Guest Post: Review of Walter Bagehot’s Lombard Street

By Robert P. Baird of digital emunction

When, back in March, the Bank of England announced that it was adopting a program of quantitative easing, The Economist reported the news with some trepidation. While recognizing that the threat of deflation was real and imminent, the magazine gave voice to the fear that “that the border being crossed may be an inflationary Rubicon.” Though it came down ultimately (if barely) on the side of the new policy, you could almost hear the shrieks escape the magazine’s inflation hawk of a soul. (Four months later, The Economist’s attitude toward the policy had changed considerably.)

With one eye where one eye always should be—on Monty Python—The Economist announced the BoE’s plans to create money from thin air with the headline, “And Now for Something Completely Different.” What the magazine did not mention was that there was a time when the Completely Different was Completely Ordinary—or at least Not Completely Unexpected. Almost 150 years ago, in an issue dated May 12, 1866, The Economist would confidently tell its readers that Peel’s Act, which enforced the gold standard, was unsustainable in times of panic:

It is often said that Sir R. Peel’s Act broke down in 1847 and 1857, but it should also be said that it must always break down under like circumstances. Its provisions are adapted to a state of quiet and tranquility…. But those provisions are not adapted to a state of alarm and confusion. On the contrary, they tend to aggravate that alarm.

The diagnosis was no mere intellectual exercise. When the article was published Britain was in the midst of a panic caused by the failure of Overend, Gurney and Co., the so-called “banker’s bank.” At the height of the panic, the London Times would describe a full-fledged bank run: “The doors of the most respectable banking houses were besieged…and throngs heaving and tumbling about Lombard Street made that narrow thoroughfare impassable.” The Economist’s proposed solution was a temporary suspension of Peel’s Act, which would produce an effect not all that different from quantitative easing: it would allow the Bank of England to print money at will. Sure enough, by the time the next issue of the magazine appeared the British government would suspend Peel’s Act and the banking crisis would subside.

Four years later, the author of the May 12 Economist article, also the editor of the magazine, set out to write a book drawing on his experiences during the panic of 1866. The author-editor was Walter Bagehot, and the book he produced was his now-classic Lombard Street: A Description of the Money Market.

As its subtitle suggests, the explicit intent of Lombard Street is to describe the banking industry in concrete and comprehensible terms: “A notion prevails that the Money Market is something so impalpable that it can only be spoken of in very abstract words,” Bagehot says. “But I maintain that the Money Market is as concrete and real as anything else; that it can be described in plain words; that it is the writer’s fault if what he says is not clear.”

Bagehot more than makes good on the promise. Lombard Street is a fluent read, written in a conversational style that The Economist still brags about to this day. Unlike most of the financial media in his day (and ours) Bagehot avoids jargon as a matter of principle and makes his subject neither more nor less complicated than it needs to be. As a result, his descriptions of basic economic phenomena—how money is borrowed and lent, why booms and busts occur, the early history of banking—are limpid and precise.

Lombard Street reaches well beyond mere description. Beneath the book’s genial surface lies a closely argued polemic against the Bank of England that rests on a simple thesis: “All our credit system depends on the Bank of England for its security. On the wisdom of the directors of that one Joint Stock Company, it depends whether England shall be solvent or insolvent” (emphasis his). Out of this argument grew the main polemical point of Lombard Street, which later became known as “the Bagehot principle”: that the Bank of England ought to act as a lender of last resort in times of panic, lending freely (albeit at penalty interest rates) to anyone who could offer good securities as collateral.

Of course, as Bagehot is quick to admit, this was a bit of an odd polemic, since the Bank of England was already de facto following the course he prescribed. What he objected to were the Bank’s words, not its deeds. “Though the Bank, more or less, does its duty, it does not distinctly acknowledge its duty,” he said, and that lack of acknowledgment forms the main target of his polemic. He protested against the pretense that the Bank of England’s private ownership and management made it like any other bank. The BoE was not like any other bank in Britain, he insisted, because the government had given it special privileges and monopolies (not least, a monopoly on printing money). Nor was it even really necessary to argue that the Bank had a special public responsibility, since some of its directors had incautiously admitted as much. What was needed, Bagehot argued, was public acknowledgement of that responsibility, and a restructuring of the Bank along the lines of that acknowledgment. (Bagehot didn’t live long after the publication of Lombard Street, but I doubt he would have been surprised to learn that none of his recommendations were taken up until well into the 20th century.)

