1937, the Fed, the stock market, and the Treasury

Sitting on cash when people want cash drives up interest rates. High interest rates discourage investment. They discourage investment even more when investors are already predisposed against expanding operations to provide for future demand that they're uncertain about. They discourage investment even more if there are arithmetic barriers to relief on interest rates (like a nominal price floor and weak inflation).

As far as the economy is concerned, it doesn't matter who does it: households increasing savings, businesses demanding and retaining higher profits, central bankers mandating higher reserves, or fiscal authorities sitting on money. As far as history is concerned, of course, sometimes one entity is more to blame than another.

Paul Krugman recently wrote a post on the "recession within a depression" of 1937, which he says eerily parallels the discourse we see today. He says (citing Friedman and Schwartz) that in 1936-1937 the Federal Reserve started getting concerned about the inflationary potential of the large growth in excess reserves. These concerns are not unlike those we are hearing today. They responded by raising reserve requirements, a decision which Friedman and Schwartz consider to be the source of the 1937 downturn. Krugman raises doubts about how important this policy really was, citing the Romers. Recent research looking at Federal Reserve member banks by Calamoris, Mason, and Wheelock (2011) confirms Krugman and the Romers' suspicion that Friedman and Schwartz were too quick to blame the Fed. They demonstrate that the reserve requirement rules were non-binding. This is all in the spirit of Krugman's own mentor, James Tobin, who said of the 1936-37 Fed policy that "raising reserve requirements may have been a mistake but it was probably a relatively harmless one."

Jonathan Catalan presents a response that ties Krugman to Friedman and Schwartz (which seems a little odd to me). Aside from the question of what Krugman thinks fo the Friedman and Schwartz argument, Jonathan does identify the common thread between the three economists, that "the point Krugman is trying to make is that tight monetary policy will definitely set a recovery back". Jonathan, of course, disagrees - a position which he has staked out earlier in his Mises Daily article on the 1937 recession. He blames the stock market crash for the contraction of the money supply. Falling stock prices increased precautionary demand for money, leading to a contraction in the money supply.

This is a little confusing to me. As I understand it, the stock market crashed in August of 1937, the monetary base started falling at the beginning of 1937, and output started falling earlier in the spring. How does Jonathan get the causality going from the stock market to the monetary base? I don't entirely understand the argument.

So barring an explanation from Jonathan, he seems to be wrong in pointing to the stock market (and thus businesses and households) as the source of the reduction in the money supply. Friedman and Schwartz are wrong that the Fed is to blame (according to Jonathan, Krugman, Calamoris, Mason, Wheelock, Tobin, Romer, and Romer). So what happened in 1937?

Well once again we can look to Calamoris, Mason, and Wheelock (2011), who suggest that the real culprit may have been the U.S. Treasury. In 1936 the Secretary Morgenthau decided to play central banker and sterilize billions of dollars of incoming gold by stock-piling it and paying for it by selling government securities (rather than by depositing it at the Federal Reserve). This is just as contractionary as it would be if the Federal Reserve had engaged in open market sales.

Of course taxes were raised and the deficit was cut too - that doesn't help. But the gold sterilization point is interesting because you don't hear people talking about it as much.

Does this history make sense? I'm no expert on the depression, but the literature seems to point to this explanation. Perhaps Friedman and Schwartz defenders can reinvigorate the case for the impact of reserve requirements or Jonathan could explain how the stock market is causal here.

Telecom, Early Republic Style

This was a very interesting post by Matt Yglesias. He writes:

"Here’s another slice of What Hath God Wrought:

The United States Post Office constituted the lifeblood of the communication system, and it was an agency of the federal government. The Constitution explicitly bestowed upon Congress the power “to establish post offices and post roads.” Delivering the mail was by far the largest activity of the federal government. The postal service of the 1820s employed more people than the peacetime armed forces and more than all the rest of the civilian bureaucracy put together. Indeed, the U.S. Post Office was one of the largest and most geographically far-flung organizations in the world at the time. Between 1815 and 1830, the number of post offices grew from three thousand to eight thousand, most of them located in tiny villages and managed by part-time postmasters. This increase came about in response to thousands of petitions to Congress from small communities demanding post offices. Since mail was not delivered to homes and had to be picked up at the post office, it was a matter of concern that the office not be too distant. Authorities in the United States were far more accommodating in providing post offices to rural and remote areas than their counterparts in Western Europe, where the postal systems served only communities large enough to generate a profitable revenue. In 1831, the French visitor Alexis de Tocqueville called the American Post Office a “great link between minds” that penetrated into “the heart of the wilderness”; in 1832, the German political theorist Francis Lieber called it “one of the most effective elements of civilization.”

A reminder that when big government is made to work well, the gains are gigantic. Nowadays it seems to me that publicly owned and operated post offices are basically anachronistic, but this was a crucial public service in geographically expanding and overwhelmingly rural country at a time when letters in the mail represented state of the art communications technology. And the underlying idea of the USPS, that the government should be facilitating the creation of high-quality communication, remains true today. That’s why the question of the AT&T/TMobile merger seems so important. The fact that the Computer & Communications Industry Association (Google, Microsoft, EBay, Yahoo, Facebook) is vehemently opposed to the deal strikes me as a credible indication that letting it go through would be a mistake."

People today have a view of the founders that I think would have shocked the founders themselves. We look back and we don't see a very active federal government, and of course there's a reason for that. The founders placed a premium on limited government. That has been the quintessential American tradition. But a lot of people take that tradition and turn it into a case for sterilizing self-government and democracy where it could be the most productive, and it's this tendency that I think would be most shocking to the founders - particularly the Jeffersonians. In a lot of ways, the government was on the cutting edge and the post office is one example. Jefferson also pushed for state-sponsorship of a truly modern post-secondary education institution. Prize funds and bounties were common for industrial innovations. The early republic only looks libertarian today because the Post Office seems so quaint, so we write it off. We don't see it as the major intervention that it was. The Post Office is also a good example because we probably really don't need public mail delivery anymore. It's an example of how these things change over time. Space exploration is the same way. We are past the point where NASA needs to dominate space exploration. At one time NASA did need to do that, but now it's not clear it does. Once we establish colonies on Mars, it's not clear that we'll need any space agency at all (until that time, there are major externalities associated with colonization that I think really require a public agency).

