Saturday, April 29, 2006

Finally: Rebalancing Legitimized!

Rebalancing Legitimized!

Time For A New Global Architecture

by Stephen Roach (Hong Kong)

At long last, global rebalancing is center stage in the world policy theater. That’s an important conclusion to take out of the results of April’s power councils — the G-7 meeting as well as the annual gathering of the full complement of some 184 members of the IMF. This is good news for an unbalanced world. It is not, however, the silver bullet for dealing with a very tough problem. The road to global rebalancing is likely to be long and arduous, and the new approach still has some problems. But as someone who has led the charge in worrying about the pitfalls of an unbalanced world, I am delighted that the Wise Men have finally seen the light.

Policy makers have always communicated in strange and almost ritualistic ways. That’s true at the national as well as at the global level. Statements typically are steeped in jargon and opaque phraseology. Nuanced language allows for multiple interpretations — providing the cover, or hedge, if things go awry. All those caveats aside, there can be no mistaking a very important message sent on 21 April by the G-7 finance ministers and central bank governors after their recent meeting in Washington: Global imbalances have now been officially anointed as a major concern by the stewards of globalization. Not only were they given prominent mention in the official G-7 communiqué, but they were also the focus of a rare “annex” to the statement. In G-7 circles, that’s about as loud as an alarm ever gets.

The annex lays out three basic principles that shape the G-7’s approach to global rebalancing: One, it is a shared responsibility — an obvious but very important statement that readers of my work will also recognize. It is policy jargon for saying “no” to scapegoatting — pinning the blame unfairly on a nation like China. Two, rebalancing requires, first and foremost, a realignment of global saving and investment flows; this identifies disparities between current account surpluses and deficits as the major source of global instability — again, quite consistent with my own thinking and clearly putting the US, with its world record current account deficit, at the top of the problem list. Three, the G-7 annex stresses that rebalancing strategies must be designed with an aim toward maximizing sustained economic growth; in my view, that’s the weakest element of the G-7’s proposed strategy. While rapid growth is an understandable goal, its emphasis may obscure the heavy lifting that will ultimately be required of an effective global rebalancing strategy.

This latter point deserves elaboration. Economic growth has become the elixir of political angst — the perceived remedy for all that ails a nation’s economy. Pro-growth politicians win elections — and re-elections — while the anti-growth set is doomed to a quick oblivion. Growth has become such an important part of the policy rubric that it has spawned its own theoretical framework — supply-side economics. A broad array of pro-growth policies — especially tax cutting — has come into fashion as the rising tide that lifts all boats. Supply-siders believe that self-financing budget deficits, narrowing income inequalities, and surging productivity are all part of the growth miracle. Never mind America’s gaping budget deficit and the recent widening of disparities in the US income distribution — the pro-growth principles of supply-side economics have taken on almost a religious fervor in Washington and on Wall Street.

America’s current account deficit — the world’s most serious imbalance — is, first and foremost, an excess consumption problem. I make that statement on the basis of three facts: One, tradable goods imports by the US are currently 89% larger than its exports of tradables. That means exports now have to grow twice as rapidly as imports just to hold the US trade deficit constant. Two, import penetration has reached very high levels in America; tradable goods imports now account for a record 37% of US expenditures on goods. That means that the faster US domestic demand grows, the faster imports will grow — implying that faster growth begets an ever-widening US trade deficit and ever-mounting global imbalances. Three, US consumption is currently holding at a record 71% of US GDP — a huge breakout from the 25-year average of 67% that prevailed over the 1975 to 2000 period. These three points imply that it will be extremely difficult for the US to accept its role in the shared responsibility of global rebalancing without coming to grips with its excess consumption problem. And that, I’m afraid, could well spell slower economic growth in America. Such a conclusion not only flies in the face of the pro-growth principles of the G-7’s newly-articulated rebalancing strategy, but it is also very much at odds with the supply-side policy biases that currently dominate the Washington consensus.

