Party Like It's 1926

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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Stirling Newberry


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  • Thanks for such a thought-provoking article. A very interesting set of ideas, many of which I have not encountered before.

    The distinction sometimes made between tangible economy and financial economy, is something like the distinction being made between present day currency and speculative currency.

    We need to utilize “speculative” approach, ie looking forward approach, in many situations. Else there would be no education system or capital investment, ie willingness to swap present consumption for anticipated future benefits. So it is not all bad that we utilize an accounting artifact, called “speculative currency” in the article, as a means of motivating ourselves (political will) to do the necessary.

    I’m curious whether you have looked at Ben Graham’s least-read book, “Storage and Stability”? Published 1937, it was his attempt to define a basis for currency value in terms of a basket of commodities, ie tangibles. Somewhat related to the article’s thinking, I believe.

  • A thought-provoking analysis.

    The question must be raised, given the nature and flaws of the system, of whether there was intent to push us into this position. The overall aura of tunnel-visioned incompetence of Bush-Cheney, and a decreasing number of accomplices, has been challenged by the assertion that there is great competence on their part in accomplishing their true goal. That goal being to bring down the US economy so that all FDR programs become no longer affordable and must terminated. Reading John Dean’s books on the subject adds fuel to the fire as does the recent coming to light of the growing financial reserve in Iraq. The reserve, I believe, has grown to $40 billion, most of it being held back and little is being spent on reconstruction in Iraq, while US taxpayer money is the main engine of rebuilding. Rather than insisting that the Iraqis pony up the bucks, GW has proposed significant cuts to Medicare.

    One could consider this scenario of GW-Cheney bringing down the economy as far fetched, except that it’s the only model where GW-Cheney appear competent. It’s easy to see GW as the guy from Mad magazine, and his record of financial management of corporations that he owned is a sad tale where he appeared to have done well because he sold the businesses to people who knew what they would be worth if well managed, and who happened to be friends of GHW Bush. The people lurking behind the throne, on the other hand, would not be so clueless. The Bushs, the Walkers and some others would be happy to see the entire record of everything FDR obliterated from the historical record. There was a time, back in the 1930s, when their elders watched with interest the operations of a strutting, emerging dictator in Germany and wondered if some of the same principles could be applied in the US.

    So asking which model works, in terms of (a)”why” we are in this situation and (b)was there intent to put us here, seems to me to be an important element for consideration.

    Ventura CA USA

  • The fundamental problem with capitalism is that there isn’t sufficient investment potential to satisfy everyone’s desire for independent wealth. What drove the speculative boom was a desire to create more captal then could be sustained. As I see it, the only logical long term solution is to start treating money as the public utility that it already is, given that the public assumes the risk to the currency and public debt is the bedrock of investment. I could see national currency, with banking as largely a function of local government, so that there is a connection/feedback between the local economy and the infrastructure supporting it. And some degree of federal regulation along with maintaining the currency. If the ability to accumulate abstract wealth was contained, there would be the most benefit derived from doing the best job possible over the long term, as that is what would increase one’s social standing, thus the need for various forms of regulation might actually be reduced.

  • Here:

    It is equally evident, that the members of each department should be as little dependent as possible on those of the others, for the emoluments annexed to their offices. Were the executive magistrate, or the judges, not independent of the legislature in this particular, their independence in every other would be merely nominal. But the great security against a gradual concentration of the several powers in the same department, consists in giving to those who administer each department the necessary constitutional means and personal motives to resist encroachments of the others. The provision for defense must in this, as in all other cases, be made commensurate to the danger of attack. Ambition must be made to counteract ambition. The interest of the man must be connected with the constitutional rights of the place. It may be a reflection on human nature, that such devices should be necessary to control the abuses of government. But what is government itself, but the greatest of all reflections on human nature? If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government to control the governed; and in the next place oblige it to control itself.

    Speaking of new Constitutional orders…

  • S2191, America’s Climate Security Act, note how the little fascists just have to get the word “Security” in there. Hey, enjoy the non-existent breadlines, FEMA “relocation” camps……….

  • Awesome. I love how nerdy and intellectual most everyone here is. It’s impossible for me to come here and not feel stupid. There’s so much to learn.

  • The purpose of capitalism is capturing the surplus value of production contributed by labor, because market competition equalizes the capture of value from capital goods and materials.

    There are essentially four ways of dealing with this. The first three can be used in combination. The final one is the remedy of last resort. They are: regulation, legislation, taxation, and revolution.

    The fifth is, of course, passing their share of value creation to labor. However, this just doesn’t happen because the purpose of capitalism is profit (ROI) based on market competition, rather than social welfare and the common good. The ideal of capitalism is to dominate (monopolize) market share and control labor costs in order to maximize return, i.e., capture surplus value.

  • Reuters – The Federal Reserve and Bank of England denied a report on Saturday that they were in talks over possibly using public funds to make mass purchases of mortgage-backed securities to ease the global credit crisis.

