Tag: economics

Sophisticated economics

Lest you be under the impression that the Federal Reserve is in control of anything, consider this informal Q&A with Ben Bernanke:

RUHLE: … you recently had dinner with Ben Bernanke. What went down? We didn’t get to be there.

EINHORN: Well, it was — I watched him for years in front of Congress and speaking and watched him on TV and “60 Minutes” and —

RUHLE: And what was your opinion of him before you had dinner?

EINHORN: I was — I’ve been critical. I’ve been critical of him for a very long time. And the dinner for me, in one way it was cathartic because I got to ask him all these questions that had been on my mind for a very long period of time, right? And then on the other side, it was like sort of frightening because the answers weren’t any better than I thought that they might be.

SCHATZKER: What did you ask him?

EINHORN: I asked several things. He started out by explaining that he was 100 percent sure that there’s not going to be hyperinflation. And not that I think that there’s going to be hyperinflation, but it’s like how do you get to 100 percent certainty of anything? Like why can’t you be 99 percent certain and like how do you manage that risk in the last 1 percent? And he says, well, hyperinflations generally occur after wars and that’s not here. And there’s no sign of inflation now and Japan’s done a lot more quantitative easing than we’ve done, and they don’t have it. So if there is a big inflation, the Fed will know what to do. That was kind of the answer.

RUHLE: What did you say?

EINHORN: That was it. Then it went to the next question. So then a few minutes later it came back and I got to ask him about the jelly donuts. And my thesis is that it’s like too much of a good thing. Like lowering rates and quantitative easing and these stimulative things, they help but with a diminishing return. And eventually you go too far and it’s like eating the 35th jelly donut. It just doesn’t help you. It actually slows you down and makes you feel bad. And my feeling has been that by having rates at zero for a very, very long time the harm that we’re doing to savers outweighs the benefits that might be seen elsewhere in the economy. So I got to ask him about this.

SCHATZKER: Okay, and what did he say?

EINHORN: Well first of all he says, you’re wrong. That it was good. And then he said the reason is if you raise interest rates for savers, somebody has to pay that interest. So you don’t create any value in the economy because for every saver there has to be a borrower.

And what I came back to him was I said, but wait a minute. You said for a long time we haven’t had enough fiscal stimulus, and who’s on the other side of the low interest trade? It’s the government. And so if the government — if we raise the rates, the government would have to pay more money to savers. You’d have the bigger deficits. You’d create the stimulus, the fiscal stimulus that you’ve been complaining that Congress wouldn’t give to you, right? And savers would benefit from the higher rates and because savings is spent at a very high rate in terms of interest — interest income on savings is spent at a high percentage, you’d get a real flow through into the economy.

It gets incredibly tiresome hearing these idiot Keynesians – and yes, monetarists are Keynesians – constantly reminding everyone that for every buyer, there has to be a seller. Although Bernanke’s formulation is technically incorrect, as there does NOT have to be a borrower for every saver because not all savers are lenders.

We can cut him some slack on that; it was an informal conversation and since the discussion concerned interest rates, only savers who are lenders, (which is to say depositors), were in context here. But what we cannot cut him any slack on is the idea that this statement of the obvious actually addressed the issue.

The real reason there isn’t a risk of hyperinflation is the same reason rates have been keep artificially low for years: we are in an ongoing state of credit disinflation. All that cheap credit has gone into the banks and the equity markets to prop them up, but as Einhorn has noted, the law of diminishing returns is beginning to take effect.

Karl Denninger explains the problem with quantitative easing:

The basic economic equality is MV = PQ; that is, “Money”(ness) X Velocity (times each unit of “moneyness” is spent in a given amount of time) = Price (of each item or service produced) X Quantity (number of goods and/or services sold.)

This is a fact and nothing can change it.

Now here’s the problem — we state “PQ” (otherwise known as GDP) in units of “M”.

If you don’t understand the problem that QE presents (indeed, that any borrowing presents) with this you’re not very bright.

Short-term borrowing — that is, a loan that is quickly extinguished — doesn’t change “M”.  It time shifts a transaction but economically is otherwise a non-event from a monetary perspective.  If I borrow $100 from you to buy a night at the bar, get paid on Friday and give you back your $100 (with or without interest) I have simply changed the night at the bar’s economic event from Friday to Tuesday; further, the event Tuesday now cannot happen on Friday (as well) because the $100 has already been spent.