I don’t want to come across as too negative in assessing the implications of the G-7’s epiphany. As an unabashed champion of the imperatives of global rebalancing for longer than I care to remember, I believe the 21 April communiqué was something close to an historical breakthrough. Moreover, it was followed by an equally impressive effort from the IMF at its companion annual meeting — an endorsement of the principles of “multi-lateral surveillance and consultation.” This is policy jargon for a big change in the modus operandi of the Fund, which has long conducted its work mainly on the basis of single-country missions and consultations. By taking its functionality to the multi-lateral level, the IMF is accepting the very important task of coming to grips with the “spillovers” across nations that arise from imbalances of trade and capital flows. The surveillance aspect of this task essentially empowers the IMF to sound warnings when multi-lateral imbalances reach dangerous levels — a welcome development for a world that is inclined to ignore such problems until it is too late. The multi-lateral consultation function will undoubtedly be a good deal thornier to execute, since it could conceptually involve arbitrating the costs and benefits of a shift in US fiscal policy versus structural reforms in Europe, weighing in reserve management practices of the oil producers and Asian exporters, and so on. Globalization is not just about integration — it is also about navigating the ever-contentious waters of cross-border structural and policy tradeoffs.

For the IMF, this new role could well be a key to its survival as a relevant global institution. In my view, it is unconscionable that the stewards of globalization could have allowed the world’s imbalances to reach such dangerous proportions. The Fund will now be able to demonstrate if it is up to the challenge of its mandate. The IMF, in effect, has been charged with the execution of the G-7’s newly stated principles of global rebalancing. By accepting this important responsibility, the IMF has the opportunity to provide an unbalanced world with legitimate hope on the road to rebalancing. Success could lay the groundwork for a major breakthrough in the reform of the world’s policy architecture. Failure could spell curtains for the IMF as we know it — portending a painful slip into the obscurity that Governor Mervyn King of the Bank of England has raised as a worrisome possibility (see my 24 April dispatch, “Time for a New Global Architecture”).

There’s one element of this new rebalancing agenda that continues to gnaw at me — the insistence on Chinese currency flexibility as an important element of the global adjustment process. I definitely believe that China has an important role to play in global rebalancing. I also think that China accepts its responsibility to do just that. As I have noted, the newly enacted 11th Five-Year Plan has rebalancing written all over it, as China attempts the Herculean task of shifting the mix of its economic growth from exports and investment to private consumption (see my 24 April 2006 Special Economic Study, “China’s Rebalancing Challenge”). Instead of fixating on the currency as the main lever of rebalancing — and implying that a sharp revaluation of the RMB is needed — the G-7 and the broader global policy councils need to give China credit where credit is due: China is attempting to do something that Japan, Korea, and the rest of the so-called Asian dynamos have utterly failed to do — embracing and delivering on a pro-consumption growth strategy. Success of this plan will turn China into a very positive force in the rebalancing sweepstakes. Conversely, large currency movements — especially for a poor country with a still shaky financial system — borrow a page right out of the script of the “yen blunder” that Japan acceded to in the 1980s (see my 21 April dispatch, “Bad Advice”). Global rebalancing needs enlightened policies from China — not a replay of the painful mistakes that led Japan astray 20 years ago.

Globalization is a complex and challenging transformation of the world order. The stewards of globalization have been asleep at the switch — allowing unprecedented imbalances of trade and capital flows to mount. The G-7 and the IMF have finally come together to recognize the dangers of these problems. In doing so, they have rejected (thankfully) the “new paradigm” views of those who argue that imbalances are a perfectly sustainable attribute of a new world order. The long march down the road of global rebalancing may have just begun. Notwithstanding some of my quibbles noted above, this is excellent news for an unbalanced world. If the G-7 strategy works, it is also good news for financial markets. In particular, a successful rebalancing should lower the risks of a global hard landing — tempering the fears of a crash in the US dollar and/or a related sharp increase in real long-term US interest rates. So far, the hope is all on paper — buried in the rhetoric of a communiqué. Now it’s time for the heavy lifting.

