Friday, July 29, 2022
If the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff had a nickel for every time he heard a California liberal defend the nation's highest state income tax rate (13.3%) and myriad of other local taxes and fees with "see, you need taxes to run a government" he might have enough to afford one L.A. County unionized lifeguard.
Read about $500,000 lifeguards at:
Tuesday, July 26, 2022
7 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff examines U.S. banking in the quarter-century before the Civil War, a chapter when the federal government withdrew from regulating banks but state governments filled in the gap. Accordingly, the period has been misnamed the “free banking era” by many economists who present it as proof that “laissez-faire” and “deregulation” in American banking has already been tried and failed.
|The Panic of 1857|
After the Second Bank of the United States was shuttered and the Panic of 1837 passed, the federal government backed away from intervening in the American monetary system. For the next 25 years its only contribution to money and banking was at the U.S. Treasury which accepted newly mined gold and silver from the public and minted it into coins.
For this reason, the quarter century from 1837 to 1862 has been misnamed the “free banking era” by many economists and historians.
But even without federal intervention the period was hardly free from government interference.
Washington might have temporarily bowed out, but the states still played a disruptive role in the regulation of banks and in fact increased their interventions. Legislatures ratcheted up their control over the industry with a slew of new, also misnamed “free banking” laws.
Unfortunately, the free banking misnomer has stuck with the mainstream economics and journalism communities—in the Correspondent’s opinion deliberately—and the problems that sprang from the era’s regulations have been blamed on a nonexistent “deregulation” and “laissez-faire” of the time.
(to read some examples see the comments section of this article)
Why wasn’t the free banking era all that free?
First, state unit banking regulations hadn’t gone anywhere. The lion’s share of U.S. banks were still made artificially weak and fragile by anti-branching regulations dating back to the nation’s founding. No bank anywhere in the USA was permitted to branch outside its home state. Many states restricted intrastate banking to just one or a few counties while others forbade branching entirely, mandating that a bank could literally be only one building (ie. a "unit bank").
Unable to branch, banks couldn’t diversity their loan portfolios or depositors, couldn't shift capital from healthy branches to distressed ones experiencing elevated customer withdrawals, and endured a host of other regulation-induced problems.
The Economics Correspondent has previously written in detail on the problems of branch banking restrictions and you can revisit the topic at:
Adding atop old problems were new and widespread state “free banking” laws that added more mechanisms for failure.
Prior to 1837 it took a lot for a prospective banker to get a charter from his state legislature. To open a new bank one often had to lend to state governments so that legislatures could in turn buy ownership stakes in the bank itself, using dividend payments as a revenue source.
Banks also had to pay hefty fees to secure a charter and the charters had rapid expiration dates, meaning banks had to return only a few years later and pay another “fee” to renew licenses. Often “fees” implicitly meant flat out paying bribes to state officials which was sometimes euphemistically called a “bonus.”
When the federal government backed away from bank regulation in 1837 there was an outcry in many states against these onerous and sometimes downright corrupt charter provisions—both from the public and the bankers themselves. Many states responded by altering the rules to make it easier—more “free,” if you will—to open a bank.
And one of the first problems with the characterization of “free banking” is that free banking states required banks applying for new charters to operate as unit banks (Surro, Calomiris).
Yes, “free banking” meant that operating branch offices was against the law.
Already the historical fable of laissez-faire under this system is undermined. But we’re just getting started.
YOU MUST BUY OUR BONDS
Yet free banking laws went much further with their regulatory interventions. For they not only expanded the onerous unit banking mandate but built another giant problem upon it: the bond deposit requirement for issuing currency.
It's important to remember that in 1837 there was no monopoly central bank issuing paper currency. Instead private banks, which accepted gold and silver deposits from customers, issued banknotes which were payable on demand in the dollar’s defined weight of specie (24.75 grains of pure gold or 371.25 grains of silver).
Like nearly every other country at the time, America relied on private banks to provide paper currency. But unhappy to leave well enough alone, the free banking states placed a new condition on the private issuance of currency: banknote issuances had to be 100% backed by bonds.
And just what kind of bonds? The state government’s itself of course.
What was the reason and how did this regulation breed financial instability?
The political rationale advertised to the public was “If your bank fails what better asset to back your banknote than a government bond that is repaid with the power of the state’s taxing authority?”
But the real impetus was that state legislatures wanted a generous source of revenue for “infrastructure” spending.
In the 1830’s, 40’s, and 50’s the U.S. was engulfed in an infrastructure craze. Steamboats, canals, railroads, bridges, and turnpikes were all the rage and being built up everywhere.
While building an advanced infrastructure for a country is generally a good thing, state governments weren’t content letting private industry handle the work. Many states decided to get in on the party themselves and borrowed heavily to do so.
And if you want to borrow a lot of money quickly and easily, what better place to get it than from banks? Banks are concentrated money centers, and it’s far easier to borrow from a handful of banks than it is to solicit thousands of private households or wealthy widows to loan you money in small, disparate pieces.