I have not changed whether it happens at all.

QE, however, is a permanent change in “M”.  It is intended to “make up” for private borrowing for which there is either no demand or no supply.  That is, in the market today there is insufficient incentive for private capital to be loaned either because the interest rate that can be earned doing so is unattractive for the risk inherent in the loan or there is nobody willing and able to borrow at the offered rate.

But since “QE” is not “paid back” and withdrawn it permanently changes the amount of “M” in the system.  Since GDP is stated in “M” to get an accurate account of GDP you must subtract back off any permanent change in “M” from GDP.

QE, on a rolling 12 month basis, is about $1 trillion.  The US Economy is about $17 trillion.  Therefore you must subtract the amount of QE added back out, which is about 5.9% of the total economy!

In other words with the current GDP “growth” of effectively zero (0.1%) the economy is in fact in deep recession as the actual “growth rate” is currently -5.8%.

This is caused by QE.

Krugman has learned nothing

The ur-Nobel prizewinner still hasn’t accepted that his economic theory is flat-out wrong:

On Wednesday, I wrapped up the class I’ve been teaching all semester: “The Great Recession: Causes and Consequences.” (Slides for the lectures are available via my blog.) And while teaching the course was fun, I found myself turning at the end to an agonizing question: Why, at the moment it was most needed and could have done the most good, did economics fail?

I don’t mean that economics was useless to policy makers. On the contrary, the discipline has had a lot to offer. While it’s true that few economists saw the crisis coming — mainly, I’d argue, because few realized how fragile our deregulated financial system had become, and how vulnerable debt-burdened families were to a plunge in housing prices — the clean little secret of recent years is that, since the fall of Lehman Brothers, basic textbook macroeconomics has performed very well.

I saw the crisis coming. From the fall of 2002 to the spring of 2008, I pointed out that the housing market was going to crash and potentially take down the global financial system with it. Because no individual, family, business, or nation can sustain infinite debt. And the claim that “basic textbook macroeconomics” has performed very well is a bad joke, especially in light of the stagnant GDP report that was just released. There is no recovery.

And the diagnosis of our troubles as stemming from inadequate demand had clear policy implications: as long as lack of demand was the problem, we would be living in a world in which the usual rules didn’t apply. In particular, this was no time to worry about budget deficits and cut spending, which would only deepen the depression. When John Boehner, then the House minority leader, declared in early 2009 that since American families were having to tighten their belts, the government should tighten its belt, too, people like me cringed; his remarks betrayed his economic ignorance. We needed more government spending, not less, to fill the hole left by inadequate private demand.

But a few months later President Obama started saying exactly the same thing. In fact, it became a standard line in his speeches. Nor was it just rhetoric. Since 2010, we’ve seen a sharp decline in discretionary spending and an unprecedented decline in budget deficits, and the result has been anemic growth and long-term unemployment on a scale not seen since the 1930s.

Lack of demand isn’t the problem. The problem is the credit-imposed limits of demand. To Krugman, demand is a magical entity. Invent money ex nihilo and the spirit will be summoned to magically expand the economy. He’s appealing to a logically incoherent system that can NEVER address the problem; it’s like trying to fix a car that won’t start by pouring water on the driveway. Krugman keeps calling for more water and insisting that just one more big dowsing of water will make the car start.

He’s also being wildly deceptive here. Have a look at that “unprecedented decline in budget deficits” from 2012 to 2013.

In other words, the federal government is still rapidly increasing its debt-spending, but at a slower rate than the four record-setting years. This is hardly the “austerity” he elsewhere claims it to be.

Mainstream economics didn’t see the crisis coming. Mainstream economics has not fixed the problem. And mainstream economics is obviously unaware that the first crisis was only the first wave downward. The magnitude of the next one is indicated by the length of the anemic five year “recovery”.

The moving goalposts of PC morality

A basic concept of economics explains why the various evils of the equalitarians can never be conquered and serves as the logical basis for demonstrating that there is nothing moral about political correctness.

A positional good is a good that people acquire to signalise where
they stand in a social hierarchy; it is acquired in order to set oneself
apart from others. Positional goods therefore have a peculiar property:
the utility their consumers derive from them is inversely related to
the number of people who can access them.