Bagehot makes his case against the Bank of England as interesting as a 150-year-old polemic can be, but let’s face it: outside the cramped quarters of Ron Paul’s cranium the question of establishing central banks is pretty well settled. What remains vital in Lombard Street is Bagehot’s thinking about the history and structure of the banking system—which, for all the hype, hasn’t changed as much as some might like to think—and the causes and effects of financial panics. As is often the case with classics, what we take from the book depends in large part on what we ask from it.

If we want relevant maxims, we will find them, for Bagehot was a master of concise observation. It is impossible to read a sentence like the following, for example, and not think of the last couple of years: “Every great crisis reveals the excessive speculations of many [banking] houses which no one before suspected, and which commonly indeed had not begun or not carried very far those speculations, till they were tempted by the daily rise of price and the surrounding fever.” Or this, on fraud: “The good times too of high price almost always engender much fraud. All people are most credulous when they are most happy; and when much money has just been made, when some people are really making it, there is a happy opportunity for ingenious mendacity.” Or this, on bank failures: “Any aid to a present bad Bank is the surest mode of preventing the establishment of a future good bank.”

If we come to Lombard Street looking for something more substantial—a theory, say—we will find that too. The Bagehot principle is only the start, for it doesn’t take much imagination to recognize that the basic lesson of Lombard Street is the same lesson we’ve all been (re)learning these last couple of years: that the pretense of government non-intervention in our financial system—i.e., the idea that the financial markets can ever be truly free—is exactly that, a pretense. And while a person might be able to dream up several theoretical schemes to keep a financial panic from destroying the real economy, historical circumstance has left us with only one real option: a bank with the government-guaranteed authority to print money must stand as the lender of last resort.

(Readers of this blog know don’t need to be told how vigorously central banks around the world have embraced the lender-of-last-resort role that Bagehot prescribed, but if proof were lacking they could turn to Richard Fisher, the CEO and president of the Dallas Fed, who last February called Bagehot a “patron saint” of central banking who had, along with Henry Thornton, written “the basic playbook for how a central bank, as the economy’s lender of last resort, deals with a financial crisis.”)

Bagehot also argues vigorously against those who would suggest that deposit banking was the logical outgrowth of economic laws of nature, insisting that the whole scheme came about by chance and historical contingency. It is, he admits, the most ordinary thing in the world for an Englishman to put his money in a bank and to expect a five-percent return on his deposits. But he insists that there is nothing natural about any part of this. Only a peculiar set of historical circumstances could produce a system in which it seemed normal to trust a stranger to hold—not to mention loan out—your money. (One of the book’s most famous anecdotes describes Alexander Pope’s father retiring to the country with twenty thousand pounds in a strongbox, from which he’d draw whatever he needed for household expenses.) Likewise, there was nothing “natural” about earning interest, as a simple look around the globe proves:

Most saving persons in most countries are afraid to ‘put their money’ into anything. Nothing is safe to their minds; indeed, in most countries, owing to a bad Government and a backward industry, no investment, or hardly any, really is safe.

The most important lesson of Lombard Street may well be its relentless insistence on what notions like “the long boom,” “the risk revolution,” and “the Great Moderation” have encouraged us to forget: that for all its power, a credit-based financial system is fundamentally a fragile thing. “The briefest and truest way of describing Lombard Street,” Bagehot writes early on, “is to say that it is by far the greatest combination of economical power and economical delicacy that the world has ever seen.” The power of the system is obvious: by the seeming magic of leverage, “a new man, with small capital of his own and a large borrowed capital, can undersell a rich man who depends on his own capital only.” But the delicacy usually remains hidden. It’s only during times of panic that we’re forced to recall the true nature of credit, which is never more and never less than its etymology suggests: i.e., a form of trust. “The peculiar essence of our banking system,” Bagehot says, “is an unprecedented trust between man and man: and when trust is much weakened by hidden causes, a small accident may greatly hurt it, and a great accident for a moment may also destroy it.”

