The cause of the current economic problems is very simple: Bad economics. Instead of closely examining the monetary theory that got us into this mess economists have started playing the blame game. Alan Greenspan blamed Wall Street irrational for making irrational economic decisions the appear to have brought the US economy to the brink of disaster.
On the other hand, Morgan Stanley's Stephen Roach blames "Greenspan's blend of politics and ideology" for the current financial mess, arguing that it "led to bad economics and a succession of policy blunders whose severity is only now becoming clear". All that Roach made clear is his ignorance of economic history and sound economic theory.
Yale University economist Robert Shiller also feels the need to throw pearls of wisdom among the economic illiterati asserting that their exists the possibility that house prices will plummet by more than 30 per cent, exceeding the dramatic 1929-1933 plunge in prices. Determined not to be left out Paul Volcker stated in a speech to the Economic Club of New York that the sub-prime mortgage debacle has become "the mother of all crises". (These blokes cannot even update their vocabulary).
Not only is there no economic theory here, there is also no economic perspective. A financial crisis that would be even worse than the Great Depression? Through 1930 and 1933 something like 10,000 banks went under. Now that is what I call a banking crisis. Shiller warns of a collapse in prices. How about this: Starting with July 1929=100 we find that wholesale prices dived by 38 per cent. It was no coincidence that money supply contracted by about 35 per cent. And no wonder considering the following account:
The number of bank failures in the single year 1931, on the other hand, was greater than the total for all the years from 1900 to 1929, and more banks failed in the single month of October, 1931, than in the two years 1920-1921. A very large part of the annihilation of bank credit after 1929 came about in this way. (C. A. Phillips, T. F. McManus, R. W. Nelson, Banking and the Business Cycle: A Study of the Great Depression in the United States, The Macmillan Company, 1937 pp. 168-9).
So severe was the monetary contraction that "all of the bank credit inflation of 1922 to 1929 was wiped out in the short space of the three years following 1929". (Ibid. 168). Yet it is always being overlooked by our economic commentariat is the 1920-21 financial crisis. Wholesale price peaked in May 1920 and they plummeted by 48 per cent, levelling out roundabout July 1921. How is it that within a period of some 15 months an amazing drop in wholesale prices of 48 per cent only raised unemployment by 11 per cent? How is it that despite the severity of this crisis the economy was well on the road to recovery by the beginning of 1922? So what was the main difference between this crisis and the crisis of 1929? Answer: Hoover and Roosevelt.
It is still being preached that the Great Depression was caused by market failure and that President Hoover deepened the depression by implementing 'orthodox' economic policies. This is pure baloney The Great Engineer, as Hoover was sometimes called, had never accepted what ignorant commentators and academics call the "economic orthodoxy of the day" or what the informed correctly call laissez-faire policies. It is indeed ironic that the man who laid the foundations for Roosevelt's New Deal is still labelled by the lumpen intelligentsia as an advocate of failed free-market policies. It is also a bitter commentary on those who are paid to know better, including certain economists who pretend to be knowledgeable about the US economy of the 1920s and 1930s.
The "orthodox" economic prescription for depressions was to allow the market to liquidate the malinvestments that the preceding boom had created -- what the classical economists called "disproportionalities" -- and allow prices and costs to adjust to proper market conditions. This policy was based on the vital insight that supporting unsound investments and trying to hold prices, especially wages, at boom-time levels would deepen and prolong a depression. The 1920-21 depression was the last time in American history that the wisdom of this policy was largely allowed to do its work.
On his return from Europe shortly after WW I, Hoover touted his "Reconstruction Program" that was based on government planning euphemistically called "voluntary" but which relied on "central direction". From the moment he was appointed Secretary of Commerce in March 1921 he set about trying to intervene in the economy, designing several policies that he thought would help end the depression. Fortunately for America the depression ended before Hoover's interventionist schemes could do any damage. That the laisezz-fair policy of "leave it alone" swiftly ended the depression. Yet Hoover -- a highly intelligent man -- completely failed to learn the lesson.
Economics taught that during deflationary periods it was vital that prices, especially money wages, be allowed to adjust to the new monetary conditions. Only by this means could market clearing prices be established. It was clearly absurd to believe that boom-time money wage rates could be maintained during a deflation without causing lasting widespread unemployment. Hoover, however, detested "orthodox" thinking on wage rates, believing instead that living standards were a product of high real wages. He made his rejection of the "old economics" clear in a speech on 12 May 1926:
There a marked change... not so many years ago -- the employer considered it was in his interest to use the opportunities of unemployment and immigration to lower wages irrespective of other considerations. The lowest wages and longest hours were then conceived as the means to obtain lowest production costs and largest profits.... But we are a long way on the road to conceptions. The very essence of production is high wages and low prices, because it depends upon a widening range of consumption, only to be obtained from the purchasing-power of high real wages and increased standard of living. . . (Herbert Hoover, The Memoirs of Herbert Hoover, New York: Macmillan, 1952, p. 108).
This was the "new economics" that Hoover and others now preached and which became the prevailing theory of the time. One could easily be forgiven for thinking that Hoover was a Keynesian before Keynes was. When depression struck in 1929, Hoover, as president, was now free to implement his interventionist (or should I say Keynesian) schemes that gave the world the Great Depression. He reacted swiftly to the crisis, persuading the country's industrialists to maintain money wage rates at pre-depression levels.
Alarmed by Hoover's interventionist policies, Secretary of Treasury Mellon urged him to allow the depression to follow its natural course as had all previous administrations. No way. He continued with his destructive economic policies which, after his electoral defeat, Roosevelt co-opted with a vengeance. It was not the market that failed America, but a badly flawed monetary policy that fuelled the "Roaring Twenties" and resulting in a bust that was aggravated and prolonged by two economic illiterates.
The loose monetary policies that helped fuel America's booms -- including Clinton's -- are what lie at the root of the current crisis. Unfortunately, Shiller, Roach, Volcker, Greenspan, etc., just don't get it. No wonder the world is in such a financial mess. This brings me to the world's financial sages. Some of them have noted that U.S. stocks underperformed other investments during both the 1930s and the 1970s. Of course they did. This always happens during recessions and periods of stagflation.
Nevertheless, some bright sparks now believe they have uncovered a pattern behind the trends and they are now marketing it. And guess what the pattern reveals? That boom years are followed by 'underperforming' stocks which eventually return to their "normal rate of return". So the time to buy is when stocks are low and then wait for the upturn.
Shiller, however, is warning that a housing bust could savage consumption and thus delay any recovery. The warning is based on the belief the economy is driven by consumer spending. It is not. Business is what counts and this is about twice the level of consumer spending. In short. Consumption spending accounts for a bout one-third of total spending.
Note: Only the Austrian school of economics has been able to provide a satisfactory explanation of the great depression. Unfortunately the Australian media refuses to publish articles based on Austrian analysis. I suspect this is due to Australian journalists' deep-rooted attachment to Keynesian economics and its rationale for large-scale government spending.
