The Federal Reserve and the "Fatal Conceit" of Economics - Necessary and Sufficient Conditions to Cause Enormous Economic Damage
The move "Goodfellas" captures many of the details of the December 1978 robbery of the Lufthansa cargo terminal at New York's Kennedy Airport. One of the subtle details not fully developed was the robbery was only made possible because of the enormous gambling debts owed by a Lufthansa employee, Louis Werner, to a mob-connected bookmaker, Martin Krugman. In the movie there is a scene where the robbery's mastermind, James "Jimmy the Gent" Burke discusses killing Krugman. Burke asks his protege, Henry Hill, 'You think he (Krugman) tells his wife everything?' Hill, who doesn't want to see Krugman killed, responds, 'You know him. He's a nut job. He talks to everybody. You see his commercials, acting like a jerk. Nobody listens to what he says. Nobody cares what he says he talks so much.'
To a certain extent Hill's opinion concerning the bookmaker Martin Krugman is useful in evaluating the practical significance of the economist Paul Krugman. Because Paul Krugman talks so much, most people have long since stopped listening to him. Indeed, in my most recent post, "Paul Krugman, the Federal Reserve and the Fatal Conceit of Modern Economics," Paul Krugman was only discussed as someone who is thoroughly infected with the fatal conceit of economics. (Recall that the fatal conceit of modern economics is the belief that the economy can be completely controlled by merely manipulating interest rates.) To be sure, as a Princeton professor and through his New York Times editorials Krugman is in a unique position to make his thoroughly bogus ideas heard. However, he is not in a policy-making position and, by that standard anyway, his ability to inflict damage on the US is somewhat limited.
Regrettably, any sort of limit on the Fed to cause damage via the "fatal conceit" of modern economics does not exist. In the brief discussion below, the most spectacular example of the fatal conceit of modern economics animating the Fed to cause enormous economic damage will be reviewed. This example involves a man named Benjamin Strong. This example took place during the 1920s, but should not be dismissed as having no relevance today. Strong was the governor of the Federal Reserve Bank of New York from 1914 until his death in 1928. In this position, Strong essentially - and singlehandedly - ran the Fed.
While many people believe war is some sort of great boon to any economy, the experience of England after World War I provides definitive experience to the contrary. Well before America had entered the war on the side of the Allies, England had borrowed enormous amounts of money from American banks to purchase weapons from American companies. (1) With the war over, these debts needed to be repaid. However, because all the borrowed money had been used to build weapons and not to increase England's productive capacity, there was essentially no way for England to repay its enormous war-debts - owed in dollars - to the United States.
Investors realized that England had greatly increased its money supply without increasing its productive capacity. As a result of this, the British pound plummeted in value. In February 1920 the pound dropped to a low of $3.18 per dollar when the pre-war parity had been $4.8668 per pound. (2) Strong and his counterpart at the Bank of England - a central planner every bit Strong's equal named Montagu Norman - then conspired to return the pound to its pre-war parity with the dollar. They resolved not to do this by working together to make the pound stronger; instead they worked to make the dollar weaker. They reasoned that if the dollar was weaker, the pound would become stronger as a result.
Proof of this can be found in correspondence. For example, in May 1924 Strong told Treasury Secretary Andrew Mellon he was pursing a "readjustment" to benefit England. The "readjustment" required Strong to pursue a policy of inflation in the United States and thus keep Britain from having to raise interest rates. Here is Strong in his own words;
"...the burden of this readjustment must fall more largely upon us than upon them (Great Britain). It will be difficult politically and socially for the British government and the Bank of England to face a price liquidation in England...in face of the fact that their trade is poor and they have over a million unemployed people receiving government aid." (3)
Later,in October 1924, Norman asked Strong to continue with his policy of low interest rates, or 'easy money,' "You must continue with easy money and foreign loans and we must hold on tight until we know....what the policy of this country will be." (4)
However, even all this was not enough to keep England solvent. As a result of her massive war debts - denominated as they were in dollars, not pounds - England's position was hopeless. This hopeless position was further exacerbated by a national strike in May 1926. The strike began in Britain's most important industry, coal. (5) British industry was already in dire straits and Strong recognized the strike made further action to benefit England necessary.
Strong then took the extraordinary action of calling a meeting of the world's central bankers. The meeting was held in July 1927 on Long Island, and had a single purpose - to coordinate a world-wide policy of "loose money" to advance the interests of England. The leaders of the central banks in France and Germany balked at the proposal, but Strong pursued a policy to benefit England with great vigor. The policy Strong implemented after the July 1927 meeting proved to be an enormous disaster and directly led to the Great Depression and World War II. In fact, Adolph Miller of the Federal Reserve and a contemporary of Strong's called the 1927 credit expansion engineered to to benefit the Bank of England, "the father and mother to the subsequent 1929 collapse." (6) This can clearly be seen in the chart below.
The chart plots two Fed fueled bubbles - the 1920s stock bubble fueled by Ben Strong and the 1990s tech bubble fueled by Alan Greenspan. In both cases the bubbles were supercharged by the Fed actively interfering in the economy. (7) As described here using the example of Benjamin Strong, people everywhere would be much better off if the "fatal conceit" of modern economics was limited to the non-sequiturs and incoherent ramblings of Paul Krugman and all those like him. Unfortunately - and as the Federal Reserve has demonstrated time and time again - the fatal conceit of modern economics continues to inspire the Fed, and lies at the root of all the enormous mistakes the Fed has made and will continue to make.
30 SEP 2018
(1) William Jennings Bryan, President Wilson's secretary of state, strongly cautioned Wilson against allowing American banks to loan money to belligerents on either side. Bryan knew that once banker's money was at stake in the outcome of the war, America would eventually be forced to enter the war to protect the bankers' interest. This is exactly what happened.
(2) Benjamin Anderson, Economics and the Public Welfare, Liberty Press, Indianapolis, p. 171. In 1920, 1-oz of gold cost $20.67. At an exchange rate of $4.8668 per pound, the pound price of gold was about 4.25-pound per ounce of gold. Today, it only takes $1.3 to equal 1-pound, and the dollar price of gold is $1200 per ounce. Based on these conversions, it now takes 923-pounds to purchase the same ounce of gold that could be purchased for 4.25-pounds before WWI! In other words, the British pound is now worth less than 1/200th of what it was worth one-hundred years ago.
(3) Murray Rothbard, America's Great Depression (5th edition), Mises Institute, Auburn, AL 2000, p. 147
(4) Rothbard, America's Great Depression, p. 147-148
(5) Among the many problems facing the British coal industry were "in kind" reparations. These were reparations paid for by Germany in goods, not money. Among the largest of in kind reparations were payments in coal, and much of this coal went to France and Italy. France and Italy had both been large export markets for British coal. The in kind reparations payments in coal highlight what a contradiction the Treaty of Versailles was with itself. Only a strong Germany could pay the reparations demanded by France, but France wanted a weak Germany.
(6) William Greider, Secrets of the Temple - How the Federal Reserve Runs the Country, Touchstone Books, New York, 1987, p. 297
(7) October 1998 refers to the interest rate cut engineered by Alan Greenspan after the hedge fund LTCM collapsed. This interest rate cut - which occurred between regularly scheduled Fed meetings - gave speculators everywhere a green light to do almost anything and everything financially speaking. Note in particular how stocks soar immediately after October 1998 in exactly the same way they did after July 1927. See the "Dunce" biography of Alan Greenspan for more details.