As a society we’ve recently paid a huge price to be taught that risk is an essential, not incidental, part of our financial system. Already the lesson seems destined to be forgotten, but it’s a small comfort—small, but real—to know that Lombard Street will be there to remind us again, if we’ll let it.

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26 comments

  1. Captain Teeb

    "Most saving persons in most countries are afraid to 'put their money' into anything."

    Conspicuously omitted from this generalization was the USA, which had no central bank but yet managed to invest a great deal and to grow phenomenally. Was the US the exception that proved the rule, or the counter-example that demolished the hypothesis? The 'cramped cranium' of Ron Paul would hold for the latter, I suspect.

    Yes, central banking appears here to stay, but so did the gold standard as recently as 1910. Central banking is a great convenience to politics, not only for its well-known inflation abilities, but also for reasons of intellectual cover, secrecy, and blame-shifting when needed.

    It appears from history that financial crises are inevitable. Before fiat-money central banking there were frequent short, sharp panics; under central banking we have mostly softer but more drawn-out 'recessions' or 'stagflations', plus a major despression (which we may or may not be now entering) every couple of generations.

    Sometimes it even seems that central banking is out to ruin its reputation. In the UK it is the plaything of politicians, in the US it is the plaything of a (mostly) invisible financial oligarchy. In Japan, neo-Keynesianism was not enough to restore normalcy after a bubble crash. In Europe (my home) we are lucky that the central bank is younger and that politics are more fragmented and stalemated, but the basic problem remains.

    So, from supposed political independence, we have a world where central banks are mostly just another arm of the government. Their governors (Europe excepted) are generally political nobodies plucked from academia and likely chosen for their pliability and expansionist views.

    And also for their reluctance to rock the boat. (For example, Sir Alan, Ben, Sir Eddie, and Mervyn likely saw what was coming, but left it to pariahs like poor ol' Ron Paul to announce.) But what is independence for, if not to rock the boat? (Now independence is the excuse for extreme secrecy.)

    I would argue that, just as a wise and independent central bank can right the ship by a well-judged intervention, a captive CB can make things worse than no CB at all. I fear that we are soon going to have empirical evidence one way or the other.

    We may well live to see a time when central banking as we now know it seems as quaint a notion as paying one's bills in gold. How long ago did thrift and debt avoidance seem like a mug's game? Attitudes can change quickly.

  2. Richard Kline

    So Captain Teeb, the US in the 19th century was financed principally by European money for its major capital and industrial expansion, primarily Britain and France. Because the returns in the US were greater and regulations few and weak. There were two other principal drivers to US growth. One was unrepeatable resource acquisition: we had half a continent just 'extracted' from Native Americans and others at effectively trivial cost from which huge fortunes were derived killing off the fur bearing animals, mining, running cattle, and becoming a major wheat exporter. Via European capital, used to bring much of that to market. The other driver was urban industrial labor kept comparatively cheap by anti-union repression.

    Without British and French capital, US development would have been radically slower. It wasn't until perhaps 1900 that the US had a sufficient pool of domestic financial capital to really become self-financing. And it was not by coincidence at that juncture that the US became a political player at the global level. Such actions prior to that time could have led to a European capital boycott, and everyone in NYC and DC knew it, and made too much money to cut down the credit tree.

    I recommend that you read Lombard Street, Cap'n. A grounding in economic history matters much in making effective arguments about economic organization.

  3. Captain Teeb

    Wow, a response (albeit a remonstrance) from Richard Kline. Woo-hoo! I read all your posts and papers with interest. When will you get your own blog? Can we at least get a link to your papers?