Thursday, April 20, 2006

The Politics of Money

Hazel Henderson:

Hazel Henderson

The word is out that economics, never a science, has always been politics in disguise. I have explored how the economics profession grew to dominate public policy and trump so many other academic disciplines and values in our daily lives. Economics and economists view reality through the lens of money. Everything has its price, they believe, from rain forests to human labor to the air we breathe. Economic textbooks, Gross National Product (GNP) and the statistics on employment, productivity, investment, and globalization – all follow the money. Happily, all this focus on money is leading to the widespread awareness of ways money is designed, created and manipulated. This politics of money is at last unraveling centuries of mystification.

Civic action with local currencies, barter, community credit and the more dubious rash of digital cybermoney all reveal the politics of money. Economics is now widely seen as the faulty sourcecode deep in societies’ hard drives….replicating unsustainability: booms, busts, bubbles, recessions, poverty, trade wars, pollution, disruption of communities, loss of cultural and biodiversity. Citizens all over the world are rejecting this malfunctioning economic sourcecode and its operating systems: the World Bank, the IMF, the WTO and imperious central banks. Its hard-wired program: the now derided “Washington Consensus” recipe for hyping GNP-growth is challenged by the Human Development Index (HDI), Ecological Footprint Analysis, the Living Planet Index, the Calvert-Henderson Quality of Life Indicators, the Genuine Progress Index and Bhutan’s Gross National Happiness… not to mention scores of local city indices such as Jacksonville, Florida’s Quality Indicators for Progress, pioneered by the late Marian Chambers in 1983.

As with politics, all real money is local, created by people to facilitate exchange, transactions and is based on trust. The story of how this useful invention, money, grew into abstract national fiat currencies backed only by the promises of rulers and central bankers is being told anew. We witness how information technology and deregulation of banking and finance in the 1980s helped create today’s monstrous global casino where $1.15 trillion worth of fiat currencies slosh around the planet daily via mouse clicks on electronic exchanges, 90% in purely speculative trading.

US President Bush embraced former chief economic advisor and new Fed Chairman, Ben Bernanke’s opinion that the mystery of low bond yields and interest rates was due to a “global savings glut.” Former Fed Chairman Greenspan, whose zero real interest rates flooded the US economy with excess liquidity and helped create the dot-com, housing and global asset bubbles, declared himself “perplexed.” The anomaly involves the global economic imbalances between the USA, the world’s largest debtor – borrowing the lion’s share of global capital – and the developing countries of Asia and those exporting oil as the world’s new lenders. I doubt there is a “global savings glut” or a “Shift of Thrift” from indebted U.S. household’s zero saving rates to thrifty Asian savers as claimed in The Economist editorial of Sept. 24, 2005. My view is that there’s a global flood of fiat paper money – mostly trillions of US dollars – amplified by the pyramiding of financial “innovations” (derivatives, hedge funds, offshore “special purpose entities,” currency speculation and tax havens) vis-à-vis real production of goods and services in the real world.

Today, we see worldwide experimentation with local exchange, barter and swap clubs, such as Deli-Dollars, LETS, Ithaca Hours and other scrip currencies in the USA and Canada. Billions of people still live in traditional non-money societies and the world’s mostly female voluntary sectors. I have described these huge unchartered sectors as the “Love Economy” estimated by the Human Development Report (United Nations Development Program 1995) as $16 trillion simply missing from economists’ global GDP that year of $24 trillion. Others have described these non-money sectors, notably Karl Polanyi; in Primitive, Archaic and Modern Economies (1968); Lewis Hyde in The Gift (1979); Genevieve Vaughan in For-Giving (1997); Dallas Morning News financial editor, Scott Burns in Home, Inc (1975); Edgar Cahn’s No More Throw Away People (2004) and his time-banking programs now emulated worldwide (The Time Dollar How To Manual,

All this hands-on experimenting resulted in an explosion of grassroots awareness about the nature of money itself. As local groups and communities created their own local scrip currencies and exchange systems, they learned about economists’ deepest secret: money and information are equivalent – and neither is scarce! As money morphed from stone tablets, metal coins, gold and paper to electronic blips of pure information – the economic theories of scarcity and competition began to be bypassed by electronic sharing and community cooperation. Barter, dismissed in economic textbooks as a primitive relic – went hi-tech. eBay, the world’s largest garage sale, is an example of how to bypass existing markets.

