"The economy has entered a new era", wrote one financial journalist while another exclaimed that a "new epoch in economics" had arrived. Needless to say, these Pollyanna statements were typical of the economic slop that was served up during the Clinton boom. However, just because the same ideologically motivated commentators cannot find anything good say about the Bush boom this should not lead Republicans into wrongfully thinking that President Bush's tax cuts -- vital as they are for economic growth -- have created an economic nirvana.
I've said on numerous occasions that history does not repeat itself: it's just that people keep making the same mistakes because they deliberately ignore the lessons of history. This also goes for most economists -- especially so in Australia. It is true that during the Clinton boom a few economic commentators made a comparison between it and the "Roaring Twenties", warning that history might repeat itself. Even so, they still could not get a handle on the problem.
The great American boom of the 1920s was also hailed as a "New Era", one, so it was thought, that heralded permanent prosperity for the American people. A stable price level and booming output convinced the likes of Keynes and Professor Fisher that a new era had indeed arrived, with Keynes describing Federal Reserve Board's monetary management as a "triumph" -- a triumph whose economic and political denouement was the Great Depression. (Though Fisher was later ridiculed for his optimism, Keynes was praised for his 'wisdom'.)
Investment in the capital structure of about 6.4 per cent a year caused manufacturing productivity per worker to rise by 43 per cent while prices remained relatively stable. By 1929 America was producing virtually as many cars as in 1953, the sale of electrical products tripled, spending on radios rose from about $10.7 million dollars in 1920 to more than $411 million by 1929, a prolonged building boom provided millions of Americans with their first house.
That the period was marked by rapidly rising consumption was not disputed. There was, however, a dark side to this success story. Despite the rise in productivity many workers found it difficult to maintain their purchasing power. The increasing movement of married women into the workforce at this time tends to lend support to this view.
Although the 1920s is considered by some to be the greatest boom period in US history the greatly neglected boom of 1896-1903 exceeded it, certainly in terms of physical production though not in financial folly. Statistics show that nearly half of the rise in productivity during the 1920s took place from 1921 to 1923. US Bureau of Labor Statistics reveal that average real wages (excluding agriculture) rose by just over 6 per cent from 1921 to 1929. Needless to say, this average concealed considerable differences in pay rates.
What happened was that the attempt at price stabilisation skewed consumption and created an imbalance in production. (What the Austrian school would call misdirected production or malinvestments.) The rapid progress in productivity should have seen the price level gently decline. Convinced by the likes of Fisher, Gustav Cassel and Sir Ralph Hawtrey that allowing prices to fall was a bad thing, the Federal Reserve engaged upon massive credit expansion by forcing down the discount rate.
The result was that though the number of dollar bills remained comparatively stable ($3.68 billion in 1920 compared with $3.64 billion in 1929) credit grew from $45.3 billion in June 1921 to $73 billion in July 1929, a 61 per cent rise. It was this rapid expansion that fuelled the stock market frenzy and created malinvestments by discoordinating the market process. However, by the end of 1928 the inflation was over. Total money supply stood at $73 billion on December 31, 1928 and $73.26 billion on the 29 June 1929.
One argument advanced in support of the price stabilisation doctrine is based on the fallacy that any general fall in prices is by definition deflationary and will thus depress business activity and raise unemployment. This view makes no distinction between a money induced fall in prices caused by a monetary contraction and falling prices caused by rising productivity. Nonetheless, economic commentators argue that the period 1870-90 was a deflationary one in the US and that it was "excess capacity" that drove prices down while "production boomed. (This kind of nonsense is to be found in the Australian media along with silly comments about the gold standard and "robber barons").
The Australian Financial Review seriously argued (14 September 1998, p. 38) the case for the "excess capacity" thesis. It evidently did not occur to the author that booming output is incompatible with 'excess capacity'. Moreover, he admitted that falling prices were caused not by a monetary contraction, i.e., genuine deflation, but by increasing investment -- thus demonstrating how rife confusion is on this subject. I think that we can largely blame the monetarists for this situation, despite the fact that Milton Friedman could writh:
[T]he price level fell to half its initial level in the course of less than fifteen years and, at the same time, economic growth proceeded at a rapid rate. The one phenomenon was the seedbed of controversy about monetary arrangements that was destined to plague the following decades; the other was a vigorous stage in the continued economic expansion that was destined to raise the United states to the first rank among the nations of the world. And their coincidence casts serious doubts on the validity of the now widely held view that secular price deflation and rapid economic growth are incompatible. (Milton Friedman and Anna J. Schwartz, A Monetary History of the United States 1867-1960, Princeton, N.J.: Princeton University Press, 1971).
What is obviously not understood is that falling prices due to increased productivity benefits everyone by spreading the fruits of increased investment. Attempts to stabilise purchasing power of the monetary unit blocks this process, denying to many rises in real income they would have otherwise enjoyed. And this is precisely what happened during the 1920s boom. Credit expansion caused wage rates in the capital goods industries to significantly outstrip those in the consumer goods industries.
By expanding credit capitalists were encouraged to invest in lengthier and more complex stages of production causing them to bid up wage rates at the expense of those in the consumer goods industries. In addition, because the means (capital goods, i.e., savings) were not available to finish these stages1 they eventually revealed themselves as malinvestments, misnamed 'excess capacity'.
Put another way, labour employed in the capital goods industries had the value of its services inflated by credit expansion, which in turn allowed it to bid more goods away from other workers. It should also be clear that the credit expansion imposed forced savings which kept real wages below the level that a genuine free-market saving/consumption ratio would have dictated. And all for the sake of stable prices. No wonder Phillips, McManus and Nelson were driven to charge that "the end-result of what was probably the greatest price stabilisation experiment in history proved to be, simply, the greatest depression" (Banking and the Business Cycle, New York: The MacMillan Company, 1937).
Unfortunately it was the stock market frenzy that marked out the 1920s and became the culprit for the depression instead of credit expansion. It is also in the current stock market boom that we see shadows lurking from the financial follies of the Roaring Twenties. By 1929 the average stock had tripled its value in only 7 years. Alarmed at the apparent inexorable rise of the market and the accompanying reckless speculation, Roger Babson, a Boston financial adviser, was warning investors in September 1929 of an imminent crash. (Babson was far from being a lone voice. Sound money men like Benjamin M. Anderson and E. C. Harwood also warned that a crash was inevitable).
In early 1929 Hayek published a number of articles in the monthly reports of the Austrian Institute of Economic Research, of which he was director, arguing that the boom only had months to run. Felix Somary, another economist in the Austrian school and a Swiss banker, even warned Keynes against buying stock and predicted an impending crash. Keynes replied: "There will be no more crashes in our lifetime".
Convinced that the price level proved there was no inflation, Irving Fisher argued that "stock prices have reached what looks like a permanently high plateau". In his paper Is There Inflation in the United States?, 1 September 1928, Keynes endorsed Fisher's hopeless optimism, only to admit in 1930 that he had been mistaken about inflation.
It is therefore only a matter of time before the current boom also collapses. Unfortunately the "culture of corruption" that runs through every layer of the American media will see to it that the Republicans will be held entirely responsible for any downturn. These politically bigoted hacks will be the same ones who told us that the Clinton boom heralded a "New Era", and who tried to pin the blame for the Clinton crash on Bush.
So who or what is really to blame for the boom-bust 'cycle'? Answer: bad economics. The sort of economics that dominates most economics faculties and central banks.