    Thanks for the caution about economic history; I'm surely deficient, and I'm sure you're correct. I will read Lombard Street and try to be better informed generally.

    What I don't understand is how that affects my argument. Are you saying that 19th-century America was a one-off, able to avoid a central bank by virtue of European capital (itself heavily dependent on colonial resource appropriation) and the natural capital of easy resources?

    It takes a lot of study to begin to put oneself into the mindset of someone in the distant past, such as Bagehot and his contemporaries. For example, the review cites Bagehot as mentioning 5% return on a bank deposit. This was under the gold standard, with essential zero inflation. (This was fairly steady, too; I recall interest of 4% in 1814, mentioned in the novel Vanity Fair.) What would today's 'real' (what a concept!) equivalent be?

    Here's another context biggie (at least to a rube like me): Britain in 1866 was a democracy restricted to males of means. What effect does modern democracy (televised and all) have on the politics of money and CB?

    Or, reading Keynes (Essays on Persuasion) I am struck by how often he mentions the Russian revolution and the red menace. His sense of the emergency was not like ours, and he is only half-way between us and Bagehot.

    My (long-winded) point is that historical context deserves more weight than it receives. I recall Walter Benjamin's dictum that, to understand history, we must understand historical figures as they understood themselves. He said that because it was seldom done in his time and is likely even rarer in our time.

    My presumption is that the purpose of a modern central bank is to provide stability (lender of last resort) and to smooth out the ups and downs of a market economy. If that is so, then America without such a bank must have been a risky place for France and Britain to invest capital, though high returns might have made up for the risk. My guess is that, even without a CB, America was less risky than modern China, India, or Russia; it had a decent court system (whose precedents are still cited), and probably less petty corruption.

    Another question, while I've got you: is central banking fundamentally different under a gold standard? According to the review, Peel's Act was suspended several times, but that signaled an emergency and was always considered temporary. But without an equivalent constraint (at least post-1971), is not central banking doomed to at least gradual inflation (of the sneaky kind that Keynes denounced)?

    And finally, how well is central banking acquitting itself now? This should be its time to shine. What is its strategy for a return to obscurity? Academic economics seems to have lost credibility; will that affect CBs, given their leadership by academics? In short, where is the CB movement going? Is it really "the only option"? Is eventual capture of CBs and regulators inevitable in a modern democracy?

    It seems that much public economic debate consists in choosing one's metaphor. I lived in the US West for a while, and knew some firefighters. Longstanding policy was to fight all fires, but then researchers noticed that this policy reduced small, frequent fires in favor of fewer, larger fires. In the short term, all was well. But the underbrush accumulated until one day it produced something unpredictable.

    And if CB is indeed the only option, is it for economic or political reasons? Or is it a fiction to separate economics and politics, and pretend that one can be examined, modeled, and formalized while ignoring the other?

    I hope you have time and see fit to respond.

  4. RebelEconomist

    If anyone does want to read Lombard Street themselves, it can be found online here (hat tip Nick Rowe at wci blog).

    I would question whether the central bank should be the lender of last resort. Historically, the central bank has served as the LoLR because it acts as the banks' banker, but the LoLR is really a fiscal function. LOLR operations are supposed to serve the wider public interest, and the funding and risks involved are ultimately borne by the public, so the elected government should be seen to be responsible. The role of the central bank in LoLR operations should be confided to advising the government and providing it with a short-term overdraft facility to tide the government over until it can borrow from the market for the purpose.

  5. skippy

    May I add that the British and French investments could be considered a proxy war, South/French vs North/British with genealogy included.

    So in their European family tussle they inadvertently spurred economic growth in America, resulting in Americas eventual ascension over theirs.

    skippy…RK did you eat some old fish on your travels, if you did your a brave man.

    I feel we have come full circle and now find our selves confronted with China, and our present pain is about how to deal with it.

  6. Anonymous

    Capn-

    The CB's are B's. There is never anything wrong, that is, nothing that they will ever voice. A bank president does not go to the FDIC and asked to be taken over. Who cleans up the fed mess? They have to, so, there is no mess.