Positionality is not a property of the good itself, it is a matter of
the consumer’s motivations. I may buy an exquisite variety of wine
because I genuinely enjoy the taste, or acquire a degree from a
reputable university because I genuinely appreciate what that university
has to offer. But my motivation could also be to set myself apart from
others, to present myself as more sophisticated or smarter. From merely
observing that I consume the product, you could not tell my motivation.
But you could tell it by observing how I respond once other people start
drinking the same wine, or attending the same university….

PC-brigadiers behave exactly like owners of a positional good who panic because wider availability of that good threatens their social status. The PC brigade has been highly successful in creating new social taboos, but their success is their very problem. Moral superiority is a prime example of a positional good, because we cannot all be morally superior to each other. Once you have successfully exorcised a word or an opinion, how do you differentiate yourself from others now? You need new things to be outraged about, new ways of asserting your imagined moral superiority.

You can do that by insisting that the no real progress has been made, that your issue is as real as ever, and just manifests itself in more subtle ways. Many people may imitate your rhetoric, but they do not really mean it, they are faking it, they are poseurs. You can also hugely inflate the definition of an existing offense. Or you can move on to discover new things to label ‘offensive’, new victim groups, new patterns of dominance and oppression.

This is why SFWA overreacted so conspicuously and dramatically to my factual statements about a token writer whose main role in the organization was totemic. Their fainting fits and outrage were conspicuous consumption, designed to elevate their status within the group.

The main reason that this crowd was so deeply offended by my nomination was because it cheapens their painstakingly acquired status. Here they are, brandishing their expensive, designer outrage purses, when suddenly the Hugo voters hand them the equivalent of a notice that they’ve bought nothing but a cheap knockoff that anyone can pick up for nothing.

And this is why my usual critics, such as Jim Hines and John Scalzi, were wise to support my right to be on the ballot despite the fact that we know they could not care less about the rules are. They have already learned, (even if they haven’t publicly admitted it yet), that they simply can’t keep up with the conspicuous consumption of the more extreme elements of the PC brigade. Eventually, they will be shaken off by their putative allies, because without shaking them off, the extremists cannot maintain their conspicuous pose of moral superiority.

Which further goes to prove that their professed moral superiority is only a pose and there is nothing moral about PC morality at all. To be meaningful and coherent, to be a moral standard, morality must be universal and objective. And obviously, a dynamic morality defined by the most conspicuous consumers for the purposes of their own distinction can never be either.

Why the minimum wage should be raised

Zerohedge and other economic globalists don’t understand the real benefit of minimum-wage laws:

Most of our readers probably know what we think of minimum wages, but let us briefly recapitulate: there is neither a sensible economic, nor a sensible ethical argument supporting the idea.

Let us look at the economic side of things first: for one thing, the law of supply and demand is not magically suspended when it comes to the price of labor. Price it too high, and not the entire supply will be taken up. Rising unemployment inevitably results.

However, there is also a different way of formulating the argument: the price of labor must not exceed what the market can bear. In order to understand what this actually means, imagine just for the sake of argument a world without money. Such a world is not realistic of course, as without money prices the modern economy could not exist. However, what we want to get at is this: workers can ultimately only be paid with what is actually produced.

As Mises has pointed out, most so-called pro-labor legislation was only introduced after enough capital per worker was invested to make the payment of higher wages possible – usually, the market had already adjusted wages accordingly.

However, unskilled labor increasingly gets priced out of the market anyway, which is where the ethical argument comes in. If a worker cannot produce more than X amount of  goods or services, it is not possible to pay him X+Y for his work. Under minimum wage legislation he is condemned to remain unemployed, even if he is willing to work for less.

In Switzerland, the unions have recently managed to get the demand for minimum wage legislation on one of the quarterly referendums in the country.

The purpose of the minimum-wage laws have nothing to do with socialism and everything to do with nationalism. This should be obvious by the at-first-glance outlandish proposal to raise the Swiss minimum wage to $25 per hour. But once you understand that Switzerland has learned from the example of the USA and the EU states and is battling to avoid being overrun by cheap-labor immigrants from Africa and Eastern Europe, and the brilliance of the political tactic becomes apparent.

