The Fed to the rescue? Don't bank on it
Friday, October 3, 2008
NEIL REYNOLDS
Reynolds.globe@gmail.com
OTTAWA -- The Panic of 1907 remains famous primarily as the credit crunch crisis that legendary financier J. Pierpont Morgan solved by himself. He locked New York's most important bankers in his library on East Thirty-Sixth Street and held them prisoner until they agreed to put up the cash needed to restore confidence in the markets. It was also the panic that (seven years later) produced the U.S. Federal Reserve. Now, a century later, in the midst of another panic, the reason it produced the Fed appears elusive. At the time, the progressive politicians insisted that the U.S. could avert future crises provided it had a government-directed supreme bank.
The Panic of 1907 hit in the autumn and lasted for only three or four weeks, though the economy remained in recession for five more months. The Dow had peaked earlier, in January, 1906 (at 103), had drifted downward through March, 1907 (when it hit 75), had collapsed in October and November (falling to 53 on Nov. 22). The pessimism turned to panic on Oct. 17 when banker Augustus Heinze and his brother, Otto, tried to corner the market on copper. They failed. In a single day of trading, they went bankrupt, taking their own New York bank with them - and setting off runs on trust companies and banks.
Morgan's decisive intervention came on the weekend of Nov. 2-3 when he confined the terrified bankers for three days - releasing them finally at 4:45 a.m. on Nov. 4 when they finally signed pledges to provide $25-million (U.S.) in emergency cash, matching the $25-million that he himself had pledged.
No one expected the government to solve the Panic of 1907. It didn't try. For his part, President Theodore Roosevelt spent the climactic week on a hunting trip in Louisiana. Yet this panic would be the last financial crisis left to Wall Street to handle on its own. In the next financial crisis, in 1914, Treasury Secretary William McAdoo simply ordered the New York Stock Exchange to close down - for four months.
In his 2007 book When Washington Shut Down Wall Street, author William L. Silber dismisses the populist theory that the exchange shut itself down to prevent share prices from collapsing. Rather, he says, McAdoo intervened to prevent the British and the French from selling their shares in U.S. companies, converting the proceeds into gold and shipping the treasure back to Europe to finance the First World War. Mr. Silber, a professor of finance and economics at New York University, argues that McAdoo, by hoarding gold, bought time for the Federal Reserve to invent itself - it opened its doors early in 1914 - thus ensuring the survival (and the supremacy) of the U.S. dollar.
Almost a century later, the relevant question is this: Are we better off now - in terms of financial market stability - than we were a hundred years ago?
There are plenty of authoritative people who think that government intervention and the Fed have made things worse. The Panic of 1907 buttresses their case - especially when compared with the Panic of 2008. In the first of these crises, one financier whipped the principal bankers into shape in a matter of days. In the second, the U.S. government - the White House, Congress and a dozen regulatory agencies, all looking inept - needed to write hundreds of pages of emergency legislation before the government could take any decisive action.
Nobel Prize economist Milton Friedman was explicit in his judgment.
"The severity of each of the major contractions - 1920-21, 1929-33, 1937-39 - is directly attributable to acts of commissions and omission by the Federal Reserve authorities and would not have occurred under earlier monetary and banking arrangements," he said. "The stock of money, prices and output was decidedly more unstable after the establishment of the Federal Reserve than before."
Aside from panics, there's also the equally important issue of a sound dollar. Are we better off now - in terms of a sound currency - than we were a century ago?
Investment broker Hunter Lewis observes that U.S. consumer prices fell more often than they increased in the 50-year period between the Civil War and the First World War - ending almost precisely where they started.
"This was a time of excellent economic growth and employment growth and provided some of the best stock market returns," Mr. Lewis notes in his ideologically neutral book, Are The Rich Necessary? "All in all, during the first 90 years of the Fed, the U.S. dollar has lost 95 per cent of its purchasing power."
Former Fed chairman Paul Volcker, himself famous for wrestling inflation to the ground in the early 1980s, agrees: "By and large, if the objective is price stability, we did a better job with the 19th-century gold standard - and even with free banking."
Mr. Volcker made this observation in 2003. It's not likely that he has changed his mind. |