    Speak softly. I think why most people are impressed by Bernanke is that he just keeps calling, ie he won't show his cards. The ultimate bluff.

    My view is that regulators and banks should be separate. There can't be any grey area without someone jumping head long into it.

    It's not Bernake that jumps either, all it takes is one of them to get in over their head (the big ones) and Ben has to clean up their mess with one arm while holding back the pols with the other. All the while saying that this is just a liquidity crisis, which his really the only thing he can solve.

    You cannot have a regulator as the chief banker, or a chief banker as a regulator in this instance. You need a rabid group of very unpopular people of be a sucessful regulator. You need a big liar for a CB chief.

    Not as familiar with history as you seem to be, but those are just some thoughts, probably nothing new.

    bob

  7. patrick neid

    While Central bankers may like the book they miss its main point–lending money at PENALTY rates during a crisis, as opposed to dropping it from helicopters.

  8. Captain Teeb

    Patrick, Thanks for that. I meant to allude to that but had blathered on too much as it was.

    It happened with Marx and Keynes as well: the inconvenient things they said were ignored, but the resulting policies (-isms) bore their names nonetheless.

    The penalty rate makes all the difference. Bagehot might even say (I have yet to read him.) that without the penalty rate you're better off doing nothing.

    Forgive me if I'm mistaken, but isn't the Fed doing the opposite of a penalty rate? Don't they lend to banks at ~0% and then pay a greater rate of interest on that same cash when it's parked at the Fed? (Nice work if you can get it.)

  9. LeeAnne

    "Bagehot says. “But I maintain that the Money Market is as concrete and real as anything else; that it can be described in plain words; that it is the writer’s fault if what he says is not clear.”

    Solved -apply this principle to financial products and publishing, (TV is hopeless), financial rules, regulations and law.

  10. DownSouth

    Superb post, and also equally superb comments by Captain Teeb and Richard Kline.

    I'll stay out of the fray and let you guys slug it out so I can hopefully learn something. But I just want to make a couple of observations.

    ► Robert P. Baird said:

    The Bagehot principle is only the start, for it doesn't take much imagination to recognize that the basic lesson of Lombard Street is the same lesson we've all been (re)learning these last couple of years: that the pretense of government non-intervention in our financial system—i.e., the idea that the financial markets can ever be truly free—is exactly that, a pretense.

    Isn't this a restatement of the same thing that Reinhart and Reinhart said in "Is there scope for fiscal stimulus for debt-intolerant countries?" (see yesterday's links):

    As crisis after crisis has consistently shown, private debts turn out to be contingent government liabilities.

    ► Richard Kline said:

    There were two other principal drivers to US growth.

    I would add a third to European capital and the resources of an essentially untapped continent: scientific and technological innovation.

    ► patrick neid said…

    While Central bankers may like the book they miss its main point–lending money at PENALTY rates during a crisis, as opposed to dropping it from helicopters.

    Don't they miss another point?

    "…lending freely (albeit at penalty interest rates) to anyone who could offer good securities as collateral."

    Who in their right mind believes the securities the Fed is lending against are "good securities?"

  11. Anonymous Jones

    "As crisis after crisis has consistently shown, private debts turn out to be contingent government liabilities." This is not only true (IMO), but is just a minor example of the basic principle of Donne's "do not ask for whom the bell tolls"…

    Many, many private actions have public consequences. How this statement could ever be doubted is an embarrassment to reasoned individuals.

    This is generally what makes economics so difficult: we try to analyze it on an individual actor level when it is a team game. It is instructive to discover how much more difficult it has been for statisticians to quantify an individual player's offensive contribution to a basketball team than to a baseball team. Basketball has many more qualities of a "team game;" it is more difficult to separate one player's responsibility for success or failure of the team from the other four players. Multiply this a billion fold and what this lays bare is the false premise that an individual economic actor "deserves" his economic status in a discrete and indisputable way.