Hence the state bond mandate. If banks wanted to issue paper currency, they were forced by free banking laws to lend the same amount to their state governments and hold their bonds.
BAD BONDS = BAD BUSINESS
Even given the misnomer of “free banking,” one can already see how this state/bank arrangement provided opportunities for waste and corruption, or what many call crony capitalism today. Unfortunately, it also led to unnecessary bank failures and one significant financial crisis in 1857.
For most “free banking” state governments proved to be incompetent, if not completely corrupt, when it came to building infrastructure.
Their borrowed funds were often wasted or simply disappeared. States commonly ran out of funds before projects had even begun, the coffers running dry before the first bridge girder was installed, the first mile of turnpike was paved, or the first foot of railroad track was laid.
On a side note: Does any of this sound familiar today? Like the hundreds of billions of dollars in federal “stimulus” money from 2009 that promised to fix America’s infrastructure but mostly evaporated?
Unsurprisingly most free banking states had difficulty servicing their bonds and many of them defaulted.
And as the value of their bonds plummeted, often reaching zero, banks found themselves unable to issue paper currency since the value of notes outstanding had to equal the value of their state bonds, many of which were now worthless.
Prohibited from issuing cash, banks were faced with angry customers who demanded something they could use to conduct hand-to-hand business transactions, so they withdrew the only remaining option: gold or silver coin. The loss of gold and silver reserves forced banks to contract credit and a monetary crunch then ensued.
Worsening the strain was the impact of lousy bonds on bank balance sheets. State bonds were added to the assets side of bank ledgers, but when the bonds depreciated or became worthless the bank’s adjusted assets took a huge haircut. When word got out a bank was now technically insolvent its depositors rushed for the exits, lining up to withdraw their gold and silver coin in a classic bank run and failure.
And all because state governments forced banks to serve as a tool of fiscal policy, mandating they lend heavily to legislatures which in turn squandered the proceeds.
As monetary economist George Selgin points out “Careful economic historians have shown that [depreciating state government bonds] was the main cause of free bank failures in the antebellum United States.”
THE FINAL TALLY
At its peak how prevalent was free banking in the United States?
Selgin places the number of states at “a great many,” at least thirteen states with Michigan starting in 1837, followed by New York and Georgia in 1838.
Chris Surro (UCLA, 2015) numbers free banking states at eighteen by 1860 when there were thirty-three states (55%).
And prolific economic historian Hugh Rockoff (Rutgers, 1975) provides the most comprehensive list so far, confirming eighteen states in 1860 including their dates of adoption.
Michigan (1837, again in 1857)
New York (1838)
New Jersey (1850)
Three more states—Virginia, Kentucky, and Missouri—forced the state bondholding requirement on their banks without passing comprehensive free banking laws, bringing the total number of states requiring bond purchases to twenty-one of thirty-three (64%).
Yet despite eighteen of thirty-three states forcing their banks to become non-branching unit banks and twenty-one states compelling banks to buy their mostly lousy government securities, the absence of the additional layer of federal regulation still made the so-called “free banking” era one of the quieter periods in terms of America’s banking panics.
Only one substantial crisis, the Panic of 1857, struck during the quarter century and the country was able to rebound fairly quickly from the ensuing recession. This stands in contrast to the two panics of the First Bank of the United States era (1791-1811) and the highly destructive Panic of 1819 under stewardship of the Second Bank of the United States (1816-1836).
But that doesn’t stop many academics and the press from depicting free banking era disruptions as a failure of “deregulation” and “laissez-faire.”
The free banking era ended in 1862, but only because the Civil War Union government returned to regulating banks with a vengeance.
In our next column we’ll visit the 52-year long “National Banking System” era (1862-1914) which produced the worst run of banking crises in the nation’s history.
Wednesday, July 20, 2022
Click here to read the original Cautious Optimism Facebook post with comments
8 MIN READ - As part of his ongoing series on banking regulation the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff writes in unavoidably wonkish detail about one of the worst and most complicated financial crises in American history: The Panic of 1837.
|Caricature of hard times in 1837|
Once the Second Bank of the United States (SBUS) lost its monopoly privileges in 1836 it began to operate as just another private bank, now renamed the United States Bank of Pennsylvania (USBP).
That same year Andrew Jackson enacted the Specie Circular, an executive order mandating that all purchases of western public lands be paid in gold or silver coin—no paper notes—in an attempt to rein in a speculative boom in land investments.
Combined with a massive inflow of silver coinage from Mexico and simultaneous Bank of England malfeasance, the Panic of 1837 struck two months after Jackson left office, followed by the smaller Panic of 1839.
I. THE PANIC ITSELF
The Panic of 1837 was one of the worst economic crises in American history. Of America’s over 800 private state-chartered banks, nearly 400 failed, many of them having only opened in the previous year. Total assets held by banks fell by over 40%. After the smaller Panic of 1839 the price level fell by over 40%, a steeper decline than that of the famous 1929-33 Great Contraction.