The entire justification for importing tens of millions of Mexicans is the reduction of labor costs, thereby resulting in tremendous damage to the social fabric, the destruction of the middle class, and a permanent change in the political system. All of this can be avoided by raising the minimum wage to a level that ruins the value proposition of the immigrant worker to the large corporations.

As a general rule, the Swiss are among the sanest of nations. If you are asking if they have gone insane, that is a good reason to assume you are missing something. Americans who are interested in salvaging any vestige of traditional America should push hard for raising the minimum wage to at least $20 per hour.

A rare alignment

Will wonders never cease? I actually concur with Paul Krugman for once:

Four years ago Chris Christie, the governor of New Jersey, abruptly canceled America’s biggest and arguably most important infrastructure project, a desperately needed new rail tunnel under the Hudson River. Count me among those who blame his presidential ambitions, and believe that he was trying to curry favor with the government- and public-transit-hating Republican base.

Even as one tunnel was being canceled, however, another was nearing completion, as Spread Networks finished boring its way through the Allegheny Mountains of Pennsylvania. Spread’s tunnel was not, however, intended to carry passengers, or even freight; it was for a fiber-optic cable that would shave three milliseconds — three-thousandths of a second — off communication time between the futures markets of Chicago and the stock markets of New York. And the fact that this tunnel was built while the rail tunnel wasn’t tells you a lot about what’s wrong with America today.

Who cares about three milliseconds? The answer is, high-frequency traders, who make money by buying or selling stock a tiny fraction of a second faster than other players. Not surprisingly, Michael Lewis starts his best-selling new book “Flash Boys,” a polemic against high-frequency trading, with the story of the Spread Networks tunnel. But the real moral of the tunnel tale is independent of Mr. Lewis’s polemic.

Think about it. You may or may not buy Mr. Lewis’s depiction of the high-frequency types as villains and those trying to thwart them as heroes. (If you ask me, there are no good guys in this story.) But either way, spending hundreds of millions of dollars to save three milliseconds looks like a huge waste. And that’s part of a much broader picture, in which society is devoting an ever-growing share of its resources to financial wheeling and dealing, while getting little or nothing in return.

The financial sector is nothing but a gigantic, money-sucking tick on the US economy. None – I repeat – NONE of the claimed benefits it supposedly provides as “the lubricating oil of capitalism” are worth even one-tenth the present cost of the financial sector. There will be no recovery, there CAN be no recovery under the twin burdens of the federal and the financial sectors, which presently account for 48 percent of the outstanding debt in the American economy.

Free trade reduces US income

As I have repeatedly shown, the Rising Tide school of economic thought always leaves out the fact that the rising tide must inevitably come at the expense of workers in the wealthier societies:

Branko Milanovic, a visiting professor at CUNY who once served as a senior economist at the World Bank, has tracked worldwide changes in income growth from 1998 to 2008. Milanovic calculates that the middle class in China and India experienced 60 to 70 percent income growth from 1998 to 2008, while growth stalled for the middle and working classes in the United States.

The question then becomes, in Milanovic’s words, “Does the growth of China and India take place on the back of the middle class in rich countries,” especially the United States? Milanovic does not claim a direct causal relationship, but contends that the two “may not be unrelated.”…

Entering the fray, three economists – David Autor of M.I.T., David Dorn of the Center for Monetary and Financial Studies in Spain, and Gordon Hanson of the University of California, San Diego – have analyzed the employment consequences of globalized trade and technological advance.

In a series of papers they wrote together – “Trade Adjustment: Worker Level Evidence,” “The China Syndrome: Local Labor Market Effects of Import Competition in the United States,” and “Untangling Trade and Technology: Evidence from Local Labor Markets” — Autor, Dorn and Hanson find that in the case of trade with China, there are very painful consequences for specific categories of American workers.

Their findings show why voters are wary of free trade agreements.

Relative to the average employee in manufacturing, workers in industries that face stronger competition from imports “garner lower cumulative earnings and are at elevated risk of exiting the labor force and obtaining public disability benefits,” Autor, Dorn and Hanson write.
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And if manufacturers are ranked on a scale of 1 to 100 for exposure to import competition from China, between 1992 and 2007, workers in firms high on the exposure scale lost nearly half a year’s pay, compared to workers in firms at the low end of the scale.