I also think we gravely misread the founders because of our constitutional history. There was a major fight in the early republic over how far the general welfare clause extended. There wasn't substantial disagreement at all over whether the Congress should take on public works projects or internal improvements. There was only a disagreement over the legal niceties. Here, the Jeffersonians argued that the Constitution needed to be revised to include it. This is not a surprising argument and it should not be confused with a lack of enthusiasm on the part of the Jeffersonians. Jefferson, after all, was under the impression not only that the Constitution would be revised frequently but that it would be scrapped and rewritten many times over. Things didn't work out that way, of course. The preponderance of opinion went with a reading of the general welfare clause that took the words "general welfare" to include things like internal improvements. This wasn't some great betrayal of '76. All agreed that was a provision for the general welfare. But it's given an odd impression of creeping interventionism and some sly abandonment of what was fundamentally Jeffersonian. I really don't think it was. If Jefferson knew in advance that our Constitution worked so well and that we wouldn't scrap it and rewrite it on a regular basis, I don't see any great obstacle to him accepting what became the dominant reading of the general welfare clause. What he expected to achieve through regular democratic revision has been achieved through an understanding of the constitution itself as a democratic document giving Congress discretionary authority to provide for the general welfare. Jefferson's primary concern was that this power be held democratically and not tyrannically. His concern with the federalists was their enthrallment to stockjobbers and bankers - that they would wield power undemocratically. His solution was to keep the construction of our understanding of federal power democratic. In other words, Jefferson said what he said about the Constitution with Hamilton and Morris in mind. If he knew Jackson was just around the corner, I think he would have reacted differently. Does this make sense? And if Jefferson won and we had a regularly, democratically revised Constitution perhaps there would have been no need for Jackson.

Either way, the little dance that the Constitution and policy did in the 1810s-1840s or so has given the impression that there were a lot of libertarians running around in the early republic. I simply don't think that was the case.

Wood on Lepore and the Tea Party's Take on the Revolution

Gene Callahan favorably cites and David Sehat unfavorably cites a new article in the New York Review of Books by renowned historian Gordon Wood criticizing Jill Lepore's book The Whites of Their Eyes: The Tea Party's Revolution and the Battle Over American History. It's hard to evaluate this because I still haven't gotten a chance to read Lepore's book. She could be as boorish and snobbish as Woods suggests, but the impression I got from earlier statements by her and discussions of her suggest to me that Woods is being a little unfair.

Lepore's argument, as I understand it, is simply that the Tea Party mischaracterizes a lot of the American Revolution and at the very least is guilty of what she calls a "historical fundamentalism" that embraces a single, ideologically convenient understanding of history that doesn't truly reflect not only the Revolution, but the fact that the revolutionaries were fighting fundamentally different battles at a fundamentally different time.

It's hard to tell what Wood has a problem with. Tone? Perhaps its harsh, but I didn't get the impression it was. Historical inaccuracy? I'm not really sure.

I don't think it's that debatable to suggest that the Tea Party has recreated the American Revolution in its own image. As Lepore points out, people do that all the time in America. It's an inaccurate thing to do, but it does say a lot about how we see ourselves. I'm receptive to that and I had gotten the impression that Lepore was too (she's said that Tea Partiers are genuinely interested in Revolutionary history). What bothers me is when Tea Partiers take that and start telling people that they are traitors to the founders, etc.

Anyway - enjoy the article, and if anyone has read Lepore's book I'm interested in what you thought.

States Rights and the Constitution in Virginia

Virginia House Speaker Bill Howell (R-Fredericksburg) has announced that the Virginia legislature will consider an amendment to the Constitution that will allow two-thirds of the state legislatures to repeal federal legislation. Right now, I have no idea how plausible this is - I am skeptical about how far it would get, but it's fascinating for at least two reasons.


Reason 1: It's a pretty decent reform that is not what Tom Woods has been proposing
First, like the repeal of the seventeenth amendment, I think this is actually an excellent Constitutional reform. The arc of Constitutional reform for most of the 19th and 20th centuries was in the right direction: expansion of democracy, incorporation of the states into Constitutional defenses of liberty, and the solidification of the federal government as a functional institution of governance. But what we've found is that while democracy and equality have benefited from the amendments we've passed, federalism has atrophied as a meaningful pillar of American society. The question is, how do we give greater primacy to federalism? For a while we tried to do it legislatively with various devolution measures, and these provided a mixed record of success. In the end, my assessment is that these devolution measures ended up giving the states more freedom of action, but essentially putting them on a federal allowance. Repealing the seventeenth amendment, which provided for the direct election of Senators, would elevate the role of the states in a meaningful way, and make the federal government accountable to the states. This amendment that will be considered by the Virginia legislature would appear to do the same. Winning two-thirds of the state legislatures for repeal is quite a hurdle, after all. It's a relatively conservative measure, in that sense.

Of course for my libertarian readers, I'm sure this brings Tom Woods' recent push for nullification to mind. Nullification is a tough subject, and I think this is especially true for thoughtful Southerners. On the one hand, if a law is blatantly unconstitutional, I don't think anyone would really balk at local officials who stand up against it. Lots of states have marijuana laws, and have moved against the Patriot Act, etc. I would argue that when nullification is used against truly heinous federal laws as Jefferson and Madison originally intended it to be used against the Alien and Sedition Acts, you don't have a groundswell of opposition to it. We have an inherent sense of what is appropriate without assuming a right of the states to opt-out of the decisions of the Union. Woods doesn't have to make his case on these counts - he'd be preaching to the choir. What bothers me about Woods is that he's trying to push an opt-out understanding of the Constitution that allows any state to appeal to even the most defunct and demolished understandings of what is "unconstitutional" to chart its own course. This is not federalism - this is a repudiation of our constitutional republic. Moreover, this is not what Howell is proposing at all.