The resulting depression, while long, was not as severe as the panic. Real GDP barely fell albeit in part due to America’s rapidly growing population. Real GDP per-capita fell by a few points.
Unemployment plagued mostly the urban areas and full employment was not achieved until 1844, five years after the 1839 panic and interestingly still two years faster than the post-2008 “Obama recovery.”
But in terms of determining proximate causes, the Economics Correspondent considers the Panic of 1837 among the most complicated and difficult to ascertain of any financial crisis in U.S. history, hence a long explanation.
Mainstream economic historians place the blame squarely on Andrew Jackson’s shoulders for shuttering the SBUS and signing the 1836 Specie Circular.
A great deal of the Jackson blame has been revived only in the last few years ever since Donald Trump stated Andrew Jackson is his favorite president, sending academics and journalists scouring to produce as much Jackson-denigrating material as possible in a rush to smear Trump by extension.
However blaming Jackson ignores other, larger proximate causes such as the destabilizing effect of unit banking laws, a massive inflow of silver coinage from Mexico, and the effects of Bank of England mismanagement.
The mainstream historian fable goes as follows: The Second Bank of the United States competently managed the nation’s money supply and regulated state banks, restraining their tendency to overissue loans and banknotes. When Andrew Jackson killed the SBUS’s recharter, state banks went on a wild cheap-money ride, overissuing notes and deposits far beyond any credible ratio to their tangible gold and silver deposits.
Furthermore, many historians say, Jackson’s order of the Specie Circular required federal government land sales to be paid for in metallic coinage, precipitating a major withdrawal of gold/silver reserves which forced the banking system to sharply contract credit and produce a banking panic and depression.
Supporting the mainstream thesis is data confirming the U.S money supply did indeed rise sharply: by 12% in 1836, the year that the SBUS ceased operations as a central bank.
II. MEXICO AND ENGLAND
But data from former MIT Economics Chair Peter Temin, a Keynesian and hardly sympathetic to free banking, completely contradicts the “undisciplined state banks” thesis.
Temin’s book “The Jacksonian Economy,” written over a half-century ago and still a classic today, provides incontestable evidence that the expansion of the money supply was spurred by neither irresponsible banks nor the absence of some mythical restraining central bank.
Temin’s research confirms that the money supply did rise by 12% the year before the 1837 panic. But the data reveals that the money supply had already increased another 64% in the three years prior to the central bank’s closure (17.9% annualized).
U.S. MONEY SUPPLY:
1832 - $150 million
1833 - $168 million
1834 - $172 million
1835 - $246 million
1836 - $276 million (SBUS loses central bank status)
Source: Van Fenstermaker and U.S. Treasury
Contrary to what writers at the New York Times and Washington Post might say, the SBUS was either doing a lousy job of “restraining” state banks for those three years, or some other factor was responsible for the monetary inflation.
Indeed, Temin records that it wasn’t just bank paper that expanded. U.S. gold and silver coinage reserves rose by an incredible 129% in the same four years prior to 1836.
U.S. GOLD/SILVER SPECIE:
1832 - $31 million
1833 - $41 million
1834 - $51 million
1835 - $65 million
1836 - $71 million
With so much base metal deposited into the system, reserve ratios at the nation’s banks actually *increased* in the years leading up to the panic, the opposite of what happens when banks irresponsibly produce too much paper money.
So where did the vast imports of silver and gold come from?
Mostly from prodigious silver mines in Mexico and gold from England, both slightly offset by silver outflows to China for its growing opium purchases.
The largest driving force was Mexico’s General Santa Anna, who in 1833 had just assumed the first of what would be many of his career presidencies.
Financing his government with debased copper coinage, Santa Anna declared copper compulsory legal tender at par with traditional silver coins (Rockoff, Rutgers).
Through an age-old economic mechanism known as Gresham’s Law—sometimes stated as “bad money drives out good”—Santa Anna’s edict drove the undervalued metal, silver, out of Mexico to the United States where it created a bona fide hard-money inflation.
(the Economics Correspondent will write a more full explanation of Gresham’s Law in a future column)
To a lesser extent, the Bank of England pushed interest rates far too low for several years, sending gold overseas to its primary trading partners which included the United States.
These two international monetary phenomena are not trivial factors. To put their historic scale into perspective, a 129% increase in the United States’ stock of gold and silver specie in four years is probably a record in its history.
The Economics Correspondent has only seen tables for the first half of the 19th century and entire 20th century, and nothing comes close, not even the smaller increase of the California Gold Rush (1848-1856) which took twice as long at eight years.
The Bank of England’s monetary policy of the mid 1830’s can’t be understated either.
The BoE’s insistence of keeping interest rates at rock bottom, even as gold departed the country in droves, was condemned as the worst example of the Bank’s incompetence in its history-to-date by Scottish economist Henry Dunning Macleod who wrote: “Of all the acts of mismanagement in the whole history of the Bank, this is probably the most astonishing.”
