The excesses of the last decade seem to have finally caught up to the United States. This fact is still dawning on millions of Americans who know something is up but have not idea how serious it really is. Most expect it to blow over in a a few weeks just in time as we get ready for Christmas season. Make no mistake the past few weeks we have certainly been walking down along many of the same paths trodden in 1929, 30 and 31. For now we are very lucky to have avoided falling off the precipice. This luck is not guaranteed to last, especially with the US of A in much worse financial shape than in 1929 after living on trillions of dollars of borrowed money.
Our political leaders were briefed last week by Hank Paulson and Ben Bernanke on the severity of what happened on Wednesday when money markets locked up and were on the verge of seizing up. A threatened electronic run on all these financial instruments was in store for the next day, followed by wholesale business shutdowns, bankruptcies and massive layoffs. Once started this implosion would be impossible to halt. The vortexes put in place by the earlier collapses have spread fear and uncertainty far and wide, it's every man, woman, corporation and institution for themselves.
As Congressional leaders that were in the big meeting left shell shocked and a bit more circumspect than usual, they then arrived back in their offices to hear the fallout. Populist rhetoric about how the big institutions get bailed out while the man on main street gets the bill began immediately. Pelosi started to recover her senses as fellow democrats started to stiffen her spine and show her the political advantages of holding out for their interests. Perhaps they could get a "main street bailout" for their constituents. Ron Paul continued his brand of rhetoric that the good old gold standard and leaving these Wall Street interests to the fate they so richly deserve. Newt Gingrich chimed in to announce that this solution was just plain wrong and would lead to bigger problems down the road. As he said:"Congress was designed by the Founding Fathers to move slowly, precisely to avoid the sudden panic of a one-week solution that becomes a 20-year mess."
This is not a situation that was through out by the founding fathers where hours matter and careful deliberation is not an option. When in time of war the President does not wait on advice and consent of the Congress since to do so would invite defeat. In this case Congress is needed to approve legislation in the middle of a crisis that does not allow time for careful deliberation followed by liberal amounts of pork barrel spending. Of course it is the Congress itself that has run up our national debts while incurred financial commitments to the tune of $54 Trillion. In the end these commitments are certain to doom us.
Helicopter Ben as a student of the Great Depression knows when send out the helicopters. Unlike these people advocating inaction and deliberation in the midst of an epic battle, he and Paulson are trying to put a tourniquet on the wound. The question now is this: Will we be forced to follow the path encouraged by the Roy Young (Fed Bank Boston) in 1930 towards inaction while our financial system shuts down and our whole capitalist system implodes? Even if we learn from this past debacle, and take proper action it still may be too late to prevent it. Meanwhile, we must endure the political posturing interleaved with more panic and deterioration.
Unfortunately, the real causes of the Great Depression are not taught in schools and instead populist explanations are presented as fact. These facts blame greed, capitalism and especially the diabolical money interests located back east on Wall Street. We hear this same refrain today. People knowledgeable in the facts know that in 1929 a normal business cycle recession was turned into a Great Depression by the inaction of relatively new government agency - the Federal Reserve System.
This agency was termed the "lender of last resort" to prevent panics like the big one in 1907 from occurring again. Instead it made it much, much worse. In this epic drama the limits of a bureaucratic entity and the personalities of the different players involved would combine to create inertia while the financial lifelines of a great country congealed, businesses stopped, food rotted on the vine and millions of people were laid off to face an uncertain and bleak future.
After the stock market crash the Federal Reserve Bank of NY responded properly to the crisis by injecting money into the market to stabilize it. Harrison its governor did this from "their own account" and without approval of the board. Since the NY Bank was the de-facto leader of the Federal Reserve System dealing with its counterparts in Europe and around the world they had the experience to deal with the crisis, however the untimely death of the Benjamin Strong a powerful and respected leader has left Harrison, a lawyer running the NY Bank. The more regionally minded reserve banks were jealous of NY and took issue with Harrison's decision to inject funds. Many of them did not agree with the idea that the Federal Reserve, a government agency would and sell buy Federal securities to inject in liquidity to the market. So much for the lender of last resort. When asked why the Federal Reserve Act had specifically given them these powers, Ben Strong replied "they are there to use!" Too bad this Ben was already in his grave.
Harrison's initial effort to pump money into the system was correct and the things stabilized. Banks received more funds for a year after the crash as depositors felt lucky to not be putting their money in banks and not in stocks and bonds. A full year later the first run on the banks started with a few small banks in the west until it led to bank named the Bank of the United States. The name itself caused a panic as it was thought by some that "the" Bank of the United States had failed. The failure to salvage this bank resulted in cascading runs on other banks. The Federal Reserve remained inactive through this and the following second crisis. Keeping it's portfolio of securities dry in case an emergency would require them!
Throughout 1932, 33 the Federal Reserve tried to stay inactive, while pleading impotence and to push the blame on things like "bad" banks. Many thought it was therapeutic to let these "bad" banks fail. When Congress forced it to intervene by injecting funds it was too small a scale, especially while France was busy pulling all the gold out of the country.
Attention Ron Paul: when you are on the gold standard your internal monetary system is controlled from outside forces, a dependant variable - think China.
These banks when they suffered a run had to liquidate assets, bonds especially at a time when everyone was selling them. Since funds deposited are also lent out in a fractional reserve system they had to destroy $29 of assets to give each depositor $1 of net currency by the time the final collapse happened!
With these distressed assets on the books many of our financial institutions remain at risk to go under, taking with them more and more. This includes major US corporations. Think about companies not being able to stock store shelves. Time is critical to prevent a possible catastrophe. As demonstrated by Milton Friedman in his Monetary History, a injection of $2 billion would have fixed things easily at the early stage of the collapse. As time went on the amount of money escalated quickly. It is better to nip it in the bud that watch it expand geometrically. These lessons were learned long ago by Walter Bagehot and even Alexander Hamilton who faced the rupture of our first stock bubble in 1790s.
The potential for collapse in this instance resembles the failure of the World Trade Center - once the floors start to pancake they will continue to do so all the way down. We can argue about the building's architecture later right now the goal is to prevent the rupture.
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