Part 1 | Part 2 | Part 3 | Part 4 | Part 5 | Part 6 | Part 7 | Part 8 | Part 9 | Part 10 | Part 11 | Part 12 | Part 13 | Part 14 | Part 15 | Part 16 | Part 17 | Part 18 | Part 19 | Part 20 | Part 21 | Part 22 | Part 23 | Part 24 | Part 25 | Part 26 | Part 27 | Part 28 | Part 29 | Part 30 | Part 31 | Part 32 | Part 33 | Part 34 | Part 35 | Part 36 | Part 37 | Part 38 | Part 39 | Part 40 | Table of Contents
Hardly any economists in America anticipated that price-level stabilization during the 1920s would lead to the economic depression that began in October 1929. One of the few who saw a danger in this policy of the Federal Reserve System was Benjamin M. Anderson. As the senior economist for the Chase National Bank of New York City throughout this period, Dr. Anderson authored The Chase Economic Bulletin, which was usually published four to five times every year. He offered detailed analyses of the economic currents in the United States, with special attention to monetary and banking policy and its likely effects on general market conditions. He also often critically evaluated the theories underlying Federal Reserve policy, most particularly the notion of stabilizing the price level as a guide for economic stability.
The most insightful bulletins on this theme were “The Fallacy of ‘The Stabilized Dollar'” (August 1920); “The Gold Standard vs. ‘A Managed Currency'” (March 1925); “Bank Money and the Capital Supply” (November 1926); “Bank Expansion and Savings” (June 1928); “Two ‘New Eras’ Compared: 1896-1903 and 1921-1928” (February 1929); “Commodity Price Stabilization as a False Goal of Central Bank Policy” (May 1929); and “The Financial Situation” (November 1929).
He argued that the Federal Reserve had used its powers to reduce the reserve requirements of member banks, had set the discount rate at which member banks could directly borrow from the Fed below the market rates of interest, and had used “open-market operations” to inject new reserves into the banking system. The increase in bank reserves available for lending purposes as a result of these Fed policies had generated a huge increase in demand deposits and especially in time deposits. As a result, a large monetary inflation had been created by the Federal Reserve during the 1920s.
But the price level had remained stable, producing, Benjamin Anderson said, a false sense of economic stability. In 1926 and 1928, he argued that the amount of bank credit created by Fed policy enabled the financing of new investments in excess of actual savings in the economy. Influenced by Joseph Schumpeter’s The Theory of Economic Development (1911), Anderson argued that monetary expansion in the form of bank credit lowered interest rates, which attracted additional borrowing for long-term investment projects. These additional bank loans with newly created money enabled investment borrowers to bid resources and labor away from consumption and other uses in the economy and redirect their use towards various types of capital formation. The monetary expansion, in other words, induced the undertaking of investment activities in excess of the actual voluntary savings upon which a stable pattern of investment is ultimately dependent. Thus, Federal Reserve policy was creating a serious imbalance in the savings-investment relationship of the American economy.
Anderson estimated that between 1921 and 1928, demand deposits at Federal Reserve member banks had increased 33.8%, while time deposits (whose minimum reserve requirements had been set by the Fed significantly lower than those required for demand deposits) had increased by 135.1%. The resulting increase in lendable funds, he said, fed real-estate and construction booms and produced a dramatic rise in stock-market speculation.
In February 1929, Anderson pointed out that “excessive bank reserves generate bank expansion, that bank expansion running in excess of commercial needs will overflow into capital uses and speculative employments, and that low interest rates and abundant credit will ordinarily reflect themselves in rapidly rising capital values.” In Anderson’s view, these all pointed to the inevitability of a corrective downturn.
In May 1929, Anderson again explained that Federal Reserve policy had created a large bank-credit expansion during the decade through its discount-rate policy and its open-market operations. He admitted that the monetary expansion had not produced an absolute rise in the price level, “but I would maintain that our commodity price level would be lower today if this great expansion of bank credit had not taken place. The expansion has had its influence, not in raising commodity prices, but in maintaining them.”
During the decade of the 1920s, Anderson said, there had been a great increase in production, and many technological innovations and new cost-cutting efficiencies had been introduced into business. An index of the physical volume of production showed a 34.6% increase between 1921 and 1928. This would have tended to slowly lower prices in the American economy, as the increased supplies of goods and services were offered to the consuming public. But the increase in the money supply had counteracted this natural tendency for prices to have decreased. Argued Anderson:
“Such price changes are wholly beneficial, and should not be interfered with, and such price changes often involve not merely changes in particular prices, but also changes in the general price level of a country, if large groups of producers are involved. . . . ‘Right prices’ are prices which will move goods and clear the markets, but nobody knows in advance what prices will do this. Experimentation in the markets, with free prices and two-sided competition, is the only way to find out quickly and surely what prices are ‘right’. . . . To resist such price changes is to invite trade stagnation.”
