Our Will

Excellent as ever. Starting from the point that the 00s are like the 1920s, he goes on to say that we might be headed into something like the Great Depression. OK, not sure about this thesis, but let\’s take it that he\’s right. We should therefore be doing something different from what turned the Great Crash and the associated implosion of the banking system into that Great Depression, no? That is, not repeat the mistakes of last time around?

I know at least one central banker who spent the summer reading JK Galbraith\’s Great Crash. The first task of President Franklin D Roosevelt after his election in 1932 was the recapitalisation of the bankrupt American banks by new public agencies – which his Republican critics decried as socialism. But it pulled the US out of slump. Unless the western interbank markets start functioning again soon, the question will arise as to which governments are going to bail the western banks out of their foolishness. Will it be our own – or that of Mr Hu Jintao and the potentates of various oil producing Arab states?

Thus the conversation in Cape Town. Ominously, the first reaction to last week\’s injection of funds was a sell-off in the stock markets, but by Friday there were hopes that it might have delivered some short-term relief.

The British government should be heeding central bankers\’ concerns. It should be publicly announcing pre-emptive plans to support distressed mortgage holders and distressed lenders. It should be recasting the system of financial regulation, so that banks become tightly regulated, like utilities, as a quid pro quo for government guarantees of their deposits. Banks and building societies should be required to be much less reckless in their lending. The bill providing for the nationalisation of Northern Rock should be widened to include the other banks that will require short-term assistance. The UK should be pressing for a proper system of international financial governance and regulation.

Ah, no. Mr. Hutton is recommending that we follow exactly the same path as last time, the one that did in fact turn into the Great Depression. "Less reckless in their lending" equates exactly to a reduction in the money supply, to a restriction of credit.

Essentially, the Great Depression, in the monetarist view, was caused by the fall of the money supply. Friedman and Schwartz write: "From the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third." The result was what Friedman calls the "Great Contraction"— a period of falling income, prices, and employment caused by the choking effects of a restricted money supply.

Well done Willy!

8 comments on “Our Will

  1. I know if I ever agree with Will I am doing something wrong, but I am afraid I lean towards the slash and burn approach. The banks have large non-performing loans. We should not try to prop up failure. What the banking sector needs is a shake out. This is the mistake of Japan – they tried to prop up the banks and so their problems extended for decades even at essentially zero interest rates. What they should have done is let the worst go to the wall and allow the healthy to clean up what was left.

    So I say, jack up interest rates, curtail lending, let’s see if Citigroup goes the way of Northern Rock. We’ll all be tougher and healthier for it in the long run.

    But of course more regulation is insane.

  2. God help us the central bankers are reading Galbraith. I would love know which central banker did read “Great Crash”. Could only be Venezuela?

  3. “So I say, jack up interest rates, curtail lending, let’s see if Citigroup goes the way of Northern Rock. We’ll all be tougher and healthier for it in the long run.”

    And reform the depositors guarantees while we’re at it: it does no good at all if a bank goes down while your house purchase goes through, taking your sale cash down with it. The whole finance system seizes if deposits can’t be trusted in the system as a whole.

    I believe the German system is rather smarter, and once there is trouble the deposits are severed, and guaranteed by the state (which picks up some borrowing on the cheap), with the remains put into liquidation to be sorted out.

  4. I think it certainly makes sense to have a split between financial institutions that are government guaranteed and also regulated, and those that are neither. More free market too.

    But Tim, what solution are you proposing if you are arguing the Friedman case? Or in short, what would he have proposed? 0% interest rates or is it something else?

  5. “I know at least one central banker who spent the summer reading JK Galbraith’s Great Crash.” A bit bloody late – I mugged up on it again in 1998. What I’m reading now is Schama’s “Citizens”, his history of the French Revolution, so that when they drag Blair and Brown a la lanterne, I know the protocol.

  6. Kay Tie, I have some problems, in theory, with guaranteeing depositors’ money. But I think it ought to be done, if at all, on a basis of a stock offering. So if they want government cash, they have to provide at least an Option to swap debt for shares later on. After all, if the owners are so remiss as to need a bailout, then they deserve to have their asset watered down as punishment. Or they can go to the market place and ask for cash the normal way. Either way, if they need help, they can pay for it.

    dearieme, I’d be more worried if someone was actually reading Galbraith as anything other than a counter-factual. I think few economists have been so consistently wrong about pretty much everything. Which is saying something when you look at the field. The only problem I’d have with Schama is how on Earth can anyone make the most interesting part of the French Revolution – the Terror – the dullest part of his book? I shall now go and re-read Patrick O’Brien so that when they drag Blair and Brown a la lanterne I know how to fight on the Right side – the side of privillege, tradition, roast beef and reaction.

    But still. I am reading “China’s Cultural Revolution: not a dinner party” by Michael Schoenhals. So it could be worse.

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