In late 1836, when the Bank of England directors finally realized their gold reserves were in danger of being depleted, they rapidly raised interest rates, sparking the English Crisis of 1837 which is considered the trigger point for the American panic in May of 1837.
Another rapid hike of England’s interest rates in 1839, an attempt to quickly reverse another outflow of gold, promptly reversed the flow of metal back out of the U.S. again, worsening another panic that had already begun in March. In 1839 England’s gold position was so desperate that the Bank of England was forced to plead for a humiliating bailout loan from the Bank of France.
And in the United States, what started that second panic in March of 1839?
Nicholas Biddle’s bank, now the private but still outsized United States Bank of Pennsylvania, found itself unable to redeem its notes in specie and suspended payment. Although the USBP survived the 1839 suspension, it ultimately failed and closed its doors in 1841.
Civil suits hounded Biddle the short remainder of his life. He was arrested, indicted for fraud, and forced to pay creditors from his personal estate. The fraud charges were later dropped and Biddle died in 1845 at the age of 58, but his wife’s family was forced to bear the cost of ongoing civil lawsuits related to the USBP’s failure.
III. WHERE TO BLAME?
So how much of the complicated Panic of 1837’s origins can be blamed on government and how much on free market forces?
For once the Second Bank of the United States, which had closed its doors over a year before the panic began, can’t be blamed.
The evidence points to the largest factor by far being the massive inflows of silver from Mexico and, to a smaller extent, gold inflows from Britain.
And were those inflows a free market phenomenon?
Absolutely not. Rather they were the direct result of policies of the governments of Mexico and Great Britain—the former absurdly declaring copper to be legal tender on par with silver and the latter granting a near-monopoly on its privileged central bank to mismanage interest rates and international gold flows through incompetence.
And one more critical factor that can’t be ignored: legal restrictions on interstate branch banking and unit banking laws that persisted throughout the entire 19th century and into most of the 20th, making the entire U.S. banking system weak, fragile, and that much more crisis-prone when disruptive shocks appeared.
The Panic of 1837 would have been much milder, or perhaps not even a systemic crisis at all, had America’s banks been allowed to branch freely across the country.
Scotland, with its large and nationally branched banks, watched as crisis engulfed England in 1837. Yet sitting on its beleaguered neighbor’s northern border and sharing a common currency Scotland felt virtually none of the crisis’ effects.
As economist Robert Bell recorded in 1838 “While England, during the last year, has suffered in almost every branch of her national industry, Scotland has passed paratively uninjured through the late monetary crisis.”
And economic historian William Graham noted in 1911 that “In the heavy losses and banking failures [of 1837] which ensued, Scotland had little share.”
And Canada, allowing its banks unrestricted branching while simultaneously suffering from the Patriots War and Upper Canada Rebellion (both 1837-1838) endured stress on some Ontario banks but avoided a systemic crisis.
And what of Jackson himself? Does he play a role in the Panic of 1837?
Mainstream historians and academics, recently campaigning to attack all things Jacksonian, have laid blame on his Specie Circular since it led to the withdrawal of large balances of specie from the nation’s private state banks.
But Jackson’s Specie Circular only induced Americans to withdraw specie from banks for public land purchases to pay the federal government which in turn redeposited it right back into the private “pet banks."
According to Temin the Specie Circular simply circulated gold and silver, albeit unevenly, within the U.S. banking system, but the Bank of England drove a net loss of gold from the United States.
Friday, July 15, 2022
“The Bank is trying to kill me, but I will kill it.”
-Andrew Jackson on the Second Bank of the United States
6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff continues with his series on financial regulation throughout American and Canadian history.
|Andrew Jackson and Nicholas Biddle. Two presidents|
and arch-nemeses in the famous "Bank War"
The Panic of 1819 did the Second Bank of the United States (SBUS) no favors with the American public which largely blamed it for the financial crisis and resulting depression.
To read the Correspondent’s earlier entry on the Panic and Depression of 1819 go to:
Bank President William Jones stepped down in 1819 and after a short tenure by replacement Langdon Cheves the presidency was assumed in 1823 by the brilliant but controversial 36-year old financier and statesman Nicholas Biddle.
Just two months later a mercurial, argumentative Tennessee politician nicknamed “Old Hickory”—the future President Andrew Jackson—began his first full term in the U.S. Senate. The Democratic Jackson, whose ideology was based on Thomas Jefferson’s vision of limited government and agrarian populism, strongly opposed central banks and publicly opposed the SBUS or any suggestion of an extension of its charter.
The two men quickly found themselves on a political collision course, dubbed by historians as the “Bank War,” and best encapsulated by Jackson’s famous quip to his Vice President Martin van Buren:
“The Bank is trying to kill me, but I will kill it.”