I'm sure Tom Woods will embrace Howell's proposal in the Virginia legislature (and I'm sure that lots of normally objective liberals are going to howl against it make vague references to the Confederacy), but it's simply not the same as Woods' nullification. This is not an opt-out for states. This is a reform of the way federal legislation is passed that does provide a greater role for the states, but still relies on very broad consensus for action. Two-thirds of the states deciding they don't like one egregious piece of legislation is very different from South Carolina deciding it doesn't want to be bound by two-thirds of federal legislation because some crack-pot Constitutional "scholar" supplied them with a handful of bad arguments telling them they don't have to. This isn't the Tom Woods nullification plan - this is the anti-Woods states rights plan.

Reason 2: It opens Pandora's Box on the Constitution
Jefferson has remarked that the tree of liberty must now and then be fertilized with the blood of patriots and tyrants, and that constitutions should be scrapped and rewritten on a regular basis. I'll humbly disagree with Jefferson on this point, and submit that he probably would have come around to the modern view himself. Jefferson's primary concern was that he didn't want previous generations binding future generations to their understanding of government. In other words, Jefferson was a progressive and a democrat that wanted flexibility in government. What I think we've learned is that (1.) war is an awful and scarring way to keep government flexible, and (2.) the Constitution was constructed with deliberately flexible language for precisely the reasons that Jefferson was concerned about: the founders wanted to leave a wide open field for their descendants to chart their own destiny, within a structure that they carefully set to balance liberty, equality, and self-governance.

What does this have to do with Howell's proposal in the Virginia legislature? Howell is proposing to pass this amendment with a constitutional convention. Two-thirds of the state legislatures would have to call for a convention, at which three fourths of the states would have to ratify the amendment. No constitutional amendment has ever been passed in this way - all have originated in Congress. One of the concerns is that if a convention is called, the whole Constitution could be scrapped or modified. This is essentially what happened with the first Constitutional Convention, after all. Needless to say, I think this probably wouldn't be an ideal move. Our Constitution is working well, but I don't hold the document sacred. I'm more concerned that I don't think anyone today could write one that would improve it, and I'm especially concerned about the hostilities and passions it could raise. Of course, if a convention were called without incident or radical change, that could be a great step forward.

Federalism is weak in this country. The Constitution has served us well, but people don't place a lot of value on it and the ones that loudly proclaim the value they place on it often distort it to fit their own ideology. This Howell amendment probably won't pass, but at its heart it offers a very good proposal and raises some interesting issues.

Assault of Thoughts - Thanksgiving Edition - 11/25/2010

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

First - Happy Thanksgiving!

- The New Republic has put up a series of archived articles that it has published on the Puritans here. I'll allow it because it's still interesting New England history. But it's still shaky to associate this too closely with Thanksgiving. Thanksgiving marks a harvest celebration of the Pilgrims of Plymouth Colony, who could accurately be described as "Puritans". The important thing to remember is that while it's probably safe to call all Pilgrims "Puritans", it's not safe at all to call all Puritans "Pilgrims" or associate all Puritans with Thanksgiving. The major Puritan wave came later and settled Massachusetts Bay Colony*. Here, The New Republic seems to present some articles on the Pilgrims, but some on later waves of Puritans that had nothing to do with the establishment of Thanksgiving.

- At Think Markets, Chidem Kurdas reviews past reactions to Thanksgiving. She cites Daniel Boorstin, noting that the Puritans did not celebrate Christmas, leaving Thanksgiving as a good chance to take it easy (so here Kurdas also talks about "Puritans" rather than "Pilgrims", but since she's not talking about the first Thanksgiving - but rather later celebrations of it - she seems in the clear). She also hints at some of the thinking behind Roosevelt's decision to establish Thanksgiving as the fourth Friday in November: it provided an extra shopping day and therefore served as a stimulus of sorts.

- Thanksgiving is always a great opportunity to highlight the power of market exchange to foster social progress. I'm sure everybody knows the story - when the Pilgrims landed at Plymouth they required that everyone share everything they produced. They established a communist society, essentially. It failed miserably, Governor Bradford ended it, and they all lived happily ever after. Alex Tabarrok has a longer version here from a couple of years ago, with a good long selection from Bradford on the episode. I do think it's important to emphasize that this does not rule out charity or collective action. The survival of the colony was not merely due to the emergence of a market economy. They also have the Wampanoag to thank for their survival. But the point is clear - collectives cannot run markets. State care for the poor, of course, continued in Massachusetts throughout the colonial period and up to the present day. But that's very different from expecting a collective to run a market. I think it's great that we have such a good example of market efficiency so early in our history to point to. It sets a very important precedent.

- All this talk of Massachusetts is moot, of course. Why? Because the first Thanksgiving celebrated in English speaking America occurred where all great "firsts" in English speaking America occurred: Virginia. In 1619, two years before the Pilgrims celebrated theirs and almost a year before the Pilgrims even set sail on the Mayflower the twelve year veteran colonists in Virginia celebrated their own Thanksgiving at Berkeley Hundred (which is just up the road from William and Mary).



*This includes the earliest ancestors of mine that I know of to come to America. Thomas Joy came over to Massachusetts Bay Colony in 1635 - a Puritan, but not a Pilgrim. My maternal grandmothers maiden name was Joy and we can trace it back from there. We're going to Baltimore this Thanksgiving, and I know my paternal grandmothers line has been in Baltimore (the Eney's) since at least 1850 (I've written here before about H. Vernon Eney and his work on the Maryland Constitutional Convention of 1968). So the Eney's may go back a ways too - I just don't know. If Maryland was where they first settled, it's unlikely they've been here longer than Thomas Joy. We also have French Canadians on my mother's side - the Comeau's - who conceivably could have been here before Thomas Joy. Again I just don't know, but I imagine that's unlikely. The Kuehns themselves came from Germany in the 1890s or so, so they're the late-comers. Finally, on my Dad's side, we have Davises in ante-bellum Alabama. As I understand it, much of the settlement of Alabama came from the Carolinas, which again makes it unlikely that any of these Davises pre-date Thomas Joy - I have no reason to expect it, but again I just don't know (after the Civil War, the Alabama Davises moved to North Carolina where they stayed until the early 20th century at which point they moved to Maryland, where my great-grandmother Margaret Davis met and married my great-grandfather and well established Marylander H. Vernon Eney).