    Most of us desperately want to believe we're in control of our own lives, but we are not and we will never be (no matter how many libertarian principles are ever adopted by society at large (most of which I support, by the way)). If my bankrupt neighbor's son is careless playing with matches and my house burns down, I'm SOL without insurance. If the kid burns down the whole town, we're all SOL. Don't tell me we don't have an interest in trying to prevent that.

    [Not totally on point here, but DownSouth's well founded comment resonated with me]

  12. Siggy

    What does the word emunction mean?

    If Central Banks impute politics into the theories of economics, is that not the case that it is a Political Economy? The study of what we now style 'economic' was once called political economy.

    If it is, indeed, a political economy; then, what form of political society shall we have? Shall we have one that supports an oligarchy of theives? Shall will have a diverse society that is directed by bureaucrats? Shall we have a Republic with laws that effectively enforce productive contracts?

    I would opt for a Republic. Democracies tend toward mediocrity. Can we be a Republic again? Pretty hard to do, we now have too many people, perhaps a 100 million more than we really need. Who are they? I haven't the slightest idea.

    The opportunity for easy money and excess debt flows out of a fractional reserve system. Wouldn't we be very wise to examine how we can create a system that tends to naturally reward thrift and well reasoned risk taking and that is built on a high level of reserves. Is a currency that maintains its purchasing power too idealistic a wish for?

    I believe governments need central banks. The body politic, however, is very creative and can function quite effectively without them!

  13. HumbleBlogger

    The post and the exchanges are really interesting. All comments are penetrating – thanks to all of you for the positive externalities.

    I have one question for all of you. I keep thinking about money and its profound nature and try to "relate" it to the basic economic principle which is "there is no magic"… BUT…

    There seems to actually BE magic. Financial institutions can get free money (literally) for a very long term (short term rates were essentially promised by Ben for a long time, or see Japan in the last 20 years!). These same financial institutions, especially lately, can offer mediocre collateral, and YET… there seems to be no price to pay??! There is no inflation, which is essentially supposed to be the "price to pay" for easy money policies. There is no such thing. Can somebody light my lantern here because there must be something I do not get! Many thanks in advance.

  14. fresno dan

    I think I almost learned more from the comments than the post.
    However, think this should be inscribed over the door at the Fed:
    "Any aid to a present bad Bank is the surest mode of preventing the establishment of a future good bank."

    I would also agree with all those who point out the lack of penalty to the banks that have so foolishly lent or "invested"

  15. Mark Humphrey

    Robert Baird fantasizes that Ron Paul's "cranium is cramped", because Paul rejects conventional dogma about the Magic of Central Banking. Baird also believes Bagehot was insightful and iconoclastic, because he criticized the Bank's reluctance to trumpet its "public role". Such thinking is widely held and woefully mistaken.

    Central banking is predatory, for a fundamental inescapable reason: it employs coercion to promote the short term financial interests of its clients and patrons, at great cost to most others. The coercion I speak of is not imaginary; it is the force of law that grants special privilges and powers to the central bank.

    Collectivists resent the idea that central banking is predatory, because they haven't grasped that monetary inflation necessarily promotes capital consumption and impoverishment. They think of printing money as a "necessary evil" or a panacea. The don't think much about the consequences of capital consumption, because they imagine that "spending" causes production.

    Moreover, they are infatuated with the notion that capitalism produces, from deep within its bowels, mysterious booms and busts. However, they cannot explain how free markets could yield the odd cluster of economic errors revealed by recessions. 19th century speculative fevers and panics were caused by extensive state banking regulations that fostered uneconomic credit expansion.

    We are living through the last days of central banking. Why? Because we have passed the point of no return. The central banks have created problems so intractable and deep that we'll either suffer an accidental monetary deflation or the even worse chaos of what von Mises called the "crackup boom" of hyper-inflation. This tragic finale will finally discredit central banking. But whether policy makers replace it with a dictatorship, or with freer markets, remains to be seen.