-July 4, 1832
THE BANK AND JACKSON’S PRESIDENTIAL ELECTIONS
The details of the Bank War are many and the politics lurid. For a digestible version the Correspondent can recommend Robert Remini’s “Andrew Jackson and the Bank War.” However, here’s the basic picture in a five-minute read:
Andrew Jackson lost his run for the presidency in 1824 to John Quincy Adams in what historians title The Corrupt Bargain of 1824.
Although Jackson won a plurality of both electoral and popular votes in a four-way race, the lack of a majority winner sent the decision to the House of Representatives. From there House Speaker and Jackson nemesis Henry Clay used his influence to garner a majority of votes for Adams who reciprocated by appointing Clay as his Secretary of State.
Jackson believed the Second Bank had interfered in the election, pouring money and political support behind his opposition. Although he never found any evidence to corroborate his suspicions in 1824, the Bank made things easy for him by giving him all the evidence he needed several years later in another presidential election.
Jackson ran again in 1828, this time successfully, loudly criticizing the SBUS on the campaign trail and promising to oppose its recharter.
Bank President Nicholas Biddle, described even by the present-day Minneapolis Federal Reserve as “arrogant, hypersensitive to criticism and unschooled in politics,” was none too pleased at Jackson’s anti-SBUS rhetoric and decided to engage in open political warfare.
Biddle’s first move was to apply for the Bank’s charter renewal four years early, in 1832, signaling to Jackson that he risked opposing the charter at his own reelection year risk.
Historian Stephen Campbell records that Biddle recruited “an impressive array of branch officers, state bankers, lawmakers, intellectuals, vote counters, lawyers, and confidential agents… …to transmit pro-BUS ideas through articles, essays, pamphlets, philosophical treatises, stockholders’ reports, congressional debates, and petitions, all in a standardized campaign message.”
Campbell also notes that Biddle’s reach extended to politicians, sending “confidential agents into the state legislatures in Pennsylvania and New York, in some cases equipped with bribe money, to persuade undecided lawmakers and secure pro-BUS resolutions.”
Biddle is estimated to have spent $100,000 of his own money, loaned another $100,000 to newspaper editors, and another $150,000-$200,000 directly to Congressmen for their support. In 2022 dollars that’s roughly $10-$11 million.
And Congress reciprocated, giving Biddle his coveted renewal by a vote of 28-20 in the Senate and 107-85 in the House.
But Jackson vetoed it and pro-Bank forces did not have the numbers to override his veto (a key passage from Jackson’s veto appears at the end of this article).
Beaten but not deterred, Biddle focused on his next strategy: pouring more money and political influence into newspapers and other media to bolster Jackson’s 1832 presidential campaign opponent, Henry Clay.
Reports of Biddle’s heavy involvement gave Jackson the confirmation that the Bank was indeed interfering in the political process.
Biddle had been warned by colleagues and Washington insiders that attempting to intervene in a presidential election might backfire, and backfire it did. Jackson seized upon reports of the Second Bank’s newspaper payoffs and he subsequently campaigned as a champion of the average citizen, fighting against the corrupt financial elites who were trying to buy their way into power.
JACKSON WEAKENS THE BANK, WAR ENSUES
Jackson won reelection by a landslide, garnering 219 electoral votes to Clay’s 49.
Still angry at Biddle’s attempts to destroy him politically, Jackson moved to reduce the Bank’s power and directed his Treasury Secretary to cease using the SBUS as the federal government’s banker, to withdraw federal funds from the Bank, and to deposit them across nineteen private state banks, dubbed “pet banks” by historians.
Mainstream economic historians criticize Jackson for this move, but ironically the U.S. Treasury has maintained deposit accounts at thousands of private banks since 1979 (known as Treasury Tax and Loan or TT&L accounts).
TT&L accounts make processing tax payments and refunds easier since most taxpayers make payments or receive refunds through their private bank accounts anyway, not through the Treasury’s deposit account at the Federal Reserve—the Treasury General Account (TGA).
The TT&L program was largely suspended during the 2008 financial crisis due to concerns about possible bank failures, but the point is for what establishment historians today call a terrible policy decision, Jackson’s transfer of deposits from the central bank to private “pet banks,” was adopted by the U.S. Treasury in the late 20th century.
Biddle, now unhappy about losing the political battle over rechartering, losing in the 1832 presidential election, and losing the federal government’s deposits, contracted credit and withdrew large quantities of SBUS banknotes from circulation, creating a small financial panic and recession in 1833.
There is renewed debate among historians whether Biddle did this deliberately to discredit Jackson, some of it rekindled in recent years since Donald Trump named Andrew Jackson his favorite president and placed his portrait in the Oval Office—prompting academics to launch a new campaign to tear down Jackson’s reputation.
But there’s no debate in the Economics Correspondent’s opinion: the contraction was a deliberate political attack and prima facie exhibit of the dangers of concentrated power in the hands of a central banker.
Remini records (in 1965, long before the arrival of Trump Derangement Syndrome) that “Biddle considered it his duty to strike back—and the harder the better. If he brought enough pressure and agony to the money market, perhaps he could force the President to restore the deposits.”
