Treacherous Myopia

Why was the Great Depression so Great? Because the Fed did not implement the policies it has today, argues Ben Bernanke. Below, the great Mogambo tells Mr. Bernanke he needs to get his glasses checked…unless he is purposely avoiding seeing the truth.

Today we come to Federal Reserve Governor Ben Bernanke, who thinks he is smarter than everybody. This arrogance probably comes from the fact that he was the top dog in the economics department of Princeton, where he was molded by years of him being able to run his fat mouth without anybody having the guts to tell him that he was full of crap. Perhaps because he took the wise precaution of assembling his department out of his own coterie of lackeys, hangers-on and yes-men.

I cast these rude aspersions on him because this guy, this Bernanke person, actually said, in a speech entitled "Money, Gold and the Great Depression" to Washington & Lee students a mere two weeks ago, that he thinks that the Depression of 1930’s was the result of having a gold standard! Hahaha! This guy is too much! The Depression was caused by the gold standard! Hahaha!

Let’s let Mr. Bernanke set the scene in Bernanke-world. "Some [have] argued, for example, that overinvestment and overbuilding had taken place during the ebullient 1920s, leading to a crash when the returns on those investments proved to be less than expected." You can tell by the way Bernanke says this that he does not believe that overinvestment and overbuilding are even possible. But when you look at the data, sure enough, there was a lot of rampant speculation and borrowing all through the ’20’s, all facilitated by the Federal Reserve acting like the morons that they are and providing the money with which to engage in that kind of activity.

Ben Bernanke: No Such Thing As Overbuilding

And the Fed, even today, almost eighty years later, still does not believe that there is such a thing as overbuilding or overinvestment, although they DO recognize that there is excess productive capacity everywhere, which is, according to them, NOT overbuilding or overinvestment, but is something else entirely, although they won’t say what it is. And where did all this productive overcapacity come from? Same as today! From the Fed and the miracle of fiat currencies in a fractional banking system run amok!

Then Bernanke goes on to announce, in that "I’m so smart and you’re so stupid" way people have when they belabor the obvious, "Another once-popular theory was that a chronic problem of ‘under-consumption’ – the inability of households to purchase enough goods and services to utilize the economy’s productive capacity – had precipitated the slump." So we are right back to the same ridiculous Fed-speak: the economy was suffering because people weren’t buying enough stuff!

And why didn’t people buy stuff? Hey! Easy one! I figure that this is my big chance to show off how smart I am, so without waiting to be called upon, I happily jump to my feet and announce "For the same reason that ALL people don’t buy things they want: They didn’t have the money!"

And then Bernanke also laments that they didn’t buy things on credit, either. Which the Fed is urging people to do right now, which translates into those old-timers not going into debt when they didn’t have any money, but us new-timers ARE going into debt when we don’t have any money? And the lesson is – and notice how I am all scrunched up over my little desk, pencil poised, ready to write down the pearl of wisdom that is about to be dropped into my lap – that if they had borrowed the money, see, just like people are doing nowadays, then the Great Depression would have been, and notice by the way my voice quivers in anxious anticipation, avoided completely?

Ben Bernanke: Prosperity Through Debt

I swallow – gulp! – and can only manage to say "Wow!" You mean that a big-shot at the Federal Reserve is saying that it IS possible to achieve prosperity, and get out of an impending depression, by going into ever-more debt? You mean, I can buy lotsa neat stuff, and a real nice house, with a big ‘ol wad of equity in the stock market, and a bulging 401(k), and jet-skis, and a second home, and fancy cars, and more, if I keep borrowing until I die? You never have to pay money back?

But Bernanke doesn’t go on to tell you WHY people were not borrowing like mad to buy SUV’s and the like in the late 20’s and all the ’30’s. But I, the MoGu, will give you three, count’ em three, very good reasons why people did not go into crushing debt to buy SUV’s in the late 20’s and all the 1930’s: They didn’t buy them because 1) they didn’t have the money, and 2) SUV’s weren’t invented yet, but even if they HAD been invented, they STILL wouldn’t have had the money to buy them, and 3), they were smarter than we were, and everybody knew back then that you couldn’t have an economy that was predicated on everybody and everything going farther and farther into debt. The whole idea seemed ludicrous. And it is.

Then Bernanke drops what he thinks is some big bombshell or something. "However, in 1963, Milton Friedman and Anna J. Schwartz transformed the debate about the Great Depression. That year saw the publication of their now-classic book, A Monetary History of the United States, 1867-1960. Friedman and Schwartz argued that ‘the [economic] contraction is in fact a tragic testimonial to the importance of monetary forces’ (Friedman and Schwartz, 1963, p. 300)."

