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Doug Noland, of
prudentbear.com, wrote a note last week that addressed the
"liquidationist" approach to economic crises. Here it is:
http://www.safehaven.com/article-9879.htm
This is a discussion that
has been going on since the Great Depression. Andrew Mellon, the US Treasury
Secretary from 1921-1931, abided by the libertarian "let things take
care of themselves" approach, which has become known as the
"liquidationist" approach. This is conventional wisdom today.
Mellon: "Liquidate
labor, liquidate stocks, liquidate the farmers, liquidate real estate.
… It will purge the rottenness out of the system. High costs of living
and high living will come down. People will work harder, live a more moral
life. Values will be adjusted, and enterprising people will pick up from less
competent people."
The term "liquidate"
is a bit unusual today, as it sounds like a plan to carpet-bomb Fallujah or
something like that. But what he meant was to allow businesses with excess
labor to let people go, to sell off real estate in foreclosure, to allow the
stock market to find a market-clearing price, and so forth. In this way,
prices find their proper level, unprofitable activities are ceased, and new
profitable activities are begun. The capitalist system naturally adjusts. The
government is relatively non-interventionist.
In time, this was deemed
to be a failed approach. The suffering during the Great Depression was so
great that it was decided, at a political level, that the government should
have "done something." But what? Many things were proposed and
tried, from soup kitchens to make-work programs like the CCC, to Social
Security, a currency devaluation, destruction of agricultural commodities, a
mandated reduction in work hours, and so forth.
This debate has gone back
and forth for decades, and we won't be able to resolve it completely here.
But, here are some considerations of why the "liquidationist"
approach didn't work as well as it should have, why an
"interventionist" approach gained support, and where we stand with
these things today.
First of all, one problem
with a liquidationist approach in the early 1930s was that the problem was
not merely one of a credit/speculation boom gone bust, but a major change in
underlying macro fundamentals. The first major change was an explosion of
tariffs worldwide, beginning with the Smoot Hawley Tariff in the US (which
put a tariff of 60% on just about everything) and followed by similar
retaliatory tariffs around the globe. This was, needless to say, rather bad
for business. The system obviously can't "right itself" in this situation
unless the tariffs are abolished.
Business actually turned
down in early 1930, before the tariff was passed in June 1930. People saw
where things were going. By 1931, the downturn had caused a falloff in tax
receipts at governments worldwide, and budgets were also affected by the
demand for welfare-type spending (or "stimulus" spending) in
response to the downturn. This caused government budget deficits, which were
addressed with rather dramatic tax hikes, notably in Britain in September
1931. The US followed with a huge tax hike in 1932 that took the top income
tax rate from 24% to 65%. Ouch! Roosevelt followed with several more tax
hikes. Clearly, the system can't "right itself" in the response to
these kind of economy-crippling tax hikes. You have to legislate tax rate
reductions.
This was no
"hands-off" approach to the economy. Mellon's Republican buddies
were dropping bombs on the economy right and left. Mellon was not necessarily
a supporter of these policies, but Mellon is remembered as being part of the
gang of bozos and losers who caused the Great Depression, and had to be
broomed out of office.
Lastly, there was a round
of "beggar thy neighbor" currency devaluations, beginning with
Germany and Austria in August 1931. This was followed by Britain in September
1931 and Japan in December 1931. The countries that maintained a stable
gold-linked currency (including the US and France) were immediately
disadvantaged, in addition to all their other problems. The devaluers enjoyed
some immediate "relief," one of the timeless attractions of
devaluation and inflation.
There was no way for a
"liquidationist" approach to address this major deterioration in
economic fundamentals.
Now, let's look at the
interventionists.
History indicates that,
throughout the world but particularly in Europe, there has been a pattern of
elites and a lower class in service to the elites. This has gone by many
terms, whether the slaves of Rome, or the lords and serfs of medieval Europe,
or the slaves of the Old South. During the industrialization of the 19th
century, a new relationship emerged, that of employee/employer. Employees had
it rough in the 19th century. Many worked incredibly long hours for
subsistence pay. Child labor was common. In the US, for example, the 10-hour/6-day
workweek was standard. The elites and the underclass had their usual
back-and-forth. The uprising of oppressed serfs that led to the French
Revolution was mirrored in violent and bloody battles between management and
employees who would unionize and strike.
There have been some
exceptions to this pattern, such as the egalitarian societies of the Native
Americans, or also that of the U.S. during the colonial period and up to
about 1850. People lived more-or-less independently. These have been relatively
rare, however.
In each society, whether
that of Rome, the Old South, the medieval serfs, or the employees of the 19th
century, eventually the elites and the underclass came to some sort of
agreement. They understood that a regular workweek would be so long, and that
certain holidays were expected, and a certain level of sustenance and perhaps
welfare assistance would be forthcoming. During the 19th century, the
situation reached something of an extreme. It has been postulated by some
that, never in human history have people worked so hard as they did in the
19th century. The slaves of Rome didn't work that long, nor did the medieval
serfs.
These expectations may
change and evolve over time. The industrialization of the 19th century
resulted in greater productivity, and expectations for the working class. As
overall wealth increased, it was expected that some of it would filter down
to the working man. Compulsory education became expected, and in the 20th
century, a certain level of health care.