People began to see how central banks and national money-systems control populations by macro-economic managing of scarcity, employment levels, availability of mortgages and car loans, via the money-supply, credit, interest rates and all the secretive levers and spigots used by central bankers. Even Nobel prizes were politicized as mathematicians in 2004 challenged the so-called “Nobel Memorial Prize in Economics” demanding its de-linking from the Nobel prizes and to confess its real name, “The Bank of Sweden Prize in Economics.” The mathematicians, Peter Nobel, grandson of Nobel and many other scientists object that economists misuse mathematics to hide their faulty assumptions – and that economics is not a science but a profession. The row over the 2004 Bank of Sweden Prize was because its recipients had authored a 1977 paper with a mathematical model purporting to “prove” why central banks should be independent of political control – even in democracies. Central banking too, is politics in even deeper disguise, as I describe in “21st Century Strategies for Sustainability”

Today, rapid social learning about the politics of money and how it functions is revealing this key mythology underlying our current societies and its transmission belt: that faulty economic sourcecode still replicating today’s unsustainable poverty gaps, energy crises and resource depletion. Climate change creeping upon us for 25 years is the latest media wake up call, and predictably economists quickly “captured this issue for our profession,” as a UK economics group put it (Henderson, 1996), to promote their pollution and C02 trading “markets.” In spite of such efforts, the defrocking of economics, the deconstructing of money systems and the growth of all the healthy local, real world alternatives is propagating widely. The World Social Forum launched in sunny Porto Alegre in 2000 by Brasilian reformers is one of many such worldwide movements. Argentina’s default in 2001 taught its citizens that they could trust their own local scrip, flea markets and electronic swap systems more than the country’s official currency: the peso. Argentina, Brasil and Venezuela have announced they will repay their IMF loans in full – to free their economies from “Washington Consensus” prescriptions.

I have documented over the years many of the pioneers of money reform, from the Time Store in Cincinnati in the 1890s, Ralph Barsodi’s “constants” in New Exeter, and during the 1930s “bank holiday,” Vermont’s own Malted Cereals Company scrip, issued in Burlington and the Wolfboro Chamber of Commerce’s scrip in New Hampshire.

Margaret Thoren has kept alive The Truth in Money Book by Theodore R. Thoren and Richard F. Warner (from P.O. Box 30, Chagrin Fall, OH, 44022). Other perennials: E.F. Schumacher’s Small is Beautiful (1973); James Robertson’s Future Wealth (1989); Margrit Kennedy’s tireless teachings; Robert Swann’s Community Economics are all in the Schumacher Society’s Library. The Society runs the SHARE credit system while documenting other community credit pioneering, such as Michael Linton’s LETS experiments, Paul Glover’s Ithaca Hours and many other projects since the early 1980s. Bernard Lietaer’s The Future of Money (2001); Lynn Twist’s The Soul of Money (2004); William Krehm’s COMER Newsletter ( and James Robertson and Josef Huber’s Creating New Money (2004) continue to keep these lessons alive and updated. My bookshelf on alternative economics, barter, credit and currency system continues to grow, and includes Ralph A. Mitchell and Neil Shafer’s indispensable eye-opening self-published Standard Catalog of Depression Scrip of the United States in the 1930s (Kranse Publications, Iola, WI) (1984). It contains thousands of pictures of alternative scrip currencies issued in almost every US state and city and many in Canada and Mexico after the Great Crash of 1929 and the bank failures that followed. During the 1980’s in all my talks across North America advocating local self-reliance and alternatives to fiat money, I carried this heavy volume along to show how local inventiveness helped overcome the failures of national banking and finance. People would raise their hands in recognition as I would show on overheads the scrip used in their state. “I remember these in my Dad’s bureau!” “My Mom used that to buy our groceries!”