This ignores the fact that Friedman himself has subsequently admitted the errors in his strictly monetarist theory. But this does not deter Bernanke one iota. Maybe he ain’t heard the news, or something. So if you personally know Milton Friedman, tell him to call Ben at the Fed, as he is seriously behind in his reading, and would probably appreciate being brought up to date. Obviously nobody at his old alma mater is going to tell him.

Ben Bernanke: Don’t Prick the Asset Bubbles

Bernanke does go on to admit that taxes were raised, but like all good collectivist yahoos, he doesn’t think high taxes have any deleterious effect of economies, so he doesn’t linger there. He goes on to say that the reason things went downhill is that the Fed raised interest rates. He asks: "Why then did the Federal Reserve raise interest rates in 1928? The principal reason was the Fed’s ongoing concern about speculation on Wall Street. Fed policymakers drew a sharp distinction between ‘productive’ (that is, good) and ‘speculative’ (bad) uses of credit, and they were concerned that bank lending to brokers and investors was fueling a speculative wave in the stock market. When the Fed’s attempts to persuade banks not to lend for speculative purposes proved ineffective, Fed officials decided to dissuade lending directly by raising the policy interest rate." Ergo, the current Greenspan-Fed rationale for not trying to prick an asset bubble, but merely dealing with the aftermath.

Now we start getting into the really weird stuff. Bernanke admits that "the gold standard appeared to be highly successful from about 1870 to the beginning of World War I in 1914. During the so-called ‘classical’ gold standard period, international trade and capital flows expanded markedly, and central banks experienced relatively few problems ensuring that their currencies retained their legal value." So it worked well! So something happened, he says, between 1914 and the Depression.

He does not admit, however, that the newly formed Federal Reserve system, in operation for fifteen short years, had anything to do with subsequent calamitous economic events. The simultaneous appearance of these two things were, I suppose, merely a, you know, huge coincidence or something.

He extrapolates to announce: "Perhaps the most fascinating discovery arising from researchers’ broader international focus is that the extent to which a country adhered to the gold standard and the severity of its depression were closely linked. In particular, the longer that a country remained committed to gold, the deeper its depression and the later its recovery." I agree that this is probably true. Economic distress is the downside of the requirements that gold places on an economy, which dictate that you NOT get into an economic mess to start with, because there is no way out. And a gold standard prevents you from doing the excessive monetary expansion thing to get inflation cooking, which is supposed to bail out the debtors. In that regard, thank God for America being on the gold standard, or the Great Depression would have been much worse than it was!

Ben Bernanke: Fire up the Printing Presses!

But – and I guess this is the lesson to be learned, according to Bernanke – countries wherein you could just fire up the printing presses must have gone on to achieve lasting prosperity, like the Weimar Republic in Germany or something. Hahahaha!

Then Bernanke asks the Big Question: "What caused the Depression?" Well, he figures that it is deflation, which is confusing cause and effect. "Deflation, like inflation, tends to be closely linked to changes in the national money supply. While the fact that money, prices, and output all declined rapidly in the early years of the Depression is undeniable, the interpretation of that fact has been the subject of much controversy." Not to me, it hasn’t.

Then he gets back to the discredited monetarist approach. "Friedman and Schwartz emphasized at least four major errors by U.S. monetary policymakers. The Fed’s first grave mistake, in their view, was the tightening of monetary policy that began in the spring of 1928 and continued until the stock market crash of October 1929 (see Hamilton, 1987, or Bernanke, 2002a, for further discussion)." Note how he uses himself as a reference!

"The gist of the Friedman and Schwartz argument is that, for a variety of reasons, monetary policy was unnecessarily tight, both before the Depression began and during its most dramatic downward phase. Friedman and Schwartz concluded therefore that they had found the smoking gun, evidence that much of the severity of the Great Depression could be attributed to monetary forces."

This flies in the face of an article by Frank Shostak entitled, "Does a Falling Money Stock Cause Economic Depression?" who writes, "However, a close examination of the historical data shows that contrary to Friedman, the Fed was extremely loose and pumped reserves into the system in its attempt to revive the economy (on this see Murray Rothbard’s ‘America’s Great Depression’). The extent of monetary injections is depicted by changes in the Fed’s holdings of U.S. government securities. Thus on January 1930 these holdings stood at $485 million. By December 1933 they had jumped to $2,432 million – an increase of 401%. Moreover, the average yearly rate of monetary injections by the Fed during this period stood at 98%."