And this doesn’t even begin to get into the fact that the expansion of domestic free trade into the international arena would INEVITABLY RESULT in the same sort of labor movement that one sees in the USA. Don’t like the fact that your kids live in a different state? Well, in a true free trade regime, they might have to go to Bangladesh or Peru to find employment.

Free trade is logically incompatible with national sovereignty, the Constitution, and the maximization of human liberty. This should be obvious, as it is an aspect of globalism and a major objective of those who advocate global government.

Still bailing

It’s going to be fascinating to learn how long the great game of Let’s Pretend can continue:

Federal Reserve Chair Janet Yellen, easing investor concern that interest rates may rise earlier than previously forecast, said the world’s biggest economy will need Fed stimulus for “some time.”

Yellen said today the Fed hasn’t done enough to combat unemployment even after holding interest rates near zero for more than five years and pumping up its balance sheet to $4.23 trillion with bond purchases.

“This extraordinary commitment is still needed and will be for some time, and I believe that view is widely shared by my fellow policy makers,” Yellen said at a community development conference in Chicago. “The scars from the Great Recession remain, and reaching our goals will take time.”

The amusing thing is that if you take the GDP numbers seriously, the Great Recession was actually a very minor one. Of course, it’s all fiction at this point, and poorly written fiction at that.

Remember, the Fed always talks about the general economy, but all it actually cares about is keeping the giant banks from collapsing.

The Bank of England explains money creation

This is from “Money creation in the modern economy“, an article published in the Bank of England Quarterly Bulletin 2014. The bold text is in the original.

In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans.

Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money. The reality of how money is created today differs from the description found in some economics textbooks:

  • Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
  • In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.

Although commercial banks create money through lending, they cannot do so freely without limit. Banks are limited in how much they can lend if they are to remain profitable in a competitive banking system. Prudential regulation also acts as a constraint on banks’ activities in order to maintain the resilience of the financial system. And the households and companies who receive the money created by new lending may take actions that affect the stock of money — they could quickly ‘destroy’ money by using it to repay their existing debt, for instance.

Monetary policy acts as the ultimate limit on money creation.

The Bank of England aims to make sure the amount of money creation in the economy is consistent with low and stable inflation. In normal times, the Bank of England implements monetary policy by setting the interest rate on central bank reserves. This then influences a range of interest rates in the economy, including those on bank loans.

In exceptional circumstances, when interest rates are at their effective lower bound, money creation and spending in the economy may still be too low to be consistent with the central bank’s monetary policy objectives. One possible response is to undertake a series of asset purchases, or ‘quantitative easing’ (QE).

QE is intended to boost the amount of money in the economy directly by purchasing assets, mainly from non-bank financial companies. QE initially increases the amount of bank deposits those companies hold (in place of the assets they sell). Those companies will then wish to rebalance their portfolios of assets by buying higher-yielding assets, raising the price of those assets and stimulating spending in the economy.

This proves that Paul Krugman and the Neo-Keynesians clinging to their textbook Samuelsonian  Econ 101 have it wrong. It also shows very clearly why credit is the vital issue and why the paper-printing of the past is not going to lead to hyperinflation, but the eventual collapse of total credit market debt is going to lead to deflation.

The BoE even spells it out; “money” can be destroyed by using it to repay existing debt… or defaulting on it. By money, of course, they mean “credit money”, which is the only sort of money that matters in terms of the current global financial system.

Concerning which, Zerohedge quotes Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta:

If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.

And, as I have repeatedly stated over the last six years, the Fed cannot print borrowers. There is no “permanent money” in this particular monetary system, which is another way to say that this is a “credit money-substitute” system. This little fact explains why Congress and the Executive Branch agencies inexplicably permit the bankers to openly flout the law; they are collectively deemed too structurally important to fail or even be held legally accountable.

On the knife’s edge

In belatedly going over the Q4 2013 Z1 report, I was a little surprised to see that total credit market debt picked up a bit, increasing $909 billion in the fourth quarter alone. At 1.57 percent, that’s still not enough to keep pace with the historical quarterly advance of 2.36 percent, so it’s still disinflation mode, but it is the third-highest quarterly credit growth seen since credit disinflation began in Q1-2008.