So, today, as the global casino again reaches crises of abstraction, derivatives, currency futures and financial bubbles – we have been here before. Today’s global imbalances, deficits, bouncing currencies, poverty and debt crises require a systemic redesign of that faulty economic sourcecode. Worried finance ministers and central bankers call vainly for a “new international financial architecture.” They do little but fret about this behind closed doors, at meetings of the G-8, WTO, and in Jackson Hole and Davos. Some clever libertarians try to beat the bankers at their own game with global digital currencies backed by gold, including e-gold Ltd, Gold Money and Web Money. Based in offshore havens, Nevis, Jersey, Moscow and Panama, they have become platforms for cyber-crooks (Business Week, January 9, 2006). The rest of us are redesigning healthy homegrown sustainable local economies – all over the world.

Before we fall into “either/or” errors, we should avoid doctrinaire “smallness,” ideological localism and knee-jerk libertarianism. None can protect local communities from the ravages of market fundamentalist-driven globalization. Like it or not, we are all “glocal” now. Communities, like cells in the body-politic and the body, need boundaries or membranes to keep out elements destructive to the cell’s integrity. But all cell membranes are semi-permeable to allow needed elements, information and energy exchanges from the environment to pass through. In today’s information saturated world, communities need to understand anew which elements to reject and which to embrace. Wholesale rejection can lead to rigidity, xenophobia and misreading of history. Wholesale acceptance of current unsustainable economic global trends will surely lead to loss of local culture, biodiversity and resource-depletion. We humans have been adept at creating new scenarios and technologies that mirror our lack of systemic knowledge and foresight. From such social changes and unanticipated consequences, we must then learn and evolve – or suffer ecological collapse.

Wednesday, April 12, 2006

Banking And The Business Cycle

Banking And The Business Cycle

A Bloomberg headline caught my attention earlier in the week: “Fisher Says Globalization Reduces Inflation Threat.” In his Tuesday speech -- “A New Perspective for Policy” -- Federal Reserve Bank of Dallas’ President, Richard W. Fisher, noted a finding from recent globalization research conducted by the Bank of International Settlements. “…[F]or some countries, including—and to my mind especially—the United States, the proxies for global slack have become more important predictors of changes in inflation than measures of domestic slack.” Mr. Fisher also noted “the realization of the importance of global economic conditions for making monetary policy decisions is becoming more widespread.” Reminiscent of the late-nineties view that extraordinary productivity gains had empowered the Greenspan Fed to let the economy (and financial markets!) run hotter, today it is “globalization” that supposedly keeps “inflation” in check, thereby bestowing the Federal Reserve and global central bankers greater latitude for accommodation.

There is great irony in the fact that U.S. led Global Credit Inflation and attendant Asset Bubbles of unprecedented dimensions are fostering (over)investment in global goods-producing capacity, a backdrop that is perceived by the New Paradigmers as ensuring ongoing “slack” and quiescent “inflation.” This is dangerously flawed analysis, and I find it at this point rather ridiculous that policymakers cling to such a narrow (“core-CPI”) view of “inflation.” I suggest Mr. Fisher, Dr. Bernanke, Dr. Poole and others read (or, perhaps, re-read) the classic, Banking and the Business Cycle – A Study of the Great Depression in the United States, by C.A. Phillips, T.F. McManus, and R.W. Nelson, 1937.

The authors brought a (refreshing) degree of invaluable clarity to complex – and pertinent - economic issues that are today simply omitted from the discourse. In particular, I much appreciate the use of the terminology “Investment Credit Inflation.” It is, after all, the creation of new financial claims (Credit) that augments purchasing power, and analysts must be vigilant observers of the sources and uses of this additional spending. The key is to recognize the nature of the Processes of Credit Creation and Dissemination, especially when marketable securities, leveraged speculation, and Asset Inflation are key facets of the boom. And just as the popular proxy index for the general price level utterly failed during the ‘twenties to indicate the prevailing massive Credit Inflation, the Fed’s favored (narrow) price level indicators today only work to palliate and mislead.