The Forgotten Depression or the First Great Recession?

I now regularly Google various combinations of "1920-1921 depression" to keep my finger on the pulse of the discussion of the episode, paying particular attention to discussion of it on blogs.

One thing that pops up regularly is "the 1920-21 depression was very deep but we got out of it quickly!" I'm not sure where I'm pretty sure I know where this meme got started, but it's simply not true. The 1920-21 depression lasted 18 months, which of course pales in comparison to the Great Depression.

But if you compare that to the duration of recessions in the period after the Federal Reserve began operations (in 1914), it is tied as the second longest recession on record. And which episode is it tied with? You guessed it! The current "Great Recession" - which has also been dated as lasting 18 months.*

Now, how much do these durations really mean? That, of course, is up for debate. One of the biggest reasons why we even care about economic fluctuations is the impact they have on unemployment. Unemployment can persist long after the decline in economic activity has ended, and we've certainly had periods where growth has picked up but employment hasn't. It's legitimate that people aren't so sanguine about such occurrences. How you rank recessions based on what matters to you is your business. But the point is, under no reasonable definition was 1920-21 a quickie. Even if you redefine what matters to you so that 1920-21 is no longer tied in second place, it's still among the longer downturns in recent American economic history.

UPDATE: That's a lie... I'm not sure why I said that in the second paragraph. I know exactly where this meme got started - the same place that most of the memes about the 1920-21 depression that are floating around there got started.

*The 1913-1914 recession was longer than 1920-21, but it was well under way by the time the Federal Reserve started operations, which is why I left it out of my "post-Fed" count. This recession endured 12 months after the passage of the Federal Reserve Act in December of 1913. I'm not sure when Fed operations started in 1914, so I'm not sure how long it lasted after the Reserve System itself got off the ground.

Krugman contra Schumpeter

As we find on so many subjects, Jefferson said it best:

"We have time yet for consideration, before that question will press upon us; and the maxim to be applied will depend on the circumstances which shall then exist; for in so complicated a science as political economy, no one axiom can be laid down as wise and expedient for all times and circumstances, and for their contraries." (Jefferson, 1816)

Paul Krugman could have quoted Jefferson to good effect in his rebuke of Schumpeter this morning. He presents this passage from Schumpeter's "The Economics of the Recovery Program" (1934):

Krugman responds: "He lays out the extreme liquidationist position, arguing not just against the use of fiscal policy to fight unemployment but even against monetary policy, lest it get in the way of the “work of depressions”... But here we are, in 2010 — and something very much like that position is being forcefully advocated by Wolfgang Schauble, the government of China, Narayanan Kocherlakota, and Sarah Palin."

You might wonder, though, what "the two cases we analyzed" that Schumpeter refers to in the beginning are. Well if you read "The Economics of the Recovery Program" you'll learn he's refering to 1825 and 1873. Let's start with 1873, because this is where Jefferson comes in. The so called "long depression" following 1873 was nothing like the Great Depression that Schumpeter was commenting on, primarily because it wasn't really all that depressing! In the decade or two following 1873, the United States saw substantial improvements in productivity that lead to positive supply shocks. Prices, of course, went down. Now that deflation was painful for farming communities, etc., but aside from that sort of caveat this was good deflation and good growth. This is commented on extensively by Rothbard as well as Friedman and Schwartz. It is very broadly accepted history. But as I point out in this recent post, shifts in aggregate supply are very different from shifts in aggregate demand. I don't know if Schumpeter actually didn't realize this, or if he's just trying to play fast and loose with a less academic audience, or what but Jefferson's maxim here is especially important - you can't compare apples and oranges. You can take the experience of 1873 and use it to inform 1934*.

I don't know that much about the 1825 depression, so I did some looking. It turns out, this episode was very much comparable to the 1930s: a financial crisis caused an increase in money demand and a general glut. That would have been Keynes's diagnosis if he lived in 1825, and it was Jean Baptiste Say's diagnosis (he came around to Malthus's position eventually). A typical Keynesian solution would be fiscal and monetary stimulus, of course. Now, Schumpeter says of 1825 that "recovery came of itself" - without any artificial stimulus. Is he right about that? Again, I don't know the episode all that well, but appears he is quite wrong about this. Charles Hughs Smith in the Daily Finance writes that: "Walter Bagehot, the influential editor of The Economist in the 1860s and 70s, held the view that the first task of a central bank during a financial panic is to end the panic. In 1825, after some initial hesitancy, the Bank of England did exactly that by lending money to anyone with just about any sort of collateral -- not just sound assets but even illiquid assets. This flood of new lending staunched the panic, but the stock market slump and recession lasted into 1826."

So here's the situation: Schumpeter was right that "recovery came of itself" in 1873 but wrong that it was comparbale to the situation in 1934. Schumpeter was wrong that "recovery came of itself" in 1825, but right that it was comparable to the situation in 1934. This is why it matters to (1.) first and foremost get your history right, and (2.) think critically about how comparable historical episodes are. Not all recessions are created equal. We need to permanently dispell this myth that there is one process that causes fluctuations in economic activity. It's dangerous and it leads to bad policy.

- This is a Marxist perspective on 1825

- This is a commentary by Michael Bordo (Rutgers and NBER) on 1825, and

- This is an article by Richard Anderson (Federal Reserve Bank of St. Louis) on 1825

*I should note that there was a major monetary shock in 1873, and a financial panic that induced several bank runs and failures. So there were some very real problems in 1873 itself. But the "long depression" that followed does not appear to be a result of this - the only real thing that qualified the "long depression" as a depression was the price level changes. We experienced real growth after the initial, and very real, Panic of 1873.