However, the Household sector remains flat and the State and Local Government sector has been deflating the last three quarters in a row and seven of the last eight. This means that the private economy is still contracting because State and Local is restricted by tax revenues. Nearly all the credit growth is taking place in the Corporate and Federal sectors.

In fact, of the $7,718.7 in credit growth since Z1 peaked and began deflating in Q1 2009, $7,078.7 is Federal borrowing. In other words, the private economy is right on the knife edge of debt-deflation and has been so for the last five years despite the vast inflationary efforts by the Obama administration and the Federal Reserve.

As for the credit demand gap, at $29.4 trillion, it has now reached nearly 50 percent of Z1. That is why money printing to fill the gap is simply not an option and any attempt to do so will necessarily go right to hyperinflation and failure.

War and the Austrian Business Cycle

David Stockman explains the oft-observed connection between economic contraction and military conflict. Astute observers will note that the cycle he describes correlates much better with my “Limits of Demand” modification of the core mechanism of the Austrian Business Cycle:

During World War I the US public debt rose from $1.5 billion to $27 billion—an eruption that would have been virtually impossible without wartime amendments which allowed the Fed to own or finance U.S. Treasury debt.  These “emergency” amendments—it’s always an emergency in wartime—enabled a fiscal scheme that was ingenious, but turned the Fed’s modus operandi upside down and paved the way for today’s monetary central planning.

As is well known, the Wilson war crusaders conducted massive nationwide campaigns to sell Liberty Bonds to the patriotic masses. What is far less understood is that Uncle Sam’s bond drives were the original case of no savings? No credit? No problem!

What happened was that every national bank in America conducted a land office business advancing loans for virtually 100 percent of the war bond purchase price—with such loans collateralized by Uncle Sam’s guarantee. Accordingly, any patriotic American with enough pulse to sign the loan papers could buy some Liberty Bonds.

And where did the commercial banks obtain the billions they loaned out to patriotic citizens to buy Liberty Bonds?  Why the Federal Reserve banks opened their discount loan windows to the now eligible collateral of war bonds.

Additionally, Washington pegged the rates on these loans below the rates on its treasury bonds, thereby providing a no-brainer arbitrage profit to bankers.

Through this backdoor maneuver, the war debt was thus massively monetized.  Washington learned that it could unplug the free market interest rate in favor of state administered prices for money, and that credit could be massively expanded without the inconvenience of higher savings out of deferred consumption.  Effectively, Washington financed Woodrow Wilson’s crusade with its newly discovered printing press—-turning the innocent “banker’s bank” legislated in 1913 into a dangerously potent new arm of the state.

It was this wartime transformation of the Fed into an activist central bank that postponed the normal post-war liquidation—-moving the world’s scheduled depression down the road to the 1930s. The Fed’s role in this startling feat is in plain sight in the history books, but its significance has been obfuscated by Keynesian and monetarist doctrinal blinders—that is, the presumption that the state must continuously manage the business cycle and macro-economy.

Having learned during the war that it could arbitrarily peg the price of money, the Fed next discovered it could manage the growth of bank reserves and thereby the expansion of credit and the activity rate of the wider macro-economy. This was accomplished through the conduct of “open market operations” under its new authority to buy and sell government bonds and bills—something which sounds innocuous by today’s lights but was actually the fatal inflection point. It transferred the process of credit creation from the free market to an agency of the state.

As it happened, the patriotic war bond buyers across the land did steadily pay-down their Liberty loans, and, in turn, the banking system liquidated its discount window borrowings—-with a $2.7 billion balance in 1920 plunging 80 percent by 1927. In classic fashion, this should have caused the banking system to shrink drastically as war debts were liquidated and war-time inflation and malinvestments were wrung out of the economy.

But big-time mission creep had already set in.  The legendary Benjamin Strong had now taken control of the system and on repeated occasions orchestrated giant open market bond buying campaigns to offset the natural liquidation of war time credit.

Accordingly, treasury bonds and bills owned by the Fed approximately doubled during the same 7-year period. Strong justified his Bernanke-like bond buying campaigns of 1924 and 1927 as helpful actions to off-set “deflation” in the domestic economy and to facilitate the return of England and Europe to convertibility under the gold standard.

