1. JimP sent me this link showing that I am not the only one who thinks tight money is the cause of our current predicament:
Tim Congdon – a hard-money Friedmanite from International Monetary Research – says the Fed is still not easing enough, perhaps because it is spooked by so much criticism or faces a mutiny by its own hawks. “If Ben Bernanke and his officials are listening to this sort of stuff and taking it seriously, they are making the same mistake as the Fed in the early 1930s,” he said. The US “output gap” is near 7pc. That is a powerful lid on inflation.
The sin has been to let M2 money growth wither since January, to let bank lending contract at a 5pc annual rate, and to let 10-year bond yields rise to nearly 4pc. The Fed pays lip service to the Friedman-Schwartz theory of the Depression, but has not digested the lesson.
Mr Congdon’s prescription is what Britain did in 1931 and 1992: monetary stimulus à l’outrance (today: bond purchases), offset by spending cuts. This mix – easy money/tight fiscal – would halt debt deflation without ruining the public finances of the US, Britain, and Europe in the way that Keynesian schemes ruined Japan. “The markets would rocket,” he said.
My doppelganger. BTW, those of you who think I’m an inflation dove should note that Tim Congdon is described as a “hard money” guy.
Update 6/23/09: David Beckworth deserves some praise. The Telegraph article was influenced by David’s blog. And David also anticipated the ideas in Bob McTeer’s blog (see point 3 below) way back in October (see here.)
2. Arnold Kling has an interesting post on whether “bad bets” or co-ordination problems played a bigger role in the financial crisis. I agree with his conclusion that bad bets were more important, but I also believe he left out the most important factor. Here is my guesstimate of the relative importance of three factors:
1. Coordination failures — 5%
2. Bad bets – 20%
3. Falling NGDP (tight money) — 75%
My baseline policy is for the Fed to buy or sell unlimited amounts of NGDP futures contracts at a price that rises 5% per annum. Under that regime I think the financial crisis would have been no more than 1/4th as large, and indeed probably even less than that. Even the subprime part of the crisis (which is not the largest part) would have been considerably smaller. Had that policy been followed, NGDP would probably be around 8% higher today, and housing prices would probably be 15% to 20% higher today (as they are pricing in further subpar NGDP growth over the next few years.)
3. Bob McTeer argues that the decision to pay interest on reserves is a mistake on par with the Fed’s decision to double reserve requirements in 1936-37. I have made the same argument. He is the former president of the Dallas Fed. If only some of the current members of the FOMC understood this.
5. Tyler also linked to an interesting website that is going through the 1930 Wall Street Journals one day at a time. Here are some items from today’s link:
Treasury Secretary Mellon denies Smoot-Hawley tariff will damage business, says tariff will end uncertainty, criticism has been exaggerated, and flexible provisions in the law will be used to improve it. Says previous tariffs have always caused “gloomy prophecies” that have never materialized.
Hoover had decided to sign Smoot-Hawley on Sunday June 15th. During the previous weeks the stock market had fallen sharply, and the fall was almost certainly due to the Congressional fight over Smoot-Hawley. While the government was whistling past the graveyard, the mainstream press also tried to convince the public that all was well:
Front page above the fold editorial: “This is America. Piffling talkers would turn back the calendar to the nineties and destroy the economic progress of thirty years. Vicious rumors spread for selfish purposes; flippant predictions of a five-year slump in business; wholesale demands for the cutting of wages are unworthy of American intelligence. Credit is super-abundant. Business is no worse than three months ago. Twelve months of declining volume is behind us. Many adjustments have been all but completed. Engineering and marketing brains are as fertile as ever. Problems there have always been. To proclaim their insurmountability is childish.”
Al least academic economists opposed Smoot-Hawley, but alas their predictions were also worthless:
Economists feel the current situation in commodity markets is starting to look like a bottom; a combination of underproduction and easy credit at low rates should work as usual to correct conditions.
In fact, the decline is commodity prices was accelerating. And just as today, Congress went on a witch hunt looking to for scapegoats for a depression that was actually caused by a sharp fall in AD (caused by gold hoarding by central banks.) Their villains turned out to be short sellers. I guess their theory was that the stock crash was caused by people selling stocks:
Resolution introduced by Congressman Sabath to form a committee to investigate whether “the tremendous professional shortselling of stock on the various exchanges was responsible for the November, 1929, and present ‘crashes,’ and to what extent it is responsible for the depression of business.” Will also look into taxing short sales or outlawing them completely.
So this is the sort of propaganda that Wall Street traders read when they woke up on Monday morning, the day after Hoover decided to sign Smoot-Hawley. All was well despite the crash on Wall Street during the previous weeks. How did they react to that news? With a big %&#@ &$% to the government, the press, and the economists. The Dow fell 7% that day, the largest fall of the entire year. The markets knew the real story. This is from the following day’s NYT:
“There was a feeling of discouragement that extended to all of the speculative markets. Everywhere the disposition was to lay the blame at the doors of Congress. Loud lamentations against the tariff bill were heard throughout the financial district. Traders, gathered in the customers’ rooms of brokerage houses, berated the administration and Congress. One disgruntled person posted a placard in a brokerage house reading, ‘A Business Administration—the Only Party Fit to Rule?’” (June 17, 1930, p. 1)
In contrast, here’s how the WSJ described the reaction to Hoover’s decision:
Hoover’s announcement on tariff favorably received due to removal of business uncertainty, and his announced intention to use his authority via the tariff commission to fix problems with the law.
What’s the lesson? If you want to know what’s really going on, don’t look to the government, don’t look to the press, and don’t look to the economists. Look at the markets. They won’t sugarcoat the truth or look for scapegoats.
By coincidence, I mentioned how I had read all the 1930s NYT in yesterday’s post. Elsewhere I argued that 2008 was like 1929 and 1937. That makes 2009 like 1930 and 1938. Let’s hope it’s more like 1938.