But it is better to just let the timeless insights from “Banking and the Business Cycle” “speak” for themselves.

“It is sought to show that the main cause of the dislocation in trade and industry was, in [T.E.] Gregory’s language, the ‘disregard of the rules of common sense in the treatment of the money supply’ of the United States; the depression is proximately an effect of inflation. The post [First World] War inflation in the United States was an investment credit inflation, however, as distinguished from the commodity credit inflation of War-time.” (page 4)

“The special character of the depression is traced to the hyper-elasticity of the Federal Reserve System, and to the operation of that system as exemplified in the ‘managed currency’ experiment of the Federal Reserve Board… The depression, in other words, was the price paid for the experimentation with currency management by the Federal Reserve Board…” (pages 5/6)

“Through the purchase of investments, commercial banks impart a positive upward impulsion to the business cycle. Coming in as a marginal determining factor in the price of bonds, purchases of investments by banks force down the long-term market rate of interest so that it becomes profitable, in view of the existing realized rate of return to capital at important new investment margins, to float new bond issues and to embark upon new capital development; this results in an investment boom which affects a change in the structure of production… the purchase of investments by banks creates new deposits in the banking system in much the same fashion as does the granting of loans.” (page 6)

“The term ‘inflation’ has long been the subject of interminable and diverse definition. In the view of the writers, inflation applies to a state of money, credit, and prices arising not only from excessive issues of paper money, but also from any increase in the effective supply of circulating media that outruns the rate of increase of the physical volume of production and trade, thus forcing a rise of prices… In the modern world of finance…the most important single cause of inflation is the multiplication of bank credit by the banking machinery, resulting in an increase in the volume of purchasing power…” (page 13)

“‘Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency [quote from Keynes].’ How close the capitalist system in America has come to destruction in consequence of the inflationary debauch of the currency indulged in during and since the [First World] War by the manufacture of deposit currency is as yet uncertain.” (page 34)

“One of the duties devolving upon economists is that of pointing out the errors in fallacious economic contentions…” (page 38)

“Overinvestment, which must be assigned the role of a positive disturbing factor, has its ultimate source in an excess of credit… the policy of overinvestment, with its attendant misapplication of capital, could never have been carried to the lengths that it was during the decade of the ‘twenties' if the banks and the Government had not supplied abundant credits at artificially cheap rates.” (page 68)

“…the position of Professor [Lionel] Robbins: ‘It may prove to be no accident that the depression in which most measures have been taken to ‘maintain consumers’ purchasing power’ is also the depression of the widest extent and most alarming proportions.’” (page 72)

“The fall in prices would in itself serve to constitute an effective check upon inordinate capital development because it would bring about a decline in the rate of return going to capital; as the rate of return to capital declined consequently upon the fall in prices the rate of accumulation of capital goods would tend to diminish. Under such conditions the system is automatically self-corrective. It is just this self-corrective process which is essential to the smooth functioning of the economic machinery. And it is in this way that the system would work were it not for the disturbing factor of credit. The injections of new credit not only permit an increase in the rate of capital accumulation, but also tend to disrupt progressively the normal equilibrium relationships between costs and prices over many sectors of the pricing front. The fundamental disequilibria are not discernable until the new credits are withdrawn or cease to increase, when it then becomes apparent that the anticipated earnings of capital based on the prevailing (artificially pegged) price level will not be realized…” (page 77)

“And for an understanding of the more immediate causes of the depression it is essential that the developments taking place in the American banking system be clearly in mind, as the changes occurring in the banking system were intimately connected with the structural changes in the economic system which led to the depression.” (page 78)