So the Fed was NOT stingy in pumping up the money stock, as alleged by Bernanke. Mr. Shostak goes on to say, as I go on to say, as all thinking people go on to say, that earlier Fed excesses were, in fact, responsible for the Great Depression. "In addition to this, at some stages monetary injections were massive. For instance, the yearly rate of growth of government securities holdings by the Fed jumped from 19.7% in April 1924 to 608% by November 1924." In half a year!

This bit of evidence garners support for the brilliant Austrian school of economics insight that, as Mr. Shostak puts it, "Contrary to popular thinking, depressions are not caused by tight monetary policies, but are rather the result of previous loose monetary policies."

Ben Bernanke: Goosing up Money and Credit

In this case, the damnable Fed had spent the entire 20’s goosing up money and credit at a breathtaking pace that was unheralded in American history. A fact ignored by Mr. Bernanke, who wants us to focus on the RESPONSE to the crash and depression, NOT what caused it. And why is he so myopic about that? Because that is what he is doing right now! He goosing up money and credit, just like in the 20’s! This very minute!

Bernanke, however, goes on to give us more evidence of his profound ignorance: "The finding that leaving the gold standard was the key to recovery from the Great Depression was certainly confirmed by the U.S. experience. One of the first actions of President Roosevelt was to eliminate the constraint on U.S. monetary policy created by the gold standard, first by allowing the dollar to float and then by resetting its value at a significantly lower level." In other words, he says devaluing the currency, hopefully not to worthlessness, but just this side of worthlessness, is a "good" thing!

So Robert Rubin and all the other Treasury Secretaries up till now were wrong when they professed a desire for a strong dollar, that was supposed to be "in the best interests of America"? Get Rubin on the phone! I’ll bet he wants to hear this!

Currency devaluation might have been thinkable in 1930…but then again, we did not have a current account balance that is today, even as we speak, over $541 billion a year! 5% of GDP! A devalued currency is NEVER a good thing to a nation that imports things. It is a BAD thing to have a devalued currency if you are a nation that imports things. We import a lot of things.

By this time Japan, which has been following this ridiculous Bernanke policy prescription for fourteen years in a row, should be roaring. It is not. Bernanke does not explain why. And, in a similar vein, the United States economy should be roaring along, too, given the record-setting levels of monetary and fiscal stimulus that have been pounded into the economy, especially for the last three years. Three years!

Likewise, the U.S. economy is not roaring at all. The lessons Bernanke "learned" from the Great Depression have not resulted in his leading us into greener pastures along with his fellow partner in crime, Greenspan. Instead, we are sinking farther and farther into the stinking swamp that is shown on your maps as the area with the skull-and-crossbones, labeled "Kiss your debt-besotted butts goodbye."


The Mogambo Guru
for The Daily Reckoning
March 15, 2004

Mogambo Sez: In a nutshell, hopefully figuratively and not literally, we are going to be economically killed, and we are going to be killed because we are stupid, and we deserve to die. History is very cruel to stupid countries full of stupid people doing stupid things.

Editor’s note: Richard Daughty is general partner and C.O.O. for Smith Consultant Group, serving the financial and medical communities, and the editor of the Mogambo Guru  economic newsletter, an avocational exercise the better to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning, and other fine publications. If you’re inclined to read more, you’ll find the whole Mogambo here:

In the Temple of the American Way

The Dow lost 467 points in 4 days last week…then, in the final day of the week, rebounded 111 points. This is not the first time we’ve said so, and may not be the last…but, now, we think the top is in for the Great Bear Market Rally of 2002-2004. Mr. Bear is back…almost exactly 4 years after he began mauling the Nasdaq in mid-March 2002.

Why should stock prices fall? Two reasons, one emotional and one rational. Remember, people buy stocks at the beginning of a bull market for the right reasons – because stocks are cheap. At the end of the bull market, they buy them for the wrong reasons – because ‘everyone knows you can make a lot of money by buying stocks.’ But what ‘everyone knows’ is based on recent history. At the top of a bull market, investors do not recall that, when it started, everyone knew that you couldn’t make any money buying stocks. It is only after a long period of rising prices that people come to believe you can make money by buying stocks…no matter how pricey they’ve become.

On the left side of the brain, investors calculate how much they can make from a stock and measure that against how much they might lose. When stocks are very expensive, as they are now…the figures don’t look good. It would take years of spectacular growth in sales and profits to justify today’s prices. Where would this growth come from, the rational mind might ask?

Last week, a Seattle paper tells us that adjustable rate mortgages hit a new record low at 3.41%. Americans and their government are already spending far more than they can afford…and borrowing it at the lowest interest rates in half a century. What tinder is left to fire up a spending boom? Real incomes are flat or falling. Good jobs are hard to find. How will Americans find additional purchasing power?

