Tuesday, February 17, 2009

More Historical Perspective on Finance

Ed Perkins writes about The Rise and Fall of Relationship Banking at Common Place.

Rodrik on the Reinvention of Capitalism

Dani Rodrik writes that "we need to contemplate a transition from the national version of the mixed economy to its global counterpart.
This means imagining a better balance between markets and their supporting institutions at the global level. Sometimes, this will require extending institutions outward from nation-states and strengthening global governance. At other times, it will mean preventing markets from expanding beyond the reach of institutions that must remain national.The right approach will differ across country groupings and among issue areas.
Designing the next capitalism will not be easy."

Sunday, February 15, 2009

Reviews of the Lords of Finance

Both the New York Times and the Washington Post review Liaquat Ahamed’s Lords of Finance: the Bankers Who Broke the World. The book is about the leaders of the central banks of the U.S., England France and Germany during the years leading up to the Great Depression. Both reviews are quite positive. I have not looked at the book yet, but I m a little worried because, although both reviewers liked the book, both also seem to have come away from it with little understanding of how monetary policy, generally, or the gold standard, specifically, operated. Joe Nocera in the Times states that “In a brilliant stroke, Schact created a new currency, the Rentemark, then chose the exact right moment to fix it to the mark … In so doing, he restored faith in Germany’s currency and beat back inflation.” The key to beating inflation isn’t to introduce a new currency at the right moment. The trick is to not keep printing that currency at an ever more rapid pace. Likewise, Frank Ahrens in the Post quotes Ahamed to the effect that all the gold mined up to 1914 “was barely enough to fill a modest two-story town house.” He then adds that, “There simply was not enough of it to fund a global conflict or to allow economic recovery afterward.” To be clear the first quote is Ahamed the second is Ahrens. The small supply of gold is of course what made it useful as an international monetary standard. People didn’t carry around bags of gold. They had long used bank notes or checks as we do now. People can by the same amount of stuff with a few valuable dollars as they can with lots of worthless dollars. By requiring convertibility at a fixed rate the gold standard placed a constraint on changes in the money supply. It limited inflation and exchange rate risk, and encouraged foreign investment. It was adopted for the same sorts of reasons that countries sometimes peg their currency to the dollar or the franc, for instance. The gold standard did not create complete stability. Gold flows and, therefore, changes in the money supply could be influenced by political factors as well as economic ones. And the United States experienced periodic financial crises while on either a gold or bimetallic standard.

When I have had a chance to look at the book I’ll let you know what I think of it, but I worry that the reviewers do not seem to have come away with a very clear picture of the way things worked.

Sunday, February 1, 2009

The New Deal

In the Washington Post, Amity Shlaes writes about the failure of the New Deal to promote economic recovery. She points out that unemployment remained high and investment low for the entire decade. But this isn't really news. After all, the common wisdom is that the War ended the Depression. Bob Higgs, for one, disputes this common wisdom, nevertheless if people believe that the War ended the Depression they must know that the New Deal didn't.

So, Shlaes goes further. Because of New Deal policies "the Depression lasted a half a decade longer than it had to, from 1929 to 1940, rather than say 1929 to 1936." So we had to have depression but it shouldn't have been so great. She declares that "the monetary shock in the first years of the Depression was imense, but it was this duration that made the Depression Great." In other words, the economy would have recovered on its own if not for FDR. The recovery that did take place had nothing to do with Roosevelt. Shlaes even has a pretty good idea of when the economy would have been complete. If not for FDR’s policies, the three years of economic decline before he took office would have been wiped out three years after he took office.

In a recent paper in the AER Gauti Eggertsson points out that this sort of argument depends on the belief in a huge coincidence. In discussing recent analysis of the New Deal, he notes that “a surprisingly large part of the literature treats the recovery as inevitable and/or exogenous and coincidental with Roosevelt inauguration.” It is surprising because as he shows in a number of graphs the recovery of investment, production, and prices all coincided with the inauguration. Eggertsson argues instead that Roosevelt created a shift in expectations that caused economic recovery.

Its not hard to identify New Deal policies that do not appear conducive to growth. On the other hand, assuming that the recovery just happened to coincide with Roosevelt's innauguration seems like a questionable place to begin your analysis.