But in truth the actions of Bubbles Ben 1.0 were every bit as destructive as those of Bubbles Ben 2.0.

In the first place, deflation was a good thing that was supposed to happen after a great war. Invariably, the rampant expansion of war time debt and paper money caused massive speculations and malinvestments that needed to be liquidated.

Likewise, the barrier to normalization globally was that England was unwilling to fully liquidate its vast wartime inflation of wage, prices and debts. Instead,  it had come-up with a painless way to achieve “resumption” at the age-old parity of $4.86 per pound; namely, the so-called gold exchange standard that it peddled assiduously through the League of Nations.

The short of it was that the British convinced France, Holland, Sweden and most of Europe to keep their excess holdings of sterling exchange on deposit in the London money markets, rather than convert it to gold as under the classic, pre-war gold standard.

This amounted to a large-scale loan to the faltering British economy, but when Chancellor of the Exchequer Winston Churchill did resume convertibility in April 1925 a huge problem soon emerged.  Churchill’s splendid war had so debilitated the British economy that markets did not believe its government had the resolve and financial discipline to maintain the old $4.86 parity. This, in turn, resulted in a considerable outflow of gold from the London exchange markets, putting powerful contractionary pressures on the British banking system and economy.

Real Cause of the Great Depression: Collapse of the Artificial Boom

In this setting, Bubbles Ben 1.0 stormed in with a rescue plan that will sound familiar to contemporary ears. By means of his bond buying campaigns he sought to drive-down interest rates in New York relative to London, thereby encouraging British creditors to keep their money in higher yielding sterling rather than converting their claims to gold or dollars.

The British economy was thus given an option to keep rolling-over its debts and to continue living beyond its means. For a few years these proto-Keynesian “Lords of Finance” —- principally Ben Strong of the Fed and Montague Norman of the BOE—-managed to kick the can down the road.

But after the Credit Anstalt crisis in spring 1931, when creditors of shaky banks in central Europe demanded gold, England’s precarious mountain of sterling debts came into the cross-hairs.  In short order, the money printing scheme of Bubbles Ben 1.0 designed to keep the Brits in cheap interest rates and big debts came violently unwound.

In late September a weak British government defaulted on its gold exchange standard duty to convert sterling to gold, causing the French, Dutch and other central banks to absorb massive overnight losses. The global depression then to took another lurch downward.

But central bankers tamper with free market interest rates only at their peril—-so the domestic malinvestments and deformations which flowed from the monetary machinations of Bubbles Ben 1.0 were also monumental.

Owing to the splendid tax-cuts and budgetary surpluses of Secretary Andrew Mellon, the American economy was flush with cash, and due to the gold inflows from Europe the US banking system was extraordinarily liquid. The last thing that was needed in Roaring Twenties America was the cheap interest rates—-at 3 percent and under—that resulted from Strong’s meddling in the money markets.

At length, Strong’s ultra-low interest rates did cause credit growth to explode, but it did not end-up funding new steel mills or auto assembly plants.  Instead, the Fed’s cheap debt flooded into the Wall Street call money market where it fueled that greatest margin debt driven stock market bubble the world had ever seen. By 1929, margin debt on Wall Street had soared to 12 percent of GDP or the equivalent of $2 trillion in today’s economy.

As is well known, much economic carnage resulted from the Great Crash of 1929. But what is less well understood is that the great stock market bubble also spawned a parallel boom in foreign bonds—-specie of Wall Street paper that soon proved to be the sub-prime of its day.

Indeed, Bubbles Ben 1.0 triggered a veritable cascade of speculative borrowing that soon spread to the far corners of the globe, including places like municipality of Rio de Janeiro, the Kingdom of Denmark and the free city of Danzig, among countless others.

This is an excellent addition to both military and financial history. Be sure to read the whole thing; it’s close 10k words, but it is definitely worth the time and effort. This, in particular, is a key observation that underlines the falsity of the Keynesian narrative: “The Keynesians have never acknowledged the single most salient statistic about the war debt: namely, that the debt burden actually fell during the war, with the ratio of total credit market debt to GDP declining from 210 percent in 1938 to 190 percent at the 1945 peak!”

I’d noticed this myself in looking at total credit market debt, but never thought through the implications as Stockman has. One can even see it in the relevant chart posted in RGD.