Thoughts on the Election

Not this one, of course... I'm speaking of 1932/1936/1940/1944:

Bryan Caplan writes a review of V.O. Key's classic The Responsible Electorate (1966) which argues that "democracy works well because the electorate rewards success and punishes failure". This obviously doesn't sit well with Caplan, author of The Myth of the Rational Voter, and regular opiner that voters aren't that enlightened (which strangely enough never wins censure from his co-blogger, Arnold Kling, who regularly criticizes liberals for thinking the electorate is dumb even though, (1.) I'm not aware of any liberal save Bill Maher who has made such a claim, and (2.) Caplan makes the claim regularly). One thing that Caplan remarks on is the case of FDR. Caplan writes: "Key's passage [about Roosevelt] is bizarre on several levels. The most glaring: Roosevelt is the best U.S. counter-example to the thesis that voters reward politicians for delivering prosperity and peace. FDR's track record is bizarrely bleak: Nine years of uninterrupted depression, followed by four years of war that left half of Europe in the hands of Stalinist Russia - one of the two original aggressor nations. And the American voter loved him anyway!"

I did a double-take when I read this. The Depression was deep and it stayed deep, of course. But the economy grew through Roosevelt's entire first term! The recovery was far too slow, and we know more now why, but the only major blemish on the recovery and Roosevelt's record was 1937, and that happened after the 1936 election (so it makes sense it didn't do that much to his re-election prospects). How is Caplan missing this Roosevelt growth period? It wasn't an ideal economy, but it seems like American voters are better at thinking in terms of counter-factuals than we give them credit for (and better than a lot of economists today).

I'm also not sure why Caplan thinks the war is a mark against Roosevelt and not for him. George W. Bush waged war against a fascist too, but a relatively inert fascist (at least as far as world affairs are concerned - certainly not if you lived in Iraq). Roosevelt waged war against a fascist across the Atlantic that was taking over Western civilization and bombing the hell out of our ally Britain, and a fascist across the Pacific that had taken over China (mother-$%^&ing CHINA!) and was impinging on our ally Australia. Oh ya - and they bombed us too and destroyed a substantial portion of our fleet. What the hell is Caplan thinking? He really thinks this is something Roosevelt should be punished at the polls for?!?!? Why - because the enemy of my enemy is my friend and so we had Uncle Joe for a few years? I'm no war-monger and I think nationalism is a disease (although an improvement on feudal fiefdoms), but I don't think those views give me or anyone else license to turn a blind eye to what it was we accomplished in the second World War.

I know libertarians have an acute distaste for certain presidents. Lincoln was a protectionist and took liberties with the Constitution. Wilson was a racist and a progressive egghead. OK. I draw the line at Roosevelt, though. Come on! Dispute specific policies, fine - be my guest. But don't play dumb as to why the American people sent him to the White House twice as many times as any other president in our history and why he is the only president in the twentieth century that has really, substantially, unequivocally joined the pantheon of great American leaders that is usually reserved for the Founders.

On History and Tea

Craig Fehrman writes about historian Jill Lepore's work documenting the Tea Party's use and abuse of history, something I've brought up many times on here. Lepore has a new book out called The Whites of Their Eyes: The Tea Party's Revolution and the Battle Over American History on the same subject that looks quite good. Lepore seems to try to be open and even-handed, if critical. She calls the Tea Party "good, sweet people" who "really are interested in the Revolution". The whole Fehrman article is good, providing details not just on Lepore's criticism but on how she came to be involved in this.

I've talked about the Tea Party and its relationship to history here, here, and here, and probably a few other places too.

And speaking of the Tea Party, the Austrian Economics and Literature blog notes some things that recent Nobel laureate Mario Vargas Llosa had to say about them, that there is "in the core of this movement something healthy, realistic, deeply democratic and libertarian". As I've said in my post on Kevin Rollins's event, I think this view is naive and a little dangerous to indulge. I don't know why some libertarians have such rose-tinted glasses when it comes to the Tea Party. Maybe it's because it's their first real shot at political power? I know they'll protest that they're not interested in political power, but I seriously doubt their interest in power is any different from anyone else's. I'm not interested in political power either, but it doesn't mean that I'm going to be indifferent when a sensible Democrat like Barack Obama appears poised to topple the Bush legacy. That doesn't make me power-hungry, but it does make me involved. I think a lot of libertarians are the same way. They want to be in power, damn it! They can taste it now. It was the vibe that was running through that George Mason meeting on Sunday. Some libertarians think the Tea Party is their ticket in. I'm a little more circumspect.

Don Boudreaux on Pre-Industrial America

Don writes about how nasty life in the American colonies could be. Even our best attempts at reproducing the past, like Colonial Williamsburg, don't even begin to communicate how hard life was. A lot of this is inevitable - you're not going to start a small-pox epidemic for the sake of historical accuracy, after all.

Keynes's Foreword to the German Edition of the General Theory

Lurking in the cracks between what one school of thought considers worth talking about and what its critics feel is worth engaging with are a few niche nuggets that critics latch on to with particular ferocity and impunity. Facing few, if any, counter-arguments from an unintrigued opponent, the critical interpretations of these nuggets become ferrell and fertile, spreading very quickly, practically unbeknownst to anyone else. Such is the fate of the foreword to the German edition of The General Theory of Employment, Interest, and Money. For many, it is proof-positive that Keynes is a thinly veiled fascist. For virtually anyone else, it isn't even on the radar screen. Many that may come across the reference and the critics' interpretation of it are likely to be dismissive. It's so patently absurd that a champion of British liberalism would embrace Nazism in the way that it is asserted that these interpretations of the foreword are dismissed as ravings, rather than analysis. What Keynesian is going to waste their time delving into the issue to prove the obvious point that Keynes was not a Nazi?

That's unfortunate, because while it may be particularly bad analysis, these are analyses nonetheless - not ravings. Meeting them is the surest way of curing them. I am going to review the foreword in its entirety here.

In September, 1936, a few months after the initial release of the General Theory, Keynes penned a foreword for the new German translation of the book. The foreword made clear (as was made clear in the introduction to the book itself), that his audience was primarily economists. He began with a history of thought, reviewing the underemphasis of Marshall's (his teacher and mentor at Cambridge) macroeconomic thought:

"Alfred Marshall, on whose Principles of Economics the education of all contemporary English economists has been based, took particular pains to call special attention to the relationship of his thought to that of Ricardo. His work consisted for the most part in stuffing the law of limited use [Grenznutzen] and the law of substitution into the Ricardo tradition, and his theory of production and of consumption as a whole—contrary to his theory of producing and distributing a given production—has never been laid open. I am not certain whether he himself ever perceived the need for such a theory, but his immediate successors and disciples surely have abandoned it and evidently never perceived its absence. I was educated in this atmosphere. I have taught these doctrines myself and it was only in the course of the last decade that I became aware of their inadequacy. In my own thought and development, this book, therefore, presents a reaction, a transition and a disengagement from the classical English (or orthodox) tradition. How I have stressed this and the points in which I deviate from the recognized doctrine has been regarded by certain circles in England as extremely controversial. But how could someone educated in English economic orthodoxy, who was even once a priest of that faith, avoid some controversial emphasis, if he becomes a protestant for the first time?"

Here, Keynes sets himself up against the classics, as he does in the General Theory itself. He's careful to show his debt to the classics, though, again as he does in several places in the main work. But what do Germans get out of this? He goes on,

"I can, however, imagine that all this may concern the German readers somewhat differently. The orthodox tradition which reigned in the England of the 19th century never had such a strong influence on German thought. In Germany there have always been important schools of economics which strongly questioned the adequacy of classical theory for the analysis of contemporary events. The Manchester School as well as Marxism, have, after all, stemmed from Ricardo—a conclusion that need cause surprise only when superficially considered. But in Germany there has always been a majority of opinion which adhered neither to one school nor the other."

Keynes is still engaging German economists and now goes on to precisely what German economic thought consists of:

However, it can hardly be contended that this school of thought ever established a theoretical counter-structure, nor did it ever attempt to do this. It has been skeptical and realistic, satisfied with historical and empirical methods and results which reject a formal analysis. The most important unorthodox discussion on the theoretical level has been that of Wicksell. His books (until recently not available in English) were available in the German language; one of his most important was in fact written in German. His successors, however, were mainly Swedes and Austrians; the latter linked his ideas in with a substantially Austrian theory, and thus in reality actually brought them back to the classical tradition. Germany thus has—in contrast to her custom in most fields of science—contented herself for a whole century without a dominant and generally recognized formal theory of economics."

The "skeptical and realistic" approach, "satisfied with historical and empirical methods and results which reject a formal analysis" is, of course, the German Historical School, best known through the work of Gustav Schmoller. Max Weber is also often counted among the ranks of later German historicists, but Weber never had the zeal or intransigence of Schmoller. The community most responsible for diminishing the historicists was, of course, the Austrian School under Carl Menger and his disciples during the Methodenstreit episode in the 1880s, which is very well documented in von Mises's short piece The Historical Setting of Austrian Economics. Keynes is highlighting here that German economics and British economics are quite different. The long-dominant historicists banished classicism from Germany for quite a while, and the neoclassicism that at least partially displaced this school was Swedish and Austrian in origin. A Marshallian wave - the tradition that was so resistant to reformation by one of its own prize pupils in 1936 - never really swept over Germany in the first place. That is the setting for this foreword. Keynes goes on, with quite a bit of optimism,

"I may, therefore, perhaps expect to meet with less resistance on the part of German readers than from English, when I submit to them a theory of employment and production as a whole which deviates in important particulars from the orthodox tradition. But could I hope to overcome the economic agnosticism of Germany? Could I convince German economists that methods of formal analysis constitute an important contribution to the interpretation of contemporary events and to the shaping of contemporary policy? It is, after all, a feature of German character to find satisfaction in a theory. How hungry and thirsty German economists must feel having lived all these years without one! It is certainly worthwhile for me to make the effort. And if I can contribute a single morsel to a full meal prepared by German economists, particularly adjusted to German conditions, I will be satisfied. For I must confess that much in the following book has been mainly set forth and illustrated in relation to conditions in the Anglo-Saxon countries."

Here, Keynes seems to be operating off the assumption that most German economists are still of some historicist persuasion at this point. I don't know enough about the history of German economic thought to evaluate this assumption. So far, the purpose and the audience of the foreword strikes me as being uncontestable. Keynes is discussing his theory as it relates to classical and neoclassical theory - of the Marshallian variety, particularly. He is opposing himself to British orthodoxy (not a particularly surprising move on his part), and he is telling German economists why that should be of interest to them. With this backdrop, Keynes moves on to the sentences that are most commonly highlighted by modern critics:

The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state [eines totalen Staates] than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory. Since it is based on fewer hypotheses than the orthodox theory, it can accommodate itself all the easier to a wider field of varying conditions. Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries where a large degree of laissez-faire still prevails, nevertheless it remains applicable to situations in which state management is more pronounced. For the theory of psychological laws which bring consumption and saving into relationship with each other, the influence of loan expenditures on prices, and real wages, the role played by the rate of interest—all these basic ideas also remain under such conditions necessary parts of our plan of thought.

Here Keynes is clearly talking about his "theory of aggregate production" - namely, the macroeconomic theorizing that he lead the foreword with, of which he said earlier that Marshall's students "surely have abandoned it and evidently never perceived its absence". This is the crux of the counter-argument, so this is where people should raise issues with my reading of the foreward if they have any. It was his theory of output, of aggregate output and aggregate demand, and not his brief review of a possible policy response - that "can be much easier adapted to the conditions of a totalitarian state". If there is any lingering doubt about this, he goes on to explain that his theory is dependent on fewer assumptions than British orthodoxy. Since totalitarian Germany departs so regularly from the assumptions made by British orthodoxy, such a theory is of little use to German economists. But a general theory may be of greater use. This, at least, is the argument. I see no reference in any part of this foreword to what has been understood as a Keynesian policy response. I see only references to Keynesian economic theory. And I see no defense of totalitarianism, what I see is Keynes selling a theory that he thinks is most appropriate for explaining the operation of a totalitarian economy. For a German historicist interested in case-specific idiosyncrasies, this could be very attractive.

The concluding paragraph of the foreword is equally instructive:

"I would like to take this opportunity to thank my translator, Mr. Waeger, for his excellent effort (I hope that his vocabulary at the end of this book will prove useful beyond its immediate purpose), as well as my publishers, Messrs. Duncker & Humblot, whose enterprising spirit ever since the days sixteen years ago when they published my Economic Consequences of the Peace has made it possible for me to maintain my contact with German readers."

Here he mentions the success of his Economic Consequences of the Peace, where Keynes wrote that "If we aim deliberately at the impoverishment of Central Europe, vengence, I dare predict, will not limp. Nothing can then delay for very long that final civil war between the force of Reaction and the despairing convulsions of Revolution, before the horrors of the late German war will fade into nothing, and which will destory, whoever is the victor, the civilization and the progress of our generation. Even though the result disappoint us, must we not base our actions on better expectations, and believe that the prosperity and happiness of one country promotes that of others, that the solidarity of man is not a fiction, and that nations can still afford to treat other nations as fellow-creatures?" It was this assessment in the Economic Consequences of the Peace that earned Keynes such a following in Germany - the idea that Germany must be supported to prevent the rise of either the powers of Reaction or Revolution in the country (and elsewhere in the book he raises the prospect of Revolution, rather than Reaction.

What sense would it make to embrace fascism in a foreward to a book which itself criticizes fascism, particularly in its concluding chapter? What sense would it make to embrace fascism in a foreward that cites the popularity of an earlier book written to stave off the rise of reactionaries in Central Europe? It makes no sense at all, before even reading the content of the foreward itself. And the content of the foreward is clearly methodological, referencing the history of German economic thought and citing reasons why Keynesian theory might be more useful to Germans than other British theories.

So believe what you will about the German foreward to the General Theory. I think its meaning is quite clear and quite benign, and any other interpretation not only fails to account for the text of the foreward itself - it also fails to account for the stark incongruity between the less charitable interpretations and Keynes's own character and values.

Liberalism and the Welfare State

This weekend I finished my book on the 1848 revolutions and started Roger Garrison's Time and Money (something of a restatement of Hayek's Prices and Production). The book was very good, but there was an interesting part at the end on the relationship between nineteenth century liberalism, revolution, the resolution of the "social question" (i.e. - unemployment), and the rise of the welfare state in the conclusion that I wanted to share. I know this might sound a little odd to some readers, but there is actually a contingent out there that believes that the American welfare state emerged out of Bismarkian authoritarianism, and that it wasn't derived from, say, long liberal struggles with the issue in the 18th and 19th century and an even longer history of poor relief in the colonies that was ultimately derived from Great Britain (here, here, here, and here for a start). They often ignore this broader history and highlight the work of German-ancestry progressives in the early twentieth century that contributed to an already robust reform movement (never mind the fact, of course, that a lot of these German immigrants - like the Kuehns who had left Hesse - were escaping conscription and repression in Bismark's Germany). Anyway, this was an interesting paragraph from p. 407 of the book:

"Namier's term, a 'seed-plot of history', can be applied to this aspect of 1848 because the revolutions of that year witnessed the fatal consequences of the perennial tension between, on the one hand, the liberal emphasis on political freedom and civil liberty and, on the other, the socialist stress on social justice, or the friction between the individual and society. Since 1848 this tension has provoked a wide range of responses, ranging from liberal capitalism to totalitarianism and all points between. Most modern democracies cope with the social question because it is debated within a constitutional framework on which all parties are (more or less) agreed and which protects democratic freedoms. In 1848, no such political consensus existed in most European countries. The 'social question' could therefore not be resolved within a peaceful, legal framework. So the revolutions faced the great challenge that confronts all modern states: how to integrate the masses into the state and to resolve the social question without provoking instability? Some states, such as the French Third Republic and Britain, managed to forge a political consensus by appealing to traditions (in the French case, to the democratic inheritance of 1789), which enabled them to offer some social reform through liberal, parliamentary systems. Others imposed reform from above through more authoritarian regimes, as in Bismark's Germany during the 1880s. A third solution was revolutionary, where integration of the masses failed, or was not even seriously attempted, and where alienation lead to a violent challenge to the old order, as in Russia, where the result was a totalitarian answer to the social question, in which the needs of society and, above all, the state took precedence over the liberty of the individual."

This probably won't move some people. There are of course those who see any constitutional expression of a social contract for solving social problems as threat to human liberty. Even among those who accept constitutional liberalism for whatever reason, there are those who will argue that Roosevelt and other 20th century progressives had more in common with Otto "iron and blood" Bismark than French and British parliamentarians. Nevertheless, I think the author's point that (1.) yes this is a tension, and (2.) it was resolved in a variety of ways, shouldn't be lost on people who claim the mantle of classical liberalism. Earlier in the text, the author notes that "the social question ulcerated the liberal regimes because there was no revolutionary consensus". Despite the absence of such consensus, claims are regularly made by modern libertarians that engaging this question is an abandonment of classical liberalism. A consensus on the social question, in other words, is retroactively imposed on the 19th century by these modern libertarians.

I'd also just note the strong Public Choice Theory/James Buchanan understanding of constitutionalism in the passage I presented above.

Weimar Memories

Evan recently was asking me about the source of German austerity and I gave him the standard line - hyperinflation in the 1920s. That's not wrong - that is what's on their minds - but Matt Yglesias does a good job at outlining why even that is pretty bad history.

Hyperinflation has a very well understood cause, and an equally easy to understand solution - it is caused by resorting to the printing press for revenue, and it is solved be refraining from resorting to the printing press for revenue. That's exactly what happened in Germany. Now, whether the Weimar Republic was as rosy after the printing press was reeled in as Yglesias says it was, I'm not personally qualified to say.

His point is that the real German disaster came with the Great Depression, and that this obsession with the hyperinflation isn't just a question of German experiences vs. Anglo-American experiences - it's actually a misreading of the German experience itself. We discussed the austerity program of Heinrich Brüning (pictured, right) in an earlier post (contra some claims about him by Jonathan Catalan), which worsened the Depression in Germany. And perhaps Brüning's actions were understandable, since he had the hyperinflation fresh on his mind. But nobody after him had that excuse. It was Brüning's disastrous austerity program that in part lead to the rise of the National Socialists.

So we need to be careful when we talk about the Germans. A lot of us say "well, they had some tough inflation that we've never had to deal with so ultimately it's just a cultural thing - that's just part of being German". An honest reading of the history suggests that that's probably not valid. Granted, their reasons for reading the history that way are still understandable. I'm not surprised that they remember the disaster of the early 1930s as something other than the onset of the Great Depression. It's understandable, but still a shame - because it was a demand-deficient economy that brought Hitler to power, not a hyperinflationary one.

Good Historical Precedent for the Mandate

I've had a couple of posts up recently on misuses of American history to justify political or ideological positions today. The other day I wrote specifically about a liberal abuse of history that attempted to justify the health insurance mandate (which readers know I have major reservations about, despite my strong support for other elements of health reform). This morning, I noticed that Brad DeLong links to Paul O'Rourke's much, much better example of historical precedent for an insurance mandate (DeLong was also the source of the less convincing example I critiqued earlier). The legislation in question comes from the early Republic - the Act for the Relief of Sick and Disabled Seamen, of July 1798 (the Adams administration). The act laid a tax on all privately employed sailors, collected by their employers, of 20 cents a month (a lump sum payroll tax, essentially) to provide hospital care for the sailors. O'Rourke provides the full text of the law. Of course there are some differences - there is still no "mandate" per se (then again, there was nothing to mandate, as there was no health insurance at the time) - but the more fundamental point is the tax imposed on all sailors, whether they want the hospital care or not. This is the same mechanism that is being used to implement the mandate today.

I don't think this answers all the Constitutional questions. After all, I actually went in to the text of the Constitution to debunk the last attempt to justify the mandate, which I don't do here. I would think this one would be justified with the Article 1, Section 8 power to lay taxes and appropriate funds for the general welfare. One argument I could make is that this is really more of an example of a public option than it is a mandate (after all, no one is forced to purchase anything, they are simply taxed and provided a social service - just like Medicare). I think that's a valid argument to make about how far we should take this historical precedent. Nevertheless, I still think it is important to acknowledge, because this example is a lot sturdier constitutionally and as an analog to the current situation than the last one shared by DeLong about the militias.

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Some people talk as if the Constitution were just the Articles of Confederation with lower voting thresholds. All significant additional powers granted to the federal government are downplayed. We spin this story that the commerce clause and "necessary and proper" and the General Welfare clause are inventions of FDR in the 1930s, or at the very earliest perhaps Progressives and trustbusters a few decades earlier. This simply wasn't the case. The Constitution is not another Articles of Confederation and we need to take that seriously.

Revising or Re"vision"ing?

I think Evan's post goes a long way toward explaining why the oft-derided "historical revisionism" isn't always bad. But I would like to make some caveats to his points.

First, I think most of what Evan talks about in terms of the accessibility of information and the role of technology has less to do with "historical revisionism" as it is traditionally thought of, and more to do with revising facts. Revising happens constantly, and insofar as it is done accurately it is almost always a good thing. Technology (both social and material) like wikis accomplish this by broadening the sources of information and incentivizing those sources to be self-policing. Who shot first in South Ossetia? How many Palestinians did Israel kill? How many middle age white males voted for Obama? These are facts that should go through as much revising as it takes to get to the cold, hard, truth.

But historical revisionism is very different - and I think it hinges on a new "vision" of what the history of a situation was, rather than a revising of the facts about that history. For example - when Charles Beard challenged the idea that our founding was the culmination of an Enlightenment experiment in liberty. Or when the story of the Civil War gets written as a war over slavery... or the tariff... or states rights. The facts of the 1860s haven't changed substantially (although certainly we do still revise those facts) - but the meaning of those facts does change - and that change is what I tend to think of as "historical revisionism".

Now, having said all that and having distinguished between two strands that I think Evan talks about simultaneously (revising and revisioning), I would definitely still agree with Evan's assertion that "historical revisionism" isn't always all that bad. After all - as Evan says, much of our historical memory is derived from the memories of those who actually experience the history. And if that memory is tainted or distorted to begin with, then perhaps some historical revision is in order.

I'll close by drawing attention to a recent historical revisionism fad - claiming that the New Deal didn't work or was counterproductive. A chief culprit in this school is Amity Shlaes, of the Council on Foreign Relations . Now, I haven't read her book - but I have read her articles and reviews of her book, and she provides a new vision of the New Deal by assuming:

1.) Work program jobs aren't actually jobs

2.) The Dow Jones is the best indicator of economic strength (despite the fact that the Dow Jones is an index of the price of a handful of products - in this case, corporate stocks) rather than GDP, which is a measure of all products.

3.) Don't include the defense budget in federal spending, even thought it was the single biggest components of federal spending in the 40s, and

4.) Pretend that the brief, sharp downturn in 1937 was a result of the deficit spending of 1933-36 and not the budget balancing of 1937.

It is one thing to "revision" the past by ascribing new meaning to old facts. For example, if (God forbid) the United States ever does turn into a socialist state, historians will probably reevaluate Roosevelt as the founding father of that slow march to socialism, and will probably revision the New Deal as the first American "five year plan". If we slip into socialism, that characterization may or may not be accurate. I feel that as long as they get the facts right, ascribing significance to those facts based on the current context of the times is reasonably fair. We know the scientific revolution was a success and not a real challenge to the Church because of the perspective we have. A Vatican historian in the 1600s might not have known that, so our "revision" of that history is appropriate given the information we're privy to.

But what Shlaes and others are doing is not providing a new vision to frame old facts. They are fundamentally changing the facts themselves. I think this is where historical revisionism is the most dangerous - when the past is forced into a certain mold, not because of the new context or information that future generations have - but because new generations have new ideological imperatives to make it fit the new mold.