for example, gasoline station owner Herman Mills publicly fought the NIRA, vowing to take his case all the way to the Supreme Court on the grounds that it eliminated legitimate competition.
The government was astute enough to sidestep Mr. Mills but soon fell afoul the Schechter Brothers, purveyors of kosher chickens in Brooklyn. They bought the birds wholesale, alive, and kept them alive until a customer picked one for dinner, at which point a shochtim would ritually slaughter it if he believed it fit for human consumption. The brothers were also fierce competitors, eager to hold their own against larger rivals by cutting prices when necessary. Those practices, however, ran contrary to the NIRA codes and unusually vigilant inspectors let the Schechters know it. Eventually, the NIRA dragged them into court. Fearful that their very Jewishness was on trial, the chicken men fought like the dickens. They made it to the Supreme Court and won by showing the codes were as un-American as they were unconstitutional.
The short of all this is that another major threat to recovery is the Obama administration and the Democratically-controlled Congress. An attempt to reform healthcare, Social Security, or the tax system could energize our nation’s latent entrepreneurial talents or it could turn into our generation’s NIRA. Regulatory reformation could be salutary but could also spark a “strike of capital” the likes of which have not been seen since the 1930s. Massive fiscal stimulus added to aggressive money supply growth may spur growth but could just as easily unleash inflationary pressures too intense for the Fed to combat.
The biggest threat of all, though, may be something much more prosaic, UNCERTAINTY. We don’t fear fear itself, we sweat what schemes our politicians might concoct to win the next election. The natural response to uncertainty is timidity. Better to hold onto what one already has than to aim for the stars, most people conclude. That’s exactly what makes uncertainty so economically dangerous. I’m going to counter that, however, and propose that small business owners in Sioux Falls do not have as much to worry about as they may think. Where ever governments adequately protect life, liberty, and property economies trend upward over time. America’s long-term prosperity rests on the solid foundation of relatively non-predatory government, a modern financial system, open access entrepreneurship, and capable corporate management. We still have property rights in this country, a judicial system that for all its faults will protect us from government encroachments, and arguably the best system of federalism in the world. You may not trust the politicos in Washington – I sure as heck don’t – but the men and women in “Peer” provide us with a buffer. Their power is limited but thankfully we’re not facing a Hitler, Stalin, or Pol Pot in Washington.
And we’re not facing the antichrist either, as some bloggers contend. Maybe I’m wrong about that but if I am then nothing matters anyway. So you might as well attend the conference today and formulate safe ways to improve or expand your business tomorrow, or next week, or next month. Don’t wait for the economy to improve … collectively, you ARE the economy. Instead, have faith in your country and its ability to rebound. Due to its roots in a leveraged asset bubble the current recession is a formidable foe. But we’ve been through worse before, far worse in fact.
So let’s get back to work!
This time I’m really done. Thank you.
Saturday, May 16, 2009
The Poor's Savings
The Economist reported this week (16 May 2009, p. 82) that the world's poor have such difficulty saving that they actually pay effective negative rates on the order of 30 to 40 percent per annum. I've known about this for some years now and already developed a business plan that would allow U.S. mutual funds to tap this latent market. Before you cry no way, check out the article "Reducing the Poor's Investment Risk: Introducing Bearer Money Market Mutual Shares" in the Journal of Financial Transformation, available free here.
The real question is not how to help the poor to save but why The Economist's reporters didn't find and report on my article.
The real question is not how to help the poor to save but why The Economist's reporters didn't find and report on my article.
Friday, April 3, 2009
A little slow on the uptake
Some time ago, I blogged about my fear of a double dip recession. Others are finally catching on, as you can see here.
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