Paul Krugman reminds us what is on the other side of a series of escalating unregulated booms and bail outs. But we aren’t in 1929, but 1927.
Most people think of the 1920’s as a decade of uninterupted prosperity, the reality is that there were four downturns that began in the 1920’s: January through July of 1920, part of a double dip post-World War I Recession, May 1923 through July 1924, October 1926 through November 1927, and, of course, August 1929 through March 1933. In all this cluster of recessions from January of 1920, through the end of 1929 lated 53 months of 120. Or roughly half the decade. In all of the time that the Republicans had an easy domination of the White House from March of 1921 through February of 1933, the economy was in contraction 74 months of 144, or again, about half. What made people remember the decade as prosperous was the massive upswings of the booms. In 1920, the estimated GDP of the US was 609 Billion dollars, with a per capita GDP of 5,721 – or about what China has right now. By the end of the decade it was 7,099 dollars per capita, and 865.2 Billion dollars. Even with all the recessions, the spurts, years like 1921, 1922 and 1929 until the down turn, made large strides, while in other years, GDP per capita was basically flat.
One reason for the casino mentality was, then, the fact that much of the time people were staying in place. In 1923 GDP per capita was $6,350 and by 1928, five years later, it was $6,771 dollars. A Bush-esque crawl.
The whole experiment of the Bernanke Federal Reserve is to get 1927 right this time: bail out the banks enough without regulation. And without creating a monetary explosion that leads only to another larger crisis. Bernanke will fail simply because absent strategic equilibrium, each bail out merely means that everyone must bet on the next bail out.
What is happening right now, in effect, is an attempt to change the monetary basis of the United States. This change has been effected only a few times in our history. The first was in the colonial period where the colonies were tied to the silver penny, a basis which was largely rejected, as the colonies did much of their business with the Spanish holdings in the New World, and they looked at the currencies minted by Spain and Spanish dominions, not the Pound, as being the basic monetary unit. The word dollar comes from an Austrian unit, the thaler, and our expressions of “two bits” comes from a coin known to popular culture as “a piece of eight.”
The American revolution created a short period of true fiat money in the colonies, with Philadelphia maintaining its role as the great currency exchange of the colonies. This period lasted only until the establishment of the Federal government by the Constitution of 1787. From there until the Civil War, the United States currency was on a silver basis.
There is however, one important caveat to this, and that is that with the failure to recharter of the Bank of the United States, and the establishment of the Independent Treasury system, the United States was in effect a three basis system. The government did business in gold or silver based currencies, those doing business with England based their money on gold, as England was establishing a gold standard, and the banks could print anything they wanted as notes, based on whatever standard the local states saw fit to impose. The economic turbulence of this system would, relatively quickly, lead to a series of recessions and financial crisis points which would boil over as the American Civil War.
After the Civil War, the United States moved to an official gold standard, with some silver based money kept in circulation, both as a political sop, and as a means of keeping sufficient liquidity in the economic system. Those thinking of the late 19th century as a great economic golden age need to look more closely at the facts: there were more and longer contractions during this time than afterwards.
The next major official change was when, in the dark days of March of 1933, when banks were failing, and under the cover of a bank holiday, a bastard child was brought into the world: the asset based monetary system. Previous attempts at an endogenous monetary system had been made, however, they had collapsed or been aborted for one of two reasons. Either they blew up into inflation as those with “the keys to the printing press” printed too much money, or they were throttled as interests that wanted to keep money tightly controlled pushed currency back on to some specie basis.
No one planned the architecture per se. In fact, the most common alternate scenario was to use the post office – this is not odd, postal monetary notes had a long history by 1933 – and to directly nationalize the banks.
The architecture of the system that occured rested on three parts: regulation of the banks – including deposit insurance – the establishment of the Federal Reserve as a powerful force that could loan money to banks based on assets, rather than on specie, and the creation of Social Security. These pieces fit together, because Social Security, and other government obligations, created a break on the desire to use the printing press. If the government inflated, then it would have to start paying more immediately in Social Security. If it allowed depression economics of the 19th century style, there would not be the revenues to pay the taxes. Government, pinned on both sides, had to steer a narrower course. For the economy, money would be created endogenously, assets meaning that there would be the money loanable to buy those assets. Eventually economic theory would reach a point of describing this equilibrium in classical Keynesianism. Internationally gold was used not to restrict the amount of money, but the volume of trade, and this only after the Second World War.
As with the previous systems, this system reached a point of crisis at its mid point, and that crisis was resolved by removing restrictions to allow it to continue, but with the implicit, and sometimes explicit, promise that the whole of the public would pay the costs of of bailing the system out. This lead to the predictable proliferation of speculative money. This proliferation comes because there is a need to denominate assets which might exist, but don’t exist yet, at the same time there is a need to denominate assets which do exist. One monetary system has difficulty measuring both value, and future value. In the end the solution is to create two currencies, an every day currency, and a speculative one. Free banking did this, the rise of the stock market in the 1890-1930 period did this, and the system of derivatives and financial instruments in the present generation did this.
However, this speculative currency must be anchored to future revenue streams, that is, future assets are valuable to the extent they will command, some time in the future, real assets. This is why over time the world currency system became timed to US mortgages, because these represented the flow of future assets. This linking is both essential for the speculative currency to work, and it is fatal after a period of time. This is because those dealing in speculative currency will, among themselves, decide that everything that everyone else owns, they own.
At that point comes the collapse.
Bernanke has now allowed brokers to borrow directly from the Federal Reserve, and created a series of instruments which, in effect, allow the creation of money based on speculatively held money. Bernanke’s moves in the last few days have, in effect, created a new basis for the US currency. It is one that has been building for some time. That basis is the value of stocks held. This was visible by the “Poor Pound” thesis: that priced in independently generated currencies, the American stock market has been remarkably flat.
This change was inevitable, and predictable. Sooner or later the American Dollar must be based, in a global economy, on the global evaluation of our production. However, the question, as with every previous monetary order, is whether the pieces fit together. Presently, they do not.
The reason they don’t is because there is no narrow channel which keeps the powers that be from leaning too far in one direction. There is no consequence for those temporarily in power from simply spewing dollars in every direction, and letting those that they do not like pay the costs. That is what is happening now, the coalition of farmers and oil men that held Bush in power, are doing very well. The defense contractors have made out very well, and those that loan money to the government are doing well. Those that are being bailed out have seen their share of national wealth and income skyrocket.
The key is not re-regulation, but a Nash equilibrium, a state where no group can unilaterally improve its position at the expense of others. This state is the challenge for the next administration. It will require a fundamentally different political order, as the great overturns of monetary basis in the past have been based on different constitutional orders to both create, and navigate, the narrow channel which their monetary system rests upon.
The pieces must interlock to the regulation of the financial system, and they must end the disequilibrium where the wealthy can dump risk on others, and take the profits for themselves.
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