As the Clinton boom rolled on his media pals went into an orgy of praise, declaring that the administration had discovered the Holy Grail of a recession-free economy, that a "new epoch in economics had arrived and that the "the economy has entered a new era". These Pollyanna statements were in part the result of an inability to understand what was happening to the American economy. (There was also the undisguised partisanship. This is why the same commentators do not have a good word to say for the Bush boom).
The same sort of nonsense was said during the 1920s boom which 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 Sir Ralph Hawtrey, Keynes and Professor Fisher that the US economy had indeed entered a "New Era", with Keynes describing the 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').
Let's take a look at the kind of figures that underpinned the optimism of the time. 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 comparatively 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. Like the 1990s, however, there was 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.
Though the 1920s is considered by some to be 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.
The Fed's efforts to stabilise the price level succeeded in skewing 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 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. The result was inevitable.
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, The Australian Financial Review seriously argued (14 September 1998, p. 38) 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" [!]
It evidently did not occur to the author that booming output is incompatible with 'excess capacity'. Moreover, he then admitted that the fall in prices was caused not by a monetary contraction, i.e., genuine deflation, but by increasing investment -- thus demonstrating how rife confusion is on this subject. As Friedman and Schwartz discovered
Finally the 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 phenomenon was the seeded of controversy about the 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 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, p.15).
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 stages 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". (C.A. Phillips, T.F. McManus, and R.W. Nelson, Banking and the Business Cycle, New York: Macmillan, 1937, p. 176).
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 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 that 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 optimism, only to admit in 1930 that he had been mistaken about inflation.
As the French journalist Alphonse Karr observed: The more things change, the more they are the same.
