Sound Money

Although painful, the solution to the 2020 economic recession is simple - uncover our problems, let prices adjust and reallocate capital towards productive usages. The quicker we adjust, the shorter the recession and the sooner we create a sustainable economic foundation for future prosperity. This approach is the polar opposite to the current interventionist and inflationist orthodoxy. Murray Rothbard’s America’s Great Depression Great Depression highlights the folly of government intervention during the 1930s and the economic malaise that can follow. The similarities to today are a warning sign. It’s time push back against the stimulatory and interventionist status quo or prepare for the recession to turn into a depression.

The “roaring 20s” in the lead up to the 1929 equity market crash that started the Great Depression were characterized by numerous factors that overlap with the decade leading up to 2020. My top 3: 1) Soft CPI inflation encouraged significant monetary inflation by the Fed. US money supply grew approximately 60% between 1921 and 1929, and an astounding 145% between 2009 and 2019. Economists were myopically focused on CPI inflation, without appreciating broader inflation, particularly in asset prices. 2) Rampant equity prices appreciated the monetary inflation – the S&P500 gained 700% between 1921 and 1929, and 480% between 2009 and 2019. 3) Powerful global central bankers, with close political allegiances were overconfident in their ability to micro-manage monetary imbalances.

Bank of England Governor Montagu Norman tried to maintain London’s position as the world’s premier financier through the 1920s, lending capital to troubled European nations in return for political influence without properly assessing the risk of these loans. He returned Britain to the gold standard but failed to revalue the GBP after substantial WW1 inflation, making the link to gold implausible. The market disciplined the UK’s unwillingness to deflate prices or revalue its currency relative to gold,  withdrawing gold from UK vaults. Norman convinced Fed Governor Benjamin Strong to inflate US monetary policy to prevent further gold flows from Europe to the US. This coordinated and political approach has a remarkable resemblance to the coordination between the BoE, ECB, BoJ and Fed in the past decade. They’ve managed to create the perception of central bank omnipotence, that they can solve any crisis and that investors should just “buy-the-dip. But there’s increasing systemic fragility seen in negative bond yields, negative oil futures, illiquidity in key US fund markets. The cracks in central banking supremacy are widening into a chasm as they balloon their balance sheets in 2020.

The standard history of the Great Depression is that President Hoover made the Depression worse because he was economically indecisive and that Roosevelt began to solve the problems post his inauguration in 1933 with the fiscal and monetary expansion of the New Deal.  Rothbard shows that the New Deal began during Hoover’s Presidency with massive government intervention, clearly refuting the popular narrative. Hoover’s poor logic is characterized by his belief that America was more productive than peers because of its high wages, rather than identifying America’s superior productivity as the cause for higher real wages. His faulty logic led to numerous interventionist policies; bolstering wages and prices, expanding credit, propping up weak firms and banks, increasing government spending, public works programs, weakening bankruptcy laws, raising tariffs, increasing taxes and restrictions on immigration. The US Federal government has already implemented restrictions on immigration, hiked tariffs, expanded the size of government, is re-writing to playbook by propping up weak firms during the 2020 crisis and the 2020-1930 parallels grow stronger.

Interventionists fail to understand that a monetary inflation driven economic expansion cycle, like the 1920s and 2010s, distorts the structure of production, misleads households and businesses and miss-allocates capital. A market crash and an economic recession are opportunities to reallocate, creating a sound and sustainable foundation. Like today, the policies that Hoover implemented hinder the market adjustment mechanism and could lead to prolonged economic weakness. A few examples:

• Maintaining wage rates during a recession, when consumer prices are falling, leads to rising real wages for those who are employed. The rising cost of employing each worker leads to lay-offs and reduced hours for those who are employed. As an example, average weekly hours worked fell from 48 in 1929 to 32 in 1932. In previous recessions hours worked had never fallen by more than 10%. Governments across the globe have succumbed to minimum wage laws over recent years to protect workers, without appreciating the cost to those who are unemployed and the economic inefficiency that arises.
• In order to contend against bank run risks, authorities implemented arbitrary restrictions on withdrawals and imposed bank holidays across all banks in the 1930s. Good banks were unable to display their strength relative to the bad banks, leading to broad loss of confidence in the banking system altogether. Today, banks have ample funding from their central banks which should prevent bank runs. But watch out for redemption restrictions from investment accounts, if market conditions deteriorate.
• One of Hoover’s last acts as President in March 1933 was to weaken the property rights of creditors in bankruptcy laws in order to prevent bankruptcies. This implies that creditors can’t take ownership of their rightful assets and reallocate capital towards productive ventures. Unprofitable ventures are kept afloat, leading to a decline in productivity and efficiency. In the current cycle, authorities appear to be trying to avoid bankruptcies altogether and have reduced the property rights of savers extensively. The Fed is now buying High Yield bonds to prevent bankruptcies, which contravenes its mandate! Low-interest rates, fiscal injections and numerous relief packages fail to weed out the good businesses from the bad, leading to a less robust investment climate with reduced appreciation of real risk.
• Monetary manipulation remains the biggest hindrance during an economic crisis for a host of reasons. Touching on one; manipulating interest rates lower reduces the returns to lending, which disincentivises lending exactly at the time when the economy needs it most. Interest rates must rise in order to get savers and banks to lend real savings. During the Great Depression authorities launched campaigns against hoarding of gold & cash, and they were frustrated by banks’ unwillingness to lend. I think we’ll see increasing frustration through 2020 and 2021 as global monetary policies fail to encourage a healthy market between savers and lenders. Central banks can supply billions of bank reserves to banks, but it’s less clear if banks will lend to consumers and businesses. I expect increasing government intervention and large direct fiscal transfers to become commonplace as authorities circumvent the lending market. I also expect government measures to restrict demand for gold and bitcoin, which are the best store of value vehicles in 2020 - the 1930 hoarding equivalents.

On the surface, these interventionist policies appear morally justified because we’re protecting jobs, supporting firms and shielding households from economic pain. This argument is particularly strong during the coronavirus with a natural and external enemy. Critics to these policies are characterized as heartless who only care about profits - I know, it hurts! This surface-level and paternalistic approach followed by the majority disguises second round implications and the massive cost to human life from an extended economic depression. Joblessness, suicide, domestic violence, crime and violence were rife during the 1930s and we need to avoid these in the 2020s.

Although painful, the best policy response to recession is submission to market forces, which indeed was the policy followed during recessions before the Great Depression. Intervention delays adjustment, leading to prolonged economic pain and a weaker recovery. It’s no surprise then that the 2009-2020 US business cycle was the weakest on record after we failed to submit ourselves to real adjustment during 2008/2009. The resemblance between the 1920s and the 2010’s, and the similarity in economic response between global authorities and Herbert Hoover’s interventionist stance in the early 1930s is cause for concern.

There’s almighty support for intervention within government and big business so I’m cognizant that we are unlikely to change the policy trajectory. Elites are too invested in the status quo, both economically and intellectually, to allow their bad investments and ideas to deflate. We must invest our time and capital accordingly given the poor decisions and the risks for economic growth, capital formation and job growth. The more intervention, the deeper the recession and the greater the probability that we shift into a depression.