Sunday, December 21, 2008
Jim Grant writes another timely essay in the Wall Street Journal's weekend edition that adds to the growing doubt over the recent direction of monetary policy, not only in the U.S., but all around the world where money and credit is gushing from nearly every central bank.
Mr. Grant thinks that central banks are part of the problem, not the solution, a view that was shared by one Elihu Root almost a hundred years ago who served his only stint in the Senate during the years between the panic of 1907 and the formation of the Federal Reserve in 1913.
According to Wikipedia, his credentials are rounded out by service as Secretary of War under President McKinley (1899-1904), Secretary of State under President Roosevelt (1905), and winning the Nobel Peace Prize in 1912. Mr. Root was one of many early 20th century "wise men" who "shuttled between high-level government positions in Washington, D.C. and private-sector legal practice in New York City".
A hundred years later, contemporary "wise men" have eschewed legal practice, toiling instead for Goldman Sachs and Citigroup when not working "for the public good" in Washington.
Grant recounts how things have changed in Washington and on Wall Street over the last century, the transformation of money and credit into something infinitely more responsive to both politicians and financiers playing a central role, in a piece that is well worth reading in its entirety.
We'll skip right to the part about Elihu Root and the formation of the Federal Reserve.
Promoters of the legislation to establish America's new central bank protested that they wanted no soft currency. The dollar would continue to be exchangeable into gold at the customary rate of $20.67 an ounce. But, they added, under the Fed's enlightened stewardship, the currency would become "expansive." Accordion-fashion, the number of dollars in circulation would expand or contract according to the needs of commerce and agriculture.When brought back to the present day, the story becomes very depressing, very quickly, with talk of only two possible outcomes from our current predicament - either a "deflationary abyss" or a "doozy" of an inflation.
Elihu Root, Republican senator from New York, thought he smelled a rat. Anticipating the credit inflations of the future and recalling the disturbances of the past, Mr. Root attacked the bill in this fashion: "Little by little, business is enlarged with easy money. With the exhaustless reservoir of the Government of the United States furnishing easy money, the sales increase, the businesses enlarge, more new enterprises are started, the spirit of optimism pervades the community.
"Bankers are not free from it," Mr. Root went on. "They are human. The members of the Federal Reserve board will not be free of it. They are human....Everyone is making money. Everyone is growing rich. It goes up and up, the margin between costs and sales continually growing smaller as a result of the operation of inevitable laws, until finally someone whose judgment was bad, someone whose capacity for business was small, breaks; and as he falls he hits the next brick in the row, and then another, and then another, and down comes the whole structure.
"That, sir," Mr. Root concluded, "is no dream. That is the history of every movement of inflation since the world's business began, and it is the history of many a period in our own country. That is what happened to greater or less degree before the panic of 1837, of 1857, of 1873, of 1893 and of 1907. The precise formula which the students of economic movements have evolved to describe the reason for the crash following the universal process is that when credit exceeds the legitimate demands of the country the currency becomes suspected and gold leaves the country."
Little did Mr. Root suspect that the dollar would lose its gold backing altogether -- that, starting in 1971, there would be nothing behind it more than the good intentions of the U.S. government and (somewhat more substantively) the demonstrated strength of the U.S. economy. Still less could he have guessed that the world would nonetheless fall in love with that uncollateralized piece of paper or -- even more astoundingly -- that the United States would enjoy so great a reservoir of good will...
We need more "wise men" in our government - the early-20th century variety, that is.
This week's cartoon from The Economist: