Many people draw parallels between
today and the 1930s, labeling the present-day
state of affairs the Great Recession. They note
the high unemployment rate, referring not to the
mismeasured, official statistic, but to the number
more than double that rate, which also accounts
for those who have dropped out from the labor
force and are no longer counted as "unemployed".
Others worry about the deflationary risk,
dollar devaluation, and the status of the US
dollar as a reserve currency. Still others worry
that the "vital few" - those with high scientific
aptitudes and entrepreneurial drive - no longer
come to or stay in the United States, but stay in
or go back to the many countries whose Iron
Curtains have been rent apart since 1989.
Yet the most worrying parallel with the
1930s is one that is not
discussed. Then, as
today, societies were uncertain about the model of
society they should strive for and about how to
repair domestic and international monetary systems
after wildly varying expansions of credit during
and after World War I in different countries. In
addressing these two questions, societies ended up
betting on the wrong ideas, which had long-term,
disastrous consequences. We may be committing
similar mistakes now.
Recall the 1920s and
1930s: Germany, Hungary, Austria, and Italy all
destroyed their middle classes and financial
markets with hyperinflation - a destruction that
has always been a recipe for both political
instability and predictable centralization of
power. After all, once financial markets are
destroyed, even if inadvertently, governments and
central banks become financial intermediaries - by
default.
It happened in Austria, which -
following the large credit expansion during and
after World War I, and later the collapse of its
largest deposit bank, Credit Anstalt - injected
funds, though the problem was not liquidity but
solvency. While this happened, Austria first kept
the schilling linked to gold, though investors
realized that this could not be for long. As
capital flight continued, the government first
imposed exchange controls, but eventually delinked
the schilling from gold in 1931.
Austria's
experiment precipitated the United Kingdom's own
exit from the gold standard in that same year,
after it mistakenly relinked the pound to gold at
the pre-World War I level in 1925 - in spite of
the high inflation the United Kingdom experienced
during the war - resulting in predictable
deflation and unemployment.
As in the
1920s and 1930s, remedies are thus thought to be
not in repairing the mistakes and making sure that
the unguarded expansions of credit won't be
repeated anytime soon, but in governments and
central banks getting into the voids left in
capital markets.
France learned from the
United Kingdom's 1925 mistake. When Raymond
Poincare became French premier in 1926, he
commissioned Jacques Rueff to determine the level
at which the French franc should be stabilized.
Though Poincare thought initially to return to the
prewar gold parity of the currency, as the United
Kingdom had done, Charles Rist and Pierre Quesnay,
the deputy governors of the Bank of France,
persuaded him not to.
France relinked to
gold by fixing the franc at only one-fifth the
pre-World War I parity. Rueff chose this level to
be on the safe side and prevent deflation and
unemployment, at the risk of pricing the franc low
relative to gold. Emile Moreau, the governor of
the bank, approved. The franc was stabilized,
capital flowed back to France, credit expanded,
and the economy boomed without inflation or
unemployment, though France's "competitive
devaluation" - France and the United Kingdom were
competing powers - quickly destabilized the brief
international monetary calm.
Perhaps if
Benjamin Strong, chairman of the Federal Reserve
at the time, had lived a bit longer, he might have
managed to sustain order. But he died in 1928, and
the short-lived international cooperation he
engineered in the inter-war years fell apart. From
then on, the mazes of monetary and political
errors compounded rapidly around the world, ending
in Europe's devastating political bets that led to
World War II.
This is the similarity with
the 1930s, and the far bigger danger the world
faces today than the aforementioned, superficial,
acknowledged ones, which draw on macroeconomics -
today's astrology. Now, as then, the fact that
grave monetary mistakes and lack of international
collaboration to stabilize exchange rates have
drastic political implications appears to be out
of most sights and minds. Yet the links are
straightforward.
Prosperity is the result
of matching talents with capital, holding all
parties accountable: the talent, the capital, and
the matchmakers. This is easy to say, but hard to
realize - building and sustaining the maze of
institutions to keep the matchmakers responsible,
in particular.
After all, societies have
five sources of capital: inheritance/resources;
savings; access to financial markets; government;
and, last but not least, "crime", through military
power in particular, the use of such power being
rationalized by various ideas.
During the
1920s and 1930s, the series of monetary blunders
and lack of international cooperation decimated
people's savings and the Versailles Treaty kept
resources captive. These factors combined caused
the weakening or the destruction of capital
markets and international trade. Banks failed,
markets crashed, unemployment rose, the middle
classes lost their anchors, and the 1930s saw a
series of devaluations and introduction of tariff
policies, Smoot-Hawley being one of them.