And even Biddle-sympathizing historian George Rogers Taylor writes in 1924 that:
“In 1833-34 Biddle used the tremendous power of the Bank against the general good to force a disastrous contraction on the business community in his effort to win his personal war with President Jackson.”
“By this display of power he [Biddle] ruined whatever chances the Bank may have had for recharter… …Biddle had demonstrated what his enemies had charged: the ability of the Bank to affect the whole course of business of the country and his willingness to use that power to the public detriment and his own personal advantage.”
At first the public did blame Jackson for the recession, but by 1834 the economy had recovered nicely—due in part to an international inflow of silver which we will discuss in the next chapter—and public sentiment turned again against the SBUS for causing the 1833 slump.
Without its renewed charter the SBUS lost its special government-granted privileges in 1836 and became just another ordinary, albeit very large, private commercial bank.
But once again Americans of the 19th century proved far more adept at identifying the causes of financial and economic turmoil than their 21st century descendants.
Passage from Jackson's 1832 Bank veto message:
“It is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes… In the full enjoyment of the gifts of Heaven and the fruits of superior industry, economy, and virtue, every man is equally entitled to protection by law; but when the laws undertake to add to these natural and just advantages artificial distinctions, to grant titles, gratuities, and special privileges, to make the rich richer and the potent more powerful, the humble members of society—the farmers, mechanics, and laborers—who have neither the time nor the means of securing like favors for themselves, have a right to complain of the injustice of their Government… …In the act before me there seems to be a wide and unnecessary departure from… … just principles.”
Thursday, July 14, 2022
From the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff:
"The pressure on Federal Reserve Chair Jerome Powell to strike harder against inflation grew even stronger today as his Canadian counterpart announced a supersized interest rate hike of a full percentage point."
"The move left Canadians reeling — especially given the implications for their overheated housing market and heavy debt loads — but it also left their southern neighbors wondering if the same thing could happen here."
"With the Fed’s next meeting scheduled for July 26 to 27, analysts are already wagering that Powell will follow in Bank of Canada Governor Tiff Macklem’s heavy footsteps."
Read more details at:
Sunday, July 10, 2022
1 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff credits (of all places) an online student exam guide and Investopedia for their concise descriptions of Milton Friedman’s “fool in the shower” depiction of central bankers.
Study guide: “Nobel Prize winner Milton Friedman said that a bad central banker is like a ‘fool in the shower.’ In a shower, when you turn the faucet to change the temperature of the water, there won't be an actual change in the temperature for a few seconds. If a ‘fool in the shower’ is always making big changes in the temperature based on how the water feels right now, the water is likely to swing back and forth between too hot and too cold…”
Investopedia: “The expression is best summed up as the scenario when central banks or governments overreact to swings in the economic cycle and loosen monetary and fiscal policies too far and too fast, without waiting to gauge the impact of their initial actions. When the fool realizes that the water is too cold, they turn on the hot water. However, the hot water takes a while to arrive, so the fool simply turns the hot water up all the way, eventually scalding themself.”
Study guide: “Milton Friedman was arguing that there are inherently many lags in monetary policy which cause it to lag behind the state of the economy. For example, there is a data lag that exists because it takes time to collect the data for statistics such as GDP growth and unemployment. You also need many data points in order to spot a reversal in trend and then it takes time to implement monetary policy and for changes in the money supply to affect the overall economy. This all builds up to where the Fed may be implementing expansionary fiscal policy based on historical data when today we are in an expansionary gap and do not yet know it.”
(Economics Correspondent comment) Actually over the last nine months the Jerome Powell Fed has been more like a “fool falling asleep in the shower” when the water is already too hot and he falls asleep murmuring "the heat is just transitory" and "the correlation between steaming hot water and skin burns has not been valid for quite some time," inevitably scalding himself.
However, now that the Fed is reacting to the inflation that it previously created and trying to make up for lost time by tightening aggressively, we may just see a “fool in the shower” scenario if it overshoots and creates not only the expected recession, but a more painful recession than necessary.
To draw a parallel between the overtightening and fool depictions, Jerome Powell might turn the cold and hot water taps too quickly and go from scalding his skin to putting his entire body in a deep freeze.
Thursday, July 7, 2022
The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff presents CO Nation some lingering vestiges of ousted San Francisco District Attorney Chesa Boudin’s legacy.
|San Francisco Target pain relief aisle: under lock and key|
Well, as you can see from the photograph I took that it’s not just the electronics or “reproductive wellness” sections that need to be safeguarded now.
Yes, even the Advil, Tylenol, and Bayer aspirin have to be locked behind glass doors.
There was a sign beside the shuttered pharmacy window advising customers to “locate an associate” for assistance, but with San Francisco’s minimum wage now at $17 per hour there weren’t too many associates to be seen.
After walking the floor for a few minutes without finding a single associate I came across a security guard who advised me he doesn’t have the key, but “there should be a button on the display doors you can press to call someone over.”