Over on the right side of the brain, clouds are gathering. No particular reason for it…except that that is what happens after a long, happy period. Some contrary instinct…some malign impulse…draws us to doom. Maybe, after 20 years of sunshine, it just has to rain. Things have been too good for too long. Maybe the organs that produce optimistic juices are exhausted. Maybe we have brought it on ourselves, borrowing from tomorrow’s contentment for so long…when the time comes, there is none left.

We don’t know how it works. But there’s no reason for the same dollar’s worth of earnings to be worth $5 one year and $30 two decades later – except that the right side of the brain puts a different spin on it. The brain turns things around and around…and doesn’t stop until we’re so dizzy we fall down.

That is what happened in March of 2000. The Nasdaq collapsed and the Dow tumbled. Since then, people have tried to ‘recover.’ Propped up by artificially low interest rates, tax cuts, and public spending…they’ve managed to stand on two feet and totter along for the last 18 months. But now the right side of the brain has begun spinning the news in the opposite direction. A dervish of negativity has started to swirl. And it is not likely to stop…until…sometime in the far, gloomy future…stocks once again trade for 5 times earnings…and you can buy the entire Dow for little more than a single ounce of gold.

But while we’re waiting…here’s Addison with more news:


Addison Wiggin writing in Paris…

– "You know…Bush, Bin Laden…they play their games," our fellow passenger began, obviously eager to make a comment, "but it is the civilians who must pay the price."

– The subject, of course, was the bombings last week in Madrid. The scene? We were making our way back to Paris from Charles de Gaulle airport by train. The French security officials didn’t want the trains near the airport, so they herded us into a bus and shipped us out into the banlieue – the less-than-scenic suburbs of the City of Light – where we later met up with the commuter train. The train was then held up at two more stations for fear of ‘suspicious packages.’ Châtelet, the largest train station in the network, was a surreal wasteland as we trundled through. The usual gaggle of commuters in business suits and bums in beer-stained rags was replaced by a solitary team of police dogs…

– "Spanish, Palestinians, Israelis…it doesn’t matter. Most people could care less about the politics; they want to work and raise their families. But now they die. And those of us who are left live in fear." Well, we weren’t going to argue with him. But neither did his angst seem to warrant any further comment. So we just smiled…and said "bon courage" as we left.

– It’s a cold world, dear reader. And like a campaigning politician, Mr. Market appears to pay no heed. The Dow rallied 112 points on Friday to 10,240; an "especially heartening" rally given the circumstances. But, it lost 355 points for the week, revealing among other things how little the skirmishes in the Forever War affect the markets. Thursday’s sell-off of 168 points was but a part of a larger reversal, namely, the end of Great Reflation rally of 2003. The blasts in Madrid merely mopped up the remainder of any gains the indexes had seen 2004.

– "The market is extremely sensitive," a trader in Boston told USAToday, "and these stories can ruin your day in a hurry." "I think we’re probably in for a bumpy road," said another analyst. The Nasdaq and S&P each tacked on small gains Friday, but ended the week down over 3% a piece.

– The "bumpy road" in the markets is just what the Fed will be trying to ignore when the FOMC meets tomorrow. Since January, Greenspan has been gloating that the Fed’s strategy to treat the ‘symptoms’ of the bubble and not the bubble directly is a success. [Then again, see Mogambo’s critique, below…] Of course, as we’ve pointed out so many times we’ve even begun to annoy the proprietors of the patisserie downstairs, the one symptom the Fed is completely impotent to do anything about is: jobs.

– Despite all the back-slapping at the Fed, less Americans who want to work are doing so than have in a decade. ‘Offshoring,’ of course, gets all the blame. In an election year, it’s easy to point fingers. But as our friend John Mauldin points out, of 2.7 million jobs lost since the recession ended, only 300,000 have gone to employers overseas. That’s only 11%. The other 89% have been lost to the ‘structural’ shift of an economy almost entirely dependant on consumer spending…and increases in Greenspan’s vaunted ‘productivity miracle.’

– Still, a quick review of today’s headlines is all you need to see where the NEW jobs are being created – at wages for which Americans wouldn’t even allow their dogs to work. "China’s growth spurs demand for oil," says the Financial Times. "China’s economic engine needs power," reports the New York Times. "China’s need for metal keeps U.S. scrap dealers scrounging," says the Times again. For some .61 cents an hour, these raw materials are getting processed into goods routinely shipped to a Wally World near you. Then…apparently…when you’re finished with them…back they go to China.