    However, the Bank said it was considering a number of other, unspecified options to address the turmoil in financial markets, which has continued despite the injection by central banks of billions of dollars of liquidity and cuts in interest rates.

    The Financial Times, without citing sources, said central banks on both sides of the Atlantic were in talks about the feasibility of buying up mortgage-backed securities — key financial instruments which have plunged in value in recent months, wreaking havoc on banks’ balance sheets and shares.

    “Central banks, including the Bank of England, have been looking at ways to ease the strain,” a BoE spokesman said. “The BoE is not, however, among those reported today to be proposing schemes that would require the taxpayer, rather than the banks, to assume the credit risk.” more at link

    1.”George Washington did not cross the Delaware for Capitalism,” -Shmuley Boteach.
    2.The Dems haven’t punished the GOP enough, so you’re going to reward the Republicans?

  • which at least created the notion of a firewall between pure banking and speculation, since bridged by the 1999 repeal of the Act. Banks now free to play the “securitisation” game with suspect loans, the creation of “SPVs” and “SPEs” to seemingly off-load questionable debt, all have contributed to the current financial meltdown. Here is an excellent primer summarising much of the financial abuse directly attributable to banks compromising their basic raison d’etre and integrity by chasing potentially huge profits by shuffling trillions of dollars of dubious quality, and ignoring the downside risks.

    The Financial Tsunami and the Evolving Economic Crisis: Greenspan’s Grand Design

    by F. William Engdahl

    Global Research, January 23, 2008
    Part III

    The Long-Term Greenspan Agenda

    Seven years of Volcker monetary “shock therapy” had ignited a payments crisis across the Third World. Billions of dollars in recycled petrodollar debts loaned by major New York and London banks to finance oil imports after the oil price rises of the 1970’s, suddenly became non-payable.

    The stage was now set for the next phase in the Rockefeller financial deregulation agenda. It was to come in the form of a revolution in the very nature of what would be considered money—the Greenspan “New Finance” Revolution.

    Many analysts of the Greenspan era focus on the wrong facet of his role, and assume he was primarily a public servant who made mistakes, but in the end always saved the day and the nation’s economy and banks, through extraordinary feats of financial crisis management, winning the appellation, Maestro.1

    Destroying Glass-Steagall restrictions

    One of Greenspan’s first acts as Chairman of the Fed was to call for repeal of the Glass-Steagall Act, something which his old friends at J.P.Morgan and Citibank had ardently campaigned for. 5

    Glass-Steagall, officially the Banking Act of 1933, introduced the separation of commercial banking from Wall Street investment banking and insurance. Glass-Steagall originally was intended to curb three major problems that led to the severity of the 1930’s wave of bank failures and depression:

    Banks were investing their own assets in securities with consequent risk to commercial and savings depositors in event of a stock crash. Unsound loans were made by the banks in order to artificially prop up the price of select securities or the financial position of companies in which a bank had invested its own assets. A bank’s financial interest in the ownership, pricing, or distribution of securities inevitably tempted bank officials to press their banking customers into investing in securities which the bank itself was under pressure to sell. It was a colossal conflict of interest and invitation to fraud and abuse.

    Banks that offered investment banking services and mutual funds were subject to conflicts of interest and other abuses, thereby resulting in harm to their customers, including borrowers, depositors, and correspondent banks. Similarly, today, with no more Glass-Steagall restraints, banks offering securitized mortgage obligations and similar products via wholly owned Special Purpose Vehicles they create to get the risk “off the bank books,” are complicit in what likely will go down in history as the greatest financial swindle of all times—the sub-prime securitization fraud.

    In his history of the Great Crash, economist John Kenneth Galbraith noted, “Congress was concerned that commercial banks in general and member banks of the Federal Reserve System in particular had both aggravated and been damaged by stock market decline partly because of their direct and indirect involvement in the trading and ownership of speculative securities.

    “The legislative history of the Glass-Steagall Act,” Galbraith continued, “shows that Congress also had in mind and repeatedly focused on the more subtle hazards that arise when a commercial bank goes beyond the business of acting as fiduciary or managing agent and enters the investment banking business either directly or by establishing an affiliate to hold and sell particular investments.” Galbraith noted that “During 1929 one investment house, Goldman, Sachs & Company, organized and sold nearly a billion dollars’ worth of securities in three interconnected investment trusts–Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue Ridge Corporation. All eventually depreciated virtually to nothing.”

    ‘…strategies unimaginable a decade ago…’

    The New York Times described the new financial world created by repeal of Glass-Steagall in a June 2007 profile of Goldman Sachs, just weeks prior to the eruption of the sub-prime crisis: “While Wall Street still mints money advising companies on mergers and taking them public, real money – staggering money – is made trading and investing capital through a global array of mind-bending products and strategies unimaginable a decade ago.” They were referring to the securitization revolution.