  16. fresno dan

    Excuse me for a second post, but I was re-reading some of the comments again, and I could help but notice
    "Downsouth's" comment:

    "…lending freely (albeit at penalty interest rates) to anyone who could offer good securities as collateral."
    First thing, I totally agree with the penalty interest rate. And than I agree with the points and commentary about "good securities."
    But finally, I noticed something else in the quote…"TO ANYONE"
    I ask why exactly does the banks that have most failed, most not understood finance, get to be the only ones to get the lifeline from the central bank? I think we deserve a better answer than they were standing there.

  17. PascalMtl

    Mark Humphrey: Perhaps there is something I don't get, but booms and busts are inevitable in ANY economic system, wether it is central planning or free market, simply due to 1) the "accumulated backlog" of coordination errors between what is demanded by purchasers and what is produced by suppliers and the inevitable correction of those coordination failures once in a while and 2) pure and simple resource misallocation due to assymetric info issues, which again cause sometimes prolonged periods of misallocation followed by the market correction.

    All this is not due to any particular social system of production and income (free market, central planning, etc.), but is rather simply … pragmatic reality!

    Is there something I do not get maybe?

  18. Andrew Bissell

    Bagehot makes his case against the Bank of England as interesting as a 150-year-old polemic can be, but let's face it: outside the cramped quarters of Ron Paul's cranium the question of establishing central banks is pretty well settled.

    This little impish vignette terribly mars an otherwise excellently written review.

    For one thing, it betrays a lack of what I would call "historical imagination." As pointed out above, the gold standard seemed to be a permanent fixture of the American financial landscape at the turn of the previous century, but it was basically gone when Bretton Woods was adopted. Francis Fukuyama's "End of History" is only a very recent and visible instance of a recurring phenomenon throughout history, namely, the common practice of assuming that however things have been done in the recent past is exactly how they will be done in the future.

    Furthermore, the author is attempting to airbrush out of existence (or is perhaps not even aware of) many cogent, piercing critiques of the fundamentals of central banking. Does James Grant's tireless writing on this subject really deserve to be crammed into "the cramped quarters of Ron Paul's cranium"?

    Central banks primarily function as engines of credit. By removing a key check on lending and borrowing — namely, the possibility that one will have to liquidate assets at "firesale prices" in a panic — they allow people to assume greater debts at lower cost than would otherwise be the case. It took 151 years, from the publication of Lombard Street in 1866 to the credit markets seizure of 2007, for the world to find out just what kind of manic, extreme levels of debt central banking could create. The 370% total debt to GDP ratio reached in the U.S. gave us our answer. If today a world without central banking still seems beyond our imagination, perhaps it is because we have not yet felt the full disastrous ramifications of such a high debt load.

  19. PascalMtl

    Andrew Bissell: High debt is no doubt "not good and unsustainable", but why is specifically 370% of GDP "too much debt" – why not 500% or 100% or 40% or 900%?

    The problem seems to be that nobody can say how much debt can be continually "carried" without consequence (say, 200% of GDP?) and what the consequence of this debt burden (or lack thereof) has on structural long run growth and standards of living.

    I know the academic response to this is "no ponzi condition", but that seems truly disconnected from reality theory. Can you provide insights here?

  20. Anonymous

    The comments would be different if government hadn't guaranteed the money markets.

    Again, greed avoids controlled growth, consumers not so much.

  21. A

    If there's a "money market," does that mean that money is a commodity that fluctuates in value?

    For example, a CEO has $1000 in disposable income. A pound of apple is $1. But he can't buy 1000 pounds of apples without moving the supply and demand. Free marketers like to scream "supply and demand," but instead of one supply and demand equilibrium we have multiple supply demand equilibria and the rate at which they equilibrate is different.

    From the day-to-day op-eds on economy, I'm not seeing much discussion on the kinetics of the monetary equilibrium in different transactions (reactions), and much of it is based on dynamics. I can understand that there may be a median rate of inflation, but common sense dictate that disposable income inflate at a much higher rate than money spent on stables, which is backed by energy generation (and labor).