– In a sign of the times, last year China became the first country ever to import more than a $1 billion of scrap. Demand for scrap steel is so high, the price has soared to more than $300 per ton, compared with $156 three months ago and $77 a year before that. Overall, exports of steel scrap have doubled since 2000 to nearly 12 million tons. China imports nearly 30% of the total.

– "We send everything to China," one scrap dealer told the NYTimes. "They will use chisels, hammers, hand tools and whatever to break it apart and sort it out." Then what happens? Well, the cycle continues. "The faucets from China are coming into the United States at less than the metal value that we would have to pay," laments Joe Mayer, president of the Copper and Brass Fabricators Council.

– We can’t help but wonder. Is there any phrase the Fed can change in their press release tomorrow that will effectively stem the flow of production to China? Right now, investors are only to happy to use their all-but-free money to speculate on overpriced stocks and particle-board houses.

– Meanwhile, the Chinese are even refining the nation’s garbage into products destined once again for the never-sated yaw at the pit of the its consumerist belly…


Bill Bonner, back in Paris..

*** The Labor Department says the number of people with college degrees who have been out of work 6 months or more has risen 300% (the report we read did not say over what period of time). American firms are hiring…but not in the U.S. IBM is hiring in Calcutta, but not in White Plains. GM is hiring in Bangalore, but not in Detroit. What’s a man to do?

Robert Dunn, a 55-year-old American information technology specialist, is looking for work – in India. According to the CNN report, more and more Americans are following their jobs overseas. Indian firms find Americans very useful for managing relations with their U.S. customers.

*** Gold is stuck around $400. It went down last week to $395. It could, of course, be an entirely new era in human history…in which people have figured out how to successfully manage paper currencies, credit risk, and inflation. Now, a man can buy a derivative contract on almost anything. He can protect himself against the decline of the dollar…the collapse of the bond market…a rise in the price of oil – almost anything – without burying gold coins in his back yard.

But what protection has he that the man on the other side of the transaction will be able to pay up? The total of derivative contracts is thought to be as much as $70 to $100 trillion. The total value of all America’s stocks and real estate is only about $50 trillion. What would happen to all this ‘wealth’ in a real crisis? In the last Great Depression, more than 10,000 banks in the U.S. went belly-up. Today’s ‘banks’ are the institutions offering mutual funds and mortgage-backed derivatives. How many of them will survive?

*** Everyone believes the dollar has further to fall. This consensus opinion disturbed us for a while. For, it seemed to us that the dollar would fall, too. Yet, we knew that things everyone expects rarely come to pass.

But then, "it’s not real bearishness on the dollar," colleague Dan Denning explained. "People are just fashionably bearish. They say the dollar is going down…but they don’t really believe it."

What has been even more remarkable than the near-universal agreement that the dollar was headed down was the near-universal complacency about it. Most people even think it will be good for the U.S. economy. There, we think, is where the consensus will be wrong. The dollar will not surprise people by going down. It will surprise people by falling on their heads. Economists will rub their noggins and say they expected it. But it will crush the life out of stocks and bonds.

*** This, from South African correspondent, Evan Pickworth:

"For 2,630 years, gold was used as money. A recent decision by Durban Roodepoort Deep could see gold returning as a medium of exchange, albeit in a non-conventional sense. Let me explain…

"It’s events like 9/11 and the weakening in the U.S. dollar and the rising deficit in the U.S., and the recent massive drop in employment outlooks, that highlight just why people will be buying gold for another 2,630 years.

"Individuals are realizing they would rather own real money than depreciating paper issued by bankrupt governments.

"Individuals are becoming increasingly disgruntled with the huge inflationary pressures they’ve faced ever since Reserve Banks and governments started printing worthless paper money.

"You see, the endlessly increasing money supply (inflation) we have experienced in modern times decreases the purchasing power of money. Consumer prices that had risen a meager 13% in 114 years since the founding of America, soared 1,500% in the ensuing 90 years!

"The mastermind behind the printing of paper money is the Federal Reserve. This institution was born in 1913 with purely this devious purpose in mind and since then bankers have never run short of lendable funds. In return, the politicians were granted access to an unending supply of loans.

"But now Durban Deep has set the chain in motion for us to be able to buy things like groceries with our gold holdings, and hopefully be freed from the chains of depreciating paper money. They bought a 1.4% strategic stake in U.S.-based gold marketing website,

"The aim is to enable investors to be able to walk up to a teller and hand over their gold cards with payment being effected directly from their gold accounts, which reflects the amount of gold you hold. It will simply work like a debit card.

"It will become a very real way of storing your wealth in the future (the debit card facility is not available yet but is expected to be soon)."

The Daily Reckoning