And in Anderson’s view, the Fed’s policy of price-level stabilization and various other interventionist policies undertaken by the United States and other countries had prevented prices from telling the truth about actual supply-and-demand conditions. Instead, price-level stabilization had created imbalances that were inevitably going to require a correction.
Right after the stock-market crash, in November 1929, Anderson wrote:
“Basically, our present troubles grow out of the excessively cheap money and unlimited bank credit available for capital uses and speculation from early 1922, with an interruption in 1923, until early 1928. During this period we expanded the deposits of our commercial banks by thirteen and a half billion dollars, and their loans and investments by fourteen and a half billion. There is no intoxicant more dangerous than cheap money and excessive credit. . . . [But] when old-fashioned voices raised in protest, calling attention to old landmarks and old standards, raising prosaic questions regarding earnings and dividends and book value, they were drowned out by an indignant chorus, which chanted that we were in a “New Era,” in which book values no longer meant anything, and dividends little, and in which we might capitalize earnings in any ratio that the imagination saw fit to set. . . . To the student of economic history, it is all painfully familiar. He has seen it many times, and in many markets. . . . There is no point in assigning any particular cause for the [stock market] break’s coming at the particular time it did. It was overdue, and long overdue. A great collapse was certain the moment that doubt and reflection broke the spell of mob contagion, while the fantastic structure of prices was doomed the moment any considerable number of people began to use pencil and paper.”
The goal of price-level stabilization had all been a great illusion, Anderson argued. Furthermore, he pointed out in “Commodity Price Stabilization a False Goal of Central Bank Policy” in May 1929:
“The general price level is, after all, merely a statistician’s tool of thought. Businessmen and bankers often look at index numbers as indicating price trends, but no businessman makes use of index numbers in his bookkeeping. His bookkeeping runs in terms of the particular prices and costs that his business is concerned with. . . . Satisfactory business conditions are dependent upon proper relations among groups of prices, not upon any average of prices.”
What is important in the market, Anderson was arguing, are the relative price relationships, i.e., the prices for consumer goods relative to the prices of factors of production; the rate of interest as a cost of capital relative to the expected future rate of return from an investment; and the prices of consumer goods relative to the prices for capital goods. It is the pattern of relative demands for goods in comparison to the pattern of relative supplies of those goods that generates the structure of relative prices in the market. And it is this structure of relative prices that creates the margins of profitability that guide entrepreneurial decision-making in the use and allocation of resources and labor for the production of various types of consumer goods and capital goods.
The general price level of commodities in the market is a statistical averaging of a selected group of the individual prices of these goods. And as a statistical average, the general price level submerges beneath its surface all of the individual price relationships that actually influence the use of resources and the production of goods. Beneath the “stability” of the general price level of the 1920s, Federal Reserve policy had manipulated interest rates through monetary expansion and had distorted the profit margins between different types of investments and between the relative profitability of manufacturing consumer goods in comparison to capital goods.
These artificial relative price relationships created by Fed monetary policy had generated imbalances in the economy that were going to require readjustment and correction. As Benjamin Anderson explained in a later bulletin, issued in June 1931, entitled “Equilibrium Creates Purchasing Power: Economic Equilibrium vs. Artificial Purchasing Power,” production and prices were out of balance; costs, including wages, were out of balance with the selling prices of goods on the market; and asset and capital values were out of balance with actual market conditions. The imbalances in these price, cost, and production relationships were revealed by the Depression.
But Anderson insisted:
“The restoration of equilibrium cannot be accomplished by government planning. The power does not exist, and the wisdom does not exist, to regulate economic life by governmental edicts. The adjustments must be accomplished piecemeal by individual enterprises seeking to make profits and avert losses, guided by market prices. . . . But this mechanism works well only when prices are free to move, and tell the truth. Artificial valorization of commodities, whether accomplished by a government or by a private combination of producers, perverts the machinery and prevents the necessary adjustments.”
For Anderson, it was price and wage rigidities supported or enforced by the government that caused the severity of the Great Depression. By preventing or delaying the necessary adjustments in prices, wages, and production — and the relationships between them — the government hindered the normal working of competitive market forces from bringing the economy back towards a path of balance and growth.
While Benjamin Anderson was one of the few economists in America who questioned the idea that general economic stability would result from a policy of price-level stabilization, in Europe there was a larger number of economists who challenged the arguments of people such as Irving Fisher. The most important among them were the Austrian economists, the leading figures among whom were Ludwig von Mises and Friedrich A. Hayek. They undermined all the theoretical assumptions supporting the price-level stabilization idea and showed why the policies introduced by governments in the 1930s prolonged and intensified what became the Great Depression.