    And the more disposable income a fraction of the population have, the more they can inflate the prices and buy "luxury goods" while the value of the dollar in low-disposable income transactions are actually different. If it's a single series of reactions you can say that the rate-determining step is the slowest step (the bottleneck), but in today's economy there are a lot of interactions going on, with money of different value counting the same in the same transaction.

    In the old days we have currency exchange rates, but nowadays a dollar in the hands of a CEO and a dollar in the hands of a working class man are actually very different in value.

    So it goes like: People with disposable income inflate the value of their money in transactions by bidding up for the goods, and when the sellers take the money and try to cash it for actually goods we have inflated money (from disposable income) mixed with less-inflated money (people purchasing staples), and you end up with inflation or hyperinflation.

    It seems like a good way to avoid it is simply to remove disposable income, or instate different currencies for different types of labor, and compartmentalize the different micro-equilibria.

    Oh, this is not an endorsement for the gold standard. The main source of wealth today is generated from petroleum and automation. If anything, I think an "energy credit" is probably a much better currency to avoid the "boom and bust" cycles.

  22. Carlosjii

    IMO the Panic of 1907 is under-investigated as the correct precursor to our present Panic as it caused the creation of the Creature from Jekyll Island some years later, laying the groundwork for the world’s greatest Ponzi or debt kiting scheme that’s soon to implode, led irresponsible Presidents and equally irresponsible Congresses to print money from nothing to promote irresponsible agendas such as our entry into WW 1, Vietnam, Korea, and now Iraq & Afghanistan.

    “The combat and instability would continue because its real source was the political contract struck between democracy and capital back in 1913, the implicit decision that democratic politics could not be trusted to act responsibly in the national interest. Therefore, the authority and responsibilities of elected politicians were permanently curtailed. Put another way, the elected government was allowed to be permanently irresponsible – free to indulge its own follies and protected from the accountability by the higher authority, the non-elected central bank. The creation of the Federal Reserve represented a great retreat from democratic possibilities. The maturing of self-government was forever stunted.” Pg. 534, Secrets of the Temple – How the Federal Reserve Runs the Country, William Greider, Simon and Schuster, 1987

    “Things got worse and worse. Finally there came the awful day of reckoning for the bulls and the optimists and the wishful thinkers and those vast hordes that, dreading the pain of a small loss at the beginning were now about to suffer total amputation – without anesthetics. A day I shall never forget, October 24th 1907……No money anywhere, and you can’t liquidate stocks because there is nobody to buy them. …….Reminiscences of a Stock Operator, Edwin Lefevre, Wiley Press Pg 114

    and “By mid-November, the panic had subsided. But there was to be one last casualty. On the afternoon of Thursday, November 13, Charles T. Barney, former president of the failed Knickerbocker Trust Company, died at his home on East 38th Street from a self-inflicted gunshot. Reportedly, he was despondent over J.P. Morgan's refusal to meet with him.”

    We can hope the this panic ends similarly.

    see the Federal Reserve’s account of the Panic of 1907. http://www.bos.frb.org/about/pubs/panicof1.pdf

  23. john bougearel

    "Most saving persons in most countries are afraid to 'put their money' into anything. Nothing is safe to their minds; indeed, in most countries, owing to a bad Government and a backward industry, no investment, or hardly any, really is safe."

    You know for all the risk disclosure statements that go out on everything, most folks in developed countries simply lack the simple common sense of savers in less developed countries that "no investment is really safe" (unless you invest in yourself, and even then…).

    Sell-side institutions parade the majority of their securities as being gilt-edged, triple A, guaranteed to perform and not fail.

    Even after the credit ratings were exposed as fraudulent, what are the sell-siders doing now? Re-repackaging them into AAA securities and perpetuating the fraudulent claim that these are safe and almost riskless instruments.

    It is irksome that the sell-siders have learned nothing from this crisis.

    And with regard to the shakiest asset classes, Charles Schwab's research center in May 2009 reiterated the statistical lie that "Stocks…are estimated that to provide higher returns than bonds…are the investment with the greatest potential for long-term growth."

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