Blest paper credit. Last and best supply
To lend corruption lighter wings to fly
Greenspan is not learning from history
Gerard Jackson
BrookesNews.Com
Monday 8 March 2004
brookesnews.com
Some might consider the title of this article unfair to Greenspan on the grounds that when it comes to economics few people rarely learn from history. Unfortunately, the same can also be said of most economists. Even though the IT boom collapsed, along with a lot of balance sheets and personal bank accounts, and manufacturing tanked badly the lesson has still not been learnt, especially in the media.
So what is the lesson? Quite simply, there's no such thing as a free lunch. For years I warned that the Fed's criminally loose monetary policy had generated a boom whose consequences were inevitable. From the beginning of 1998 to the end of 2000 M3 grew by 30 per cent while money market fund assets exploded by $US800 billion, suggesting that vast amounts of new money were finding their way into this market.
Commercial paper held by these funds leapt by 21 per cent in 2000, adding weight to the monetary thesis that a loose money policy was inflating these funds' assets. The thesis was strengthened by monetary figures showing that M3 rocked by $105 billion in December 2000. Despite this monetary growth Greenspan was still unable to avert a recession.
In the 1800s (I don't mean 1890s either) David Ricardo was arguing that booms and busts were caused by excess credit, i.e., credit expansion. Although he used an aggregate approach rather than a microeconomic one his analysis was a considerable breakthrough and one that the Austrian school elaborated on nearly a hundred years later.
(See Richard Cantillon's brilliant Essay on the Nature of Commerce in General. Although it was published around 1730 it is still a remarkable work and the first to detail the microeconomic consequences of inflation).
Unfortunately Ricardo's economic analysis showing that excess credit was the root of the problem was buried by Keynesianism, aided and abetted by John Stuart Mill's propagation of a mutated version of the Ricardian analysis.
On more than one occasion I've drawn readers' attention to Britain's railway mania of the 1840s that culminated in a very nasty depression when the boom collapsed. This was a striking episode in British economic history that exhibited the kinds of speculative activities, accounting shenanigans and hopeless optimism that marked the nineties hi-tech boom.
The characteristics that these booms shared are not coincidental. Just as the money supply exploded under Greenspan in the 1990s, it also exploded under the monetary rule of the Bank of England in the 1840s. The Bank lowered its discount rate from 4 per cent to 2.5 per cent. The result was predictable.
From the end of 1844 to about February 1946 its discounts rose from about £2 million to over £13 million pounds while bank credit jumped from $22 million to nearly £36 million. What we have here is a massive credit expansion in which discounts rocked by about 464 per cent and bank credits by 64 per cent, even though there was only a modest increase in the note issue thanks to Peel’s 1844 Bank Act.
(Unfortunately, by accepting the currency school error of denying that checking accounts are money Peel inadvertently allowed the Bank of England to circumvent the Act).
Now where did a most of this money go? Into hi-tech speculation, i.e, railway investment. More than £180 million were poured into railway schemes in 1845 and 1846, about twice the investment of the previous 10 years. By September 1847 it was all over.
Almost as if it were describing the 1990s The Economist painted a grim and accurate picture of the boom, contemptuously referring to "the folly, the avarice, the insufferable arrogance, the headlong, desperate, and unprincipled gambling and jobbing, which disgraced nobility and aristocracy, polluted senators and senate houses, contaminated merchants, manufacturers, and traders of all kinds, and threw a chilling blight for a time over honest plod and fair industry."
Notice how The Economist described the inflationary spirit that "contaminated merchants, manufacturers, and traders of all kinds." Well, this brings us to Enron. The behaviour of the executives of this company, not to mention a certain accounting firm, is really the remnants of that speculative fever and "insufferable arrogance" that plagued the 1990s.
That monetary booms are corrosive of morals and ethical behaviour is a sad fact that has been commented on innumerable times. The late Lionel Robbins, a British economist, lamented that booms create "a favourable atmosphere for the fraudulent operations of sharks and swindlers. The big frauds almost all have been perpetrated on a rising market." Robbins emphasised his point with a quote from Pope:
Blest paper credit. Last and best supply
To lend corruption lighter wings to fly
The nineties boom is over and the lesson has still not been learnt. Evan as I write Greenspan's monetary policy is laying the foundations for another recession and everything that goes with it. And as always, capitalism will get the blame.
Gerard Jackson is Brookes' economics editor |