I went back to the pain relief aisle and looked the doors and shelves up and down but nope, no button.
Deciding this was more trouble that it’s worth for a single bottle of Advil I left without buying anything.
Meanwhile for two years San Francisco progressives have circled the wagons to defend their man, Chesa Boudin, from criticism that crime has gotten worse because of his soft-on-criminals policies.
"It has nothing to do with Chesa!" they've howled. "Covid has hit people economically and created desperation all over the country. This isn't just a San Francisco problem!”
The next day I happened to be in the suburb of Colma and walked into their Target store (literally 2.5 miles outside San Francisco’s southern city limit per Google maps) and the Advil was stocked on an open shelf.
I grabbed a bottle and checked out 60 seconds later.
Target sends its thanks to San Francisco’s prosecutor’s office for the added costs of securing ibuprofen and acetaminophen plus the lower sales to customers who can’t access it anyway without help from a northern spotted owl-level-endangered associate.
It's no surprise to the locals that Target operates three stores, all less than 2.5 miles outside San Francisco's southern city limit, including one 2,500 feet from the border and two more highly patronized stores separated by less than 2,000 feet.
Friday, July 1, 2022
7 MIN READ - Given that inflation is big news lately and will remain so for a while longer, the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff submits a brief history of American inflations.
Correspondent’s note: The U.S. has suffered many episodes of inflation higher than the current official 8.6% CPI (for now) and this column is by no means meant to serve as a complete history.
As we can see from the attached chart, America has experienced double-digit inflation six times as an independent country, once more during the Revolutionary War, and several times while it was a loose assemblage of British colonies.
1) 1650-1764: The colonies discover paper money.
The Economics Correspondent can’t comment on the inflation of the 1670’s.
However, in 1690 the Massachusetts Bay Colony gained the distinction of issuing the western world’s first government paper money. The inflation arose from King William’s War (known as the Nine Years War in Europe) that spread from Europe to proxy fighting between the American colonies and French settlers in Quebec and Nova Scotia.
The Economics Correspondent will provide more details on the 1690’s inflation in a future column, but the basic story is as follows:
Once Massachusetts discovered it could print unbacked paper money, with only a vague promise of metallic redemption in the future and few short-term consequences, it quickly became addicted to the printing press to fund all its past debts and future expenses.
Word spread of this seemingly magical new method of financing government expenditures and the other colonies quickly followed suit.
Predictably, they all soon learned that printing money writ large doesn’t remain consequence-free for long. Over the next half-century the colonies were rocked by wave after wave of high inflation, compounded by the disappearance/outflow of silver and gold coinage due to the unwelcome monetary phenomenon of Gresham’s Law (more on Gresham’s Law in another column too).
By the 1750’s Britain’s patience was at an end and Parliament began enacting a series of currency reforms forbidding the issuance of unbacked colonial money, culminating in the final Currency Act of 1764.
2) 1775-1781: The American Revolution.
To finance the Revolutionary War against Great Britain the Continental Congress authorized the issuance of “Continental” paper notes, backed only by the anticipation of future taxes should the revolution survive. Overissuance and high inflation quickly ensued, and in a sad irony patriotic Americans who accepted the notes and held them lost nearly everything while Tories (loyal to the Crown) who refused the notes and insisted on gold or silver coin protected most of their wealth.
As the Constitution was drafted America’s founders remembered the painful experience of the Continentals well. In 1792 they established the dollar as the official currency of the United States, defining it as a unit weight of both gold and silver.
Distrustful of government paper money, the framers inserted into the Constitution clauses that granted Congress the “power to coin money” (Article I, Section 8: Note that they did not grant Congress the “power to print money”) and forbade the states from making “any Thing but gold and silver Coin a Tender in Payment of Debts.” (Article I, Section 10)
3) 1793-1796: Antebellum central banking.
Alexander Hamilton’s Bank of the United States (BUS), America’s first central bank, launched a deliberate campaign of paper inflation following Hamilton’s theory that inflation would promote greater prosperity. However, as the BUS was forced to redeem more and more of its notes using its dwindling gold and silver coin reserves, the bank soon found itself overstretched and abruptly contracted paper money and credit in 1796, triggering the Panic and Depression of 1797.
The Economics Correspondent has written in more detail about the inflation and panics of the 1790’s at:
4) 1814-1818: The War of 1812 and postwar Second Bank of the United States.
To finance the War of 1812, Congress and the states annulled American private banks’ contractual obligations to redeem their notes and deposits in gold or silver coin. The subsequent inflation produced more wartime credit for Congress to tap into, and at war’s end the Second Bank of the United States (SBUS) was chartered by Congress with a mandate to buy up private state banknotes and coordinate a slow, controlled return to metallic convertibility.
However, the SBUS launched a massive inflation of its own notes instead which peaked in 1818 when the SBUS was forced to make good on coinage withdrawals by the U.S Treasury to repay European investors for debts related to the Louisiana Purchase. The SBUS contraction produced the Panic and Depression of 1819.