Without dispersion of powers - which only
deeper, independent sources of capital can create
- votes and beautifully written constitutions have
little if any meaning.
The first three
sources of capital thus evaporated. People turned
to the two remaining "institutions" for accessing
capital: government and "crime" - in a far broader
sense of the word. People need comforting
rationalizations for such new trends, and
"intellectuals" are never late offering them.
Words are cheap; "intellectuals" produce them
promptly, as they easily rehash ideas sitting on
shelves.
Predictably, the 1920s and 1930s
saw socialism and communism rationalizing
governments' expanded roles in some countries. In
others, theories about public works and,
eventually, the Keynesian - bombastically titled
"general" - framework became popular,
rationalizing the permanent increases in
governments' roles in raising and allocating
capital.
At the same time, "crime" took
ominous "national and racist" meanings in some
countries - Germany was the most prominent - with
the new theories "justifying" confiscation of
capital, be it from "foreigners" or groups made
"foreigners" by novel theorizing. Neither the new
rationalizations of Greece's Golden Dawn party,
the Catalans' and Scots' wishes to secede, nor the
many other parties emerging across Europe along
its older "tribal" lines should come as a
surprise: it has all happened before - although it
might come as a surprise to link them to grave
monetary mistakes, drastic expansions of credit,
and lack of international cooperation.
Intellectuals have always been good at
turning real issues into so-called moral ones with
religious, racist, and nationalist undertones,
rationalizing immediate access to capital and its
confiscation with new jargons. In the 1930s, these
were "tribal" jargons. In earlier times, they were
religious ones. In 1576, when conquering Antwerp,
Spanish troops forced the Augsburg house of Fugger
to advance a "loan" of 8 million Rhenish gulden
(about US$500 million to $800 million today,
though such comparisons are tenuous). This Spanish
paper was never paid back - the King of Spain had
no intention to repay it to start with. By 1598,
the king gave the highly placed priesthood the
role "to deal" with it. The king thought that only
the priesthood could rationalize and put a moral
stamp on lack of repayment by using theological
arguments.
What about today? The main
jargon rationalizing not paying back debts draws
on the vocabulary of "victimhood" that is
rationalized in a variety of ways, particularly on
economic jargons. Not much new under the sun -
except the languages that help disguise what we
are talking about.
The mazes of monetary
and political errors compounded rapidly around the
world, ending in Europe's devastating political
bets that led to World War II.
According
to this view of the world, unstable capital
markets are the problem, due to loss of
accountability and sudden, unjustified bursts of
optimism and pessimism. The view that grave
regulatory and monetary policy mistakes, as well
as increased government spending with no guards to
guard the public guardians, bring about loss of
accountability too, seems to be now out of many
sights and minds.
As in the 1920s and
1930s, remedies are thus thought to be not in
repairing the mistakes and making sure that the
unguarded expansions of credit won't be repeated
anytime soon, but in governments and central banks
getting into the voids left in capital markets -
though without attempting to stabilize exchange
rates. Yet their instability was then - as it is
now - a major source of preventing the world from
regaining its footing.
For Western
countries with still-deep capital markets,
stabilizing exchange rates does not seem a
priority at present, as the hundreds of trillions
of derivatives mitigate the rates' destabilizing
impact. But for the rest of the world, as their
capital markets are in their infancy, the
instability prevents them from developing.
Unless this trend is reversed - and
international cooperation to stabilize exchange
rates takes priority - the image of a model of
society worthy of emulation will get further
blurred. The thinner capital markets, the less
they are democratized. As cash flows through
governments' bureaucracies - by default the
prevailing financial intermediary - this leads to
or perpetuates inevitable centralization.
Without dispersion of powers - which only
deeper, independent sources of capital can create
- votes and beautifully written constitutions have
little if any meaning. Bureaucracies end up
matching talent and capital, and power stays
concentrated, votes notwithstanding.
Centralization of powers and the thinning
of capital markets are the most dangerous
parallels to the 1930s. What model of society will
people bet on as these trends continue, and Europe
and the United States get into mazes of error? The
1920s and 1930s offer warnings.
Reuven Brenner holds the Repap
Chair at McGill University's Desautels Faculty of
Management. The article draws on his book, The
Force of Finance and History: The Human Gamble,
and is part of a speech the author delivered on
October 30, titled "Repairing a Broken World".
First published by The American,
the online magazine of the American Enterprise
Institute. Republished with
permission.
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