“The immediate effects of this investment credit inflation were marked by important and interrelated changes in the character of bank loans and investment assets. There developed an indirectness in the processes of bank credit financing, bank credit entering into the channels of production and trade through operations in the securities and capital markets… As a result of the plethora of bank credit and the utilization by banks of their excess reserves to swell their investment accounts, the long-term rate declined and it became increasingly profitable and popular to float new stock and bond issues. This favorable situation in the capital funds market was translated into a constructional boom of previously unheard-of dimensions; a real estate boom developed, first in Florida, but soon was transferred to the urban real estate market on a nation-wide scale; and, finally, the stock market became the recipient of the excessive credit expansion. These three booms – the constructional boom proper, the real estate booms, and the stock market hysteria – combined to produce structural changes in the economic system which were directly involved with the immediate origins of the depression. This trinity of booms contributed to sustain a seeming prosperity, the tragic speciousness of which was not widely apparent until after the bubble had burst. Hence the remote effect of the investment credit inflation was depression...” (page 81)

“The growth of deposits for all the banks in the country from June, 1921, to December 1929, was over 19 billion dollars. This is to be compared with 18.6 billion in total deposits for all banks, in June, 1914… The banking years from 1922 to 1929, then, were characterized by a great credit inflation – an absolute quantitative inflation viewed from any angle, and a relative inflation viewed with respect to the needs of trade and in consideration of the price level.” (pages 82/84)

“In the course of the time…increased flotation of corporate securities in an especially favorable capital market virtually surfeited some of the issuing corporations with liquid funds for which they found a profitable use in the stock exchange call-loan market, adding new fuel to the already raging flames of stock market speculation... Real estate bond issues were brought out on a scale unmatched in previous history… Our export trade was stimulated by extensive over-seas lending… All these factors…helped to carry business activity to the false bottom of credit inflation long enough for the term ‘New Era’ to become a byword…” (pages 112/13)

“It was through these various booms of a capital nature that the ‘cheap credit’ policy of this period found its chief outlets. The net effect of these influences was to produce an alteration in the structure of production.” (page 113)

“If the recent cycle has proved so puzzling to so many students of its devious course and manifold phases, it is because the full effects of the creation and operation of this central banking system upon the commercial banks have not been widely nor adequately understood; nor, furthermore, have the influences of the changing structure of the American banking system upon the structure of production been fully realized.” (page 140)

“Most American observers who were concerned with the structural view of business cycles were unable fully to appreciate the monetary aspects of the situation; those who were advocates of the purely monetary theory were so obsessed with the stable-price level complex that they were unable properly to assess the importance of the underlying structural phenomena which were developing… The movement of wholesale prices occupies a central role in the usual monetary theory, and this concentration of attention upon the superficial phenomena of changes in the value of money has militated against an understanding of the channels through which newly created credit entered the economic system and of the effect of this new credit upon the structure of production. Further, there are certain aspects of the recent situation which render the usual monetary theory practically useless… commodity prices as measured by the wholesale prices index in this country were remarkably stable from 1922 to 1929…so that one point definitely established by the monetary experimentation involved is that stability of the price level is a doubtful safeguard against depression.” (pages 147/148)

“In the first place, the depression was as exaggerated and as protracted as it was because the stock market crash itself was the most devastating… In the second place, the alteration of the structure of production…was greater than in any previous depression… And, in the third place, during no previous collapse was there such a complex entanglement of the banking system with the course of the depression… But underlying and supplementing all these factors was a stubbornly persisting lack of equilibrium in the entire economic and price structure.” (pages 150/151)

“It has frequently been argued that the stock market boom was justified on the basis of rapidly rising corporate earnings. Some have contended that profits not only were large in absolute amount but that they were increasing at an accelerating rate… On sober afterthought, however, it appears that the stock market boom was largely a product of bank credit expansion, a mad speculative frenzy which had no rationale whatever.” (page 155)

“Although wholesale commodity prices were relatively steady, prices in a more inclusive sense did rise. That is to say, the emissions of bank credit found expression in a rise of prices other than wholesale commodity prices, the index to which most persons are accustomed to refer when considering prices in relation to increased purchasing media. For ‘credit takes various directions, and the effects of inflation can only be measured best at those points in the business structure where the use of credit has been most active.’ The ‘points’ where credit played its most active part in affecting prices in the period from 1922 onward are those already referred to – real estate, stocks, and long-term investments.”

“…the Board’s policies also had international effects that were of far-reaching import. During the period of the ‘twenties when the United States was not only the most powerful commercial and industrial nation in the world, but also was in possession of the major portion of the stock of monetary gold of the world, our domestic developments and conditions were bound to influence the course of economic events in other countries. The [Fed] in its efforts to inflate purchasing power and to support the price level in this country helped indirectly…to arrest the decline of prices in other important commercial nations…” (page 197)

“As early as June 1927, the effects of the Federal Reserve Board’s domestic credit policies upon the international situation were diagnosed by Professor Bertil Ohlin of Stockholm University as follows: ‘The influx and efflux of gold in the United States has thus lost all influence upon the monetary purchasing power and the prices level in that country. The question of granting credit is instead determined by what the Federal Reserve Board considers suitable from an economic point of view. This implies nothing less than a revolution in the monetary system not only of the United States but of all countries with a gold standard…” (page 198)

“Stability of the price level is no adequate safeguard against depression, it is contended, because any policy aimed at stabilizing a single index is bound to set up countervailing influences elsewhere in the economic system. Although the policy of stabilization may appear to be successful for a time, eventually it will break down, because there is no way of insuring that the agencies of control will be able to make their influence felt at precisely those ‘points’ of strategic importance.” (page 200)

“A sharply contrasting objective of banking policy…and the one here advocated, would be the control of the total amount of credit, such that the violent inflations and contractions of credit would be eliminated, or at least greatly mitigated, and without special regard for any one index of economic activity.” (page 202)

The authors’ delved into considerable detail and analysis elucidating the various factors and mechanisms that supported “a much larger superstructure of credit than was previously possible.” Certainly at the top of the list was the expansion of the Federal Reserve System, along with various factors and avenues that significantly reduced bank reserve-to-deposit requirements and financial innovation generally. To be sure, however, the “hyper-elasticity of the Federal Reserve System” and the fractional-reserve banking apparatus from the ‘twenties is Inflationary Child’s Play in comparison to the virtually unchecked securities-based Credit systems of our day.

The contemporary U.S. Credit system (evolving to the status of the backbone of the global Credit mechanism) comprised of banks, the GSEs, global central bank dollar holdings, brokerage firms, the MBS and ABS marketplaces, hedge funds, finance companies, insurance companies, etc., operate today generally unrestrained from either reserve or capital requirements (not to mention a gold standard). And, in the final analysis, ‘this implies nothing less than a revolution in the monetary system not only of the United States but of all countries…’ Moreover, ‘changes occurring in the [global financial] system [are] intimately connected with the structural changes in the [global] economic system…’

“The stock market crash provided the shock to confidence which definitely and dramatically started the depression on its downward course, revealing to most persons for the first time the inherent instability of the conditions which had prevailed for several years.” (page 161)

And while “Banking and the Business Cycle” does not pursue this line of reasoning, it is my view that the 1929 crash was inevitable due to the extreme nature of speculative leveraging and deep structural maladjustment, and it was as well the impetus for an unavoidable collapse of system liquidity. One never knows from where the shock to confidence will emanate, while today’s intertwined global Credit apparatus has an unknown multitude of highly leveraged marketplaces that would qualify as potential financial dislocation catalysts. Yet one can look to today’s Highly Extraordinary Global Credit and Speculative Boom Environment and state unequivocally that the system is acutely vulnerable to any break in confidence, panicked speculator deleveraging, or even any meaningful downturn in Credit growth. Admittedly, the Global Credit Bubble has quite a head of steam. But, then again, so might global interest rates.