The Economics Correspondent has written in detail about the inflation of the mid-1810’s and the Panic of 1819 at:
5) The Civil War.
The Union chose several concurrent methods to finance the Civil War: borrowing, taxation, printing unbacked “greenback” government paper notes, and forcing the nation’s banks to buy U.S. government bonds and participate in a government-conceived credit pyramiding scheme: the National Banking System. The latter two created another major inflation.
The Economics Correspondent will post an article with more specifics on the Civil War-era National Banking System and its inflationary consequences soon.
6) 1916-1920: World War I.
Once again, to finance a war the federal government employed inflation, only this time it turned to its new central bank, the Federal Reserve System, for help.
Although the Federal Reserve was still operating on a gold coin standard, it halved bank reserve requirements and prohibited the export of gold, placing America on a de jure domestic-only gold standard. The belligerent European powers also borrowed heavily from the United States and immediately spent the proceeds on U.S. war materiel and food, creating large international gold flows into the country.
The result was the greatest inflation of the 20th century.
Although most Americans believe the 1970’s stagflation era was the worst bout of 20th century inflation, the 1916-1920 period was considerably worse. The annualized inflation rate exceeded 20% in eight different months, peaking at 23.7% in June of 1920.
By mid-1920 New York Fed Governor Benjamin Strong decided a sharp increase in interest rates was needed, pushing the country into the Depression of 1920-21. Although the slump was the second worst of the 20th century, sharp, and painful, the inflation quickly fell and the country recovered very rapidly to enter a boom decade.
The Economics Correspondent plans to post a column on the Depression of 1920-21 at a future date.
7) 1942-1948: World War II.
Once again, the federal government turned to a combination of taxes, borrowing, and inflation to finance a profoundly expensive war. The domestic gold standard had been aborted in 1933 and the international gold standard was also suspended, freeing the Federal Reserve to run the printing presses.
Inflation quickly hit double-digits in 1942, but the Roosevelt administration enacted price controls which led to widespread shortages. In early 1946 price controls were lifted and five years of previously capped, but now freed, monetary inflation sent prices soaring. By 1946 monthly annualized inflation rates were surpassing 18%.
8.) 1970-1982: The Stagflation Era.
The Nixon/Ford/Carter stagflation era was one of only two peacetime episodes in the independent United States’ history when inflation reached double digits (the other being the Bank of the United States inflation of 1793-1796).
Athough Jay Powell is working hard to add a third.
By the 1970’s worldwide governments and central bankers had become captured by Keynesian economic theories: the belief that recessions and unemployment can be defeated with more inflation.
President Richard Nixon demanded a lowering of interest rates in 1972 to create an economic “sugar rush” that would secure his re-election, and Federal Reserve Chairman Arthur Burns concurred (although he was opposed to Nixon’s price controls).
However, “in theory” turned out to be a very different thing from in practice. Unemployment and high inflation both set in by late 1973 (ie. “stagflation”) and persisted for years—something the Keynesian theory claimed was impossible.
After five more years of failed Fed attempts to print the nation's way out of the slump, the Carter Administration appointed G. William Miller to chair the Federal Reserve.
Miller, a Textron executive with no banking or monetary policy experience, quickly proved to be a passive policy dove, voting with the FOMC minority against raising rates even as inflation reached 13% by late 1979.
Jimmy Carter sensed worsening stagflation was jeopardizing his reelection chances and reversed course, “kicking Miller upstairs” to head the Treasury Department and nominating Paul Volcker as new Fed Chairman.
Volcker committed himself to end what had by then become nearly a decade of inflation-by-design insanity. In an Oval Office meeting to discuss his nomination, Volcker gestured with his cigar to Miller who was in the room. “You have to understand,” he then told President Carter, “If you appoint me, I favor a tighter policy than that fellow.”
By early 1980 the inflation rate was 15% and new Fed Chair Volcker hiked the Fed Funds policy rate to 18%, peaking near 20% by early 1981.
The policy worked and inflation came down, but it created a sharp recession in 1982-83. Unemployment peaked at 11% (versus 10% after the 2008 financial crisis) and by 1983 a 1970 dollar’s purchasing power had been whittled down to just 38 cents.
However, just as was the case during the Depression of 1920-21, the recession ended quickly and the blowing out of untenable enterprises started in an environment of cheap credit and high inflation laid the groundwork for a decade of real, rational economic growth. Incredibly, in a four-consecutive quarter period during 1983-84 real GDP growth consistently exceeded 8%.
Ultimately the 1980’s was one of the top five GDP-growth decades in American history, both real and nominal, even when including the Volcker recession.
Postscript: Note that all of America’s 10%+ inflations coincide with one or both of two necessary conditions:
1. The suspension of the gold and/or silver standard
2. A privileged or monopoly central bank executing government policy
During those periods in U.S. history when neither condition was satisfied—that is, the country was on the gold standard and no central bank existed—inflation has never exceeded single digits.