    The Times quoted Goldman Sachs chairman Lloyd Blankfein on the new financial securitization, hedge fund and derivatives world: “We’ve come full circle, because this is exactly what the Rothschilds or J. P. Morgan, the banker were doing in their heyday. What caused an aberration was the Glass-Steagall Act.”9

    Robert Kuttner, co-founder of the Economic Policy Institute, testified before US Congressman Barney Frank’s Committee on Banking and Financial Services in October 2007, evoking the specter of the Great Depression:

    “Since repeal of Glass Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s – lending to speculators, packaging and securitizing credits and then selling them off, wholesale or retail, and extracting fees at every step along the way. And, much of this paper is even more opaque to bank examiners than its counterparts were in the 1920s. Much of it isn’t paper at all, and the whole process is supercharged by computers and automated formulas.” 10

    Dow Jones Market Watch commentator Thomas Kostigen, writing in the early weeks of the unraveling sub-prime crisis, remarked about the role of Glass-Steagall repeal in opening the floodgates to fraud, manipulation and the excesses of credit leverage in the expanding world of securitization:

    “Time was when banks and brokerages were separate entities, banned from uniting for fear of conflicts of interest, a financial meltdown, a monopoly on the markets, all of these things.

    “In 1999, the law banning brokerages and banks from marrying one another — the Glass-Steagall Act of 1933 — was lifted, and voila, the financial supermarket has grown to be the places we know as Citigroup, UBS, Deutsche Bank, et al. But now that banks seemingly have stumbled over their bad mortgages, it’s worth asking whether the fallout would be wreaking so much havoc on the rest of the financial markets had Glass-Steagall been kept in place.

    “Diversity has always been the pathway to lowering risk. And Glass-Steagall kept diversity in place by separating the financial powers that be: banks and brokerages. Glass-Steagall was passed by Congress to prohibit banks from owning full-service brokerage firms and vice versa so investment banking activities, such as underwriting corporate or municipal securities, couldn’t be called into question and also to insulate bank depositors from the risks of a stock market collapse such as the one that precipitated the Great Depression.

    “But as banks increasingly encroached upon the securities business by offering discount trades and mutual funds, the securities industry cried foul. So in that telling year of 1999, the prohibition ended and financial giants swooped in. Citigroup led the way and others followed. We saw Smith Barney, Salomon Brothers, PaineWebber and lots of other well-known brokerage brands gobbled up.

    “At brokerage firms there are supposed to be Chinese walls that separate investment banking from trading and research activities. These separations are supposed to prevent dealmakers from pressuring their colleague analysts to give better results to clients, all in the name of increasing their mutual bottom line.

    “Well, we saw how well these walls held up during the heyday of the dot-com era when ridiculously high estimates were placed on corporations that happened to be underwritten by the same firm that was also trading its securities. When these walls were placed within their new bank homes, cracks appeared and — it looks ever so apparent — ignored.

    (much, much more…)

    It’s easy to say that, sure, let the spivs, wideboys, and chancers running the big Wall Street investment houses get the big profits when things are running their way, but swallow 100% of the downside when all goes pear-shaped; after all, it is the sainted “free market at work, no? Unfortunately, the large, globalised commercial/consumer banks are up to their eyebrows in the same shaky business, which puts a huge added strain on the US economy as a whole, and the “Chinese wall” separating prudent fiduciary responsibilities from arrant speculation has been breached, which now requires political solutions rather than only the FOMC/Bernancke-Paulson interventions.

    “les Etats-unis, c’est le seul pays à être passé de la préhistoire à la décadence sans jamais connaitre la civilisation…”…Georges Clemenceau

  • Socialism operates in the basis of central planning of production, and it said to lead to greater inefficiencies than free market capitalism. However, the mop-up operations of the CB’s are central planning in reverse, cleaning up the inefficiency of markets.

    The problem with the later is that there is no attempt at fairness. The people, unfairly taken advantage or, are then unfairly called upon to bear the burden of the initial unfairness by funding its inefficiency.

  • so we have the last three that you mention, i.e., legislation, taxation, and revolution. But the first two(legislation and taxation) are species of regulation. So we have revolution, ultimately.

    Being a former radical, I tend to whiff this without the weatherman telling me which way the wind is blowing.

  • Yes, the the Third Way between (decentralization) between socialism (nationalization, central planning) and economic neoliberalism (laissez-faire, monopoly capital, centralization = neofascism) would require a revolution to put in place. This would require the destruction of the status quo (economic neoliberalism and the neo-imperialism it involves = military Keynesianism) through internal contradictions. A depression would provide a staging platform for this regime change, but decentralization is by no means the guaranteed outcome of a depression. It would have to be one of the chief solutions on the table, have a lot of credibility, and a champion, too.

  • interest to this topic:

    John Perkins, Confessions of an Economic Hit Man Part I

    Corporatocracy & Central and South America

    Part II

    Questions and Answers: Corporatocracy and What To Do About It
    Part III


    Ralph Nader, The Road to Corporate Fascism

    I ordered the book that Ralph Nader wrote on this topic and expect to take delivery of it in 8-10 days.

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