Among the many activities
of the US government in the 1930s were a series of actions to rectify some of
these imbalances that had built up over decades. These didn't necessarily
have that much to do with the immediate economic situation, but the
environment allowed a new arrangement -- a New Deal between elites and the
underclass -- to take shape. Working hours were reduced. Certain safety-net
programs such as unemployment insurance, Social Security, food (today's food
stamps), and so forth were provided.
Eventually, the
desperately overworked and exploited employee of the 19th century evolved
into the relatively fat and happy factor worker of the 1950s and 1960s, with
a 40-hour workweek, three weeks of vacation, health insurance, a pension, and
a salary that afforded a lifestyle that, for what had previously been the
underclass (now turned middle class), reached an unprecedented level of
material comfort.
Today, even the more
libertarian-leaning, conservative Republican voters would not complain too
loudly about the provision of a government-funded (if not necessarily
government-provided) primary education, the principle of a two-day weekend,
and basic safety-net provisions such as unemployment insurance, food stamps,
some minimum level of medical care, or even Social Security (if not
necessarily Medicare).
Thus, the Roosevelt
government gets some credit for remedying this imbalance between the elite
class and the working class that emerged during the 19th century.
However, none of these
things fixed the economic problem either -- the problem of explosive
increases in tariffs and taxes worldwide, combined later with "beggar
thy neighbor" currency warfare. While welfare-type provisions such as
today's food stamps can be very welcome in an economic downturn (and accounts
for some of the popularity of the "interventionist" politices of
the Roosevelt government), there is no way to paint this as an economic
solution.
During the 1930s, two
basic approaches to the economic problems evolved. They are actually quite
ancient, but their popularity enjoyed a resurgence in response to the
problems of the 1930s. These are a) government spending, on public works for
example, and b) currency manipulation.
These two approaches have
basically been a failure, giving interventionists a bad name. Government
spending is really a sort of welfare program, and typically a rather
expensive one at that. The spending leads to budget deficits, and the
reaction to budget deficits is quite often higher taxes, which causes even
more economic problems. You really can't "jump start" or "pump
prime" an economy with government spending. Economies improve when their
basic operating conditions -- taxes, regulation, money -- improve, or at the
very least when they find a new equilibrium at a depressed level. All in all,
some government spending of this sort can be worthwhile, as long as
expectations are in line with what these policies can produce, and as long as
the reaction to larger budget deficits isn't higher taxes.
There is probably not too
much I need to say about currency manipulation as a means of economic
management. It either does a lot of damage or a tremendous amount of damage,
although the initial effects can feel good for a while.
We might add a final interventionist
consideration, that of "systemic breakdown." This is economic
damage of such an extent that it causes more damage to entities which may
otherwise be in good shape. For example, there were many people in the 1930s
who had accumulated savings for retirement or the economic rainy day.
However, if their bank went bust, as many hundreds did, they were suddenly
left with nothing. This led to such things as deposit insurance and Social
Security. Or, if a company's bank went bust, they may be unable to pay bills
and be forced to declare bankruptcy, even if their financial health was
otherwise in good shape. There are a lot of "systemic" things
related to the financial system, which is one reason I think that today's
efforts to maintain financial system viability, as opposed to a "hands
off" stance, are probably a good thing on balance.
Neither Mellon nor
Roosevelt had all the answers. Today, we can summarize the best points of the
Andrew Mellon approach as: "Keep taxes low, money stable, and regulation
sensible, and the economy will naturally prosper (with some ups and
downs)." The best points of the Franklin Roosevelt approach could be:
"workers need fair treatment, some welfare-type activity is necessary,
and the government has a role in maintaining systemic stability."
The present situation is
rather unusual. Rarely does a credit boom reach such proportions that it
threatens systemic stability. Nevertheless, government must deal with the
cards they're given. Ideally, they will experiment with these positive
approaches, rather than the policy mistakes of the 1930s, especially higher
taxes and monetary instability.
* * *
Is it hyperinflation yet? When does inflation
become hyperinflation? There's no easy line -- it's mostly an "I know it
when I see it" type thing. However, there is, actually, an official
definition. SFAS 52 (an accounting rule) defines hyperinflation as a 100%
increase in general prices (the CPI for example) over a period of three
years. Using the Rule of 72, that works out to 24% per annum. We're still
quite a ways from that.
* * *
The World's Best Kitty
Litter: Remember
SWheatScoop? It's kitty litter made from pure wheat. (www.swheatscoop.com) I just can't help
telling people about that one. But...is it still for sale? I figured that
pure grain kitty litter might have disappeared by now. So, I was quite
delighted when my wife came home -- just last week -- with another pure grain kitty litter.
It's called World's Best Cat Litter. Yes, that's the name. (World's Best Cat Litter) It's made from 100%
corn. Wow! I get tingles just looking at it.
Lucky cats.
 
Monthly CBOT corn.
Grain prices are going much higher.
I was inspired to send
some $$$ to a charity organization. I distrust large organizations like
Oxfam, so I found a little one: Bhaktivedanta International Charities. Their
website is at foodrelief.org. They feed about 6000 families in rural India. I
sent them enough to buy about 200 lbs of corn, which, even at today's prices,
doesn't cost much.
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United
States, Japan,
and the Middle East. About the Book: Gold:
The Once and Future Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is
available at bookstores nationwide, from all major online booksellers, and
direct from the publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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