David R. Henderson  

George Selgin on "The Bernank"

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Why Haven't They Been Fired?... If the Mind Is a Muscle...

George Selgin has an excellent commentary on Ben Bernanke's maiden lecture on monetary policy at George Washington University. Not only does George dispel myths that most people believe, but also he dispels myths that I believed.

An incomplete list of myths that most people believe and George's dispelling of them:

He [Bernanke] thus attributes the greater frequency of banking crises in the post-Civil War U.S. than in England solely to the lack of a central bank in the former country, making one wish that some clever GWU student had interrupted him to observe that Canada and Scotland, despite also lacking central banks, each had far fewer crises than either the U.S. or England. Hearing Bernanke you would never guess that U.S. banks were generally denied the ability to branch, or that state chartered banks were prevented by a prohibitive federal tax from issuing their own notes, or that National banks found it increasingly difficult to issue their own notes owing to the high cost of government securities required (originally for fiscal reasons) as backing for their notes. Certainly you would not realize that economic historians have long recognized (see, for starters, here and here) how these regulations played a crucial part in pre-Fed U.S. financial instability.

In particular, he never mentions the fact that Canada had no bank failures at all during the 1930s, despite having had no central bank until 1935, and no deposit insurance until many decades later. Nor does he acknowledge research by George Kaufman, among others, showing that bank run "contagions" have actually been rare even in the relatively fragile U.S. banking system.

Bernanke's claim that output was more volatile under the gold standard than it has been in recent decades is equally unsound. True: some old statistics support it; but those have been overturned by Christina Romer's more recent estimates, which show the standard deviation of real GNP since World War II to be only slightly greater than that for the pre-Fed period. (For a detailed and up-to-date comparison of pre-1914 and post-1945 U.S. economic volatility see my, Bill Lastrapes, and Larry White's forthcoming Journal of Macroeconomics paper, "Has the Fed Been a Failure?").

Finally, Bernanke repeats the tired old claim that the gold standard is no good because gold supply shocks will cause the value of money to fluctuate. It is of course easy to show that gold will be inferior on this score to an ideally managed fiat standard. But so what? The question is, how do the price movements under gold compare to those under actual fiat standards? Has Bernanke compared the post-Sutter's Mill inflation to that of, say, the Fed's first five years, or the 1970s?

Now to the ones that were news to me:
Bernanke, in typical central-bank-apologist fashion, refers to [Walter] Bagehot's work, but only to recite Bagehot's rules for last-resort lending. He thus allows all those innocent GWU students to suppose (as was surely his intent) that Bagehot considered central banking a jolly good thing. In fact, as anyone who actually reads Bagehot will see, he emphatically considered central banking--or what he called England's "one-reserve system" of banking--a very bad thing, best avoided in favor of a "natural" system, like Scotland's, in which numerous competing banks of issue are each responsible for maintaining their own cash reserves.

Because he entirely overlooks the role played by legal restrictions in destabilizing the pre-1914 U.S. financial system, Bernanke is bound to overlook as well the historically important "asset currency" reform movement that anticipated the post-1907 turn toward a central-bank based monetary reform. Instead of calling for yet more government intervention in the monetary system the earlier movement proposed a number of deregulatory solutions to periodic financial crises, including the repeal of Civil-War era currency-backing requirements and the dismantlement of barriers to nationwide branch banking. Canada's experience suggested that this deregulatory program might have worked very well. Unfortunately concerted opposition to branch banking, by both established "independent" bankers and Wall Street (which gained lots of correspondent business thanks to other banks' inability to have branches there) blocked this avenue of reform.

Finally, Bernanke suggests that the Fed, acting in accordance with his theory, only offers last-resort aid to solvent ("Jimmy Stewart") banks, leaving others to fail, whereas in fact the record shows that, after the sorry experience of the Great Depression (when it let poor Jimmy fend for himself), the Fed went on to employ its last resort lending powers, not to rescue solvent banks (which for the most part no longer needed any help from it), but to bail out manifestly insolvent ones.

Rather less amusing was his quotation of that "famous statement by Andrew Mellon" about liquidating stocks etc.: poor Mellon never said it, in fact: the words were Hoover's, and were intended as parody.

And, most shocking to me--it shows how even I had drunk the Fed Kool-Aid--is this one:
Although he admits later in his lecture (in his sole acknowledgement of central bankers' capacity to do harm) that the Federal Reserve was itself to blame for the excessive monetary tightening of the early 1930s, in his discussion of the gold standard Bernanke repeats the canard that the Fed's hands were tied by that standard. The facts show otherwise: Federal Reserve rules required 40% gold backing of outstanding Federal Reserve notes. But the Fed wasn't constrained by this requirement, which it had statutory authority to suspend at any time for an indefinite period. More importantly, during the first stages of the Great (monetary) Contraction, the Fed had plenty of gold and was actually accumulating more of it. By August 1931, it's gold holdings had risen to $3.5 billion (from $3.1 billion in 1929), which was 81% of its then-outstanding notes, or more than twice its required holdings. And although Fed gold holdings then started to decline, by March 1933, which is to say the very nadir of the monetary contraction, the Fed still held over than $1 billion in excess gold reserves. In short, at no point of the Great Contraction was the Fed prevented from further expanding the monetary base by a lack of required gold cover.

I've excerpted about half of Selgin's excellent piece, but the whole thing is worth reading. He also supplies links to his most-important factual claims.

HT to Alex Tabarrok and Jeffrey Rogers Hummel.


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CATEGORIES: Monetary Policy , Money



COMMENTS (17 to date)
Ken B writes:

I recall some discussion of the Fed's role in accelerating the contraction in this excellent book

David R. Henderson writes:

@Ken B,
I agree that it’s excellent. See the short version I commissioned the book’s author to do for The Concise Encyclopedia:
http://www.econlib.org/library/Enc/GreatDepression.html

Ken B writes:

I also liked FDR's Folly, but it's more tendentious in tone.
Both books were accessible to a non-econ type like me.

Mark Brady writes:

Thank you, David, for providing a very useful summary of George Selgin's magnificent dissection of Bernanke. Like you, I learned a lot. And I look forward to referring students to your post.

AJ writes:

Thank you David for a great piece of blogging!

This is one of your best posts. (Your best being the Kenysian fiscal contraction at the end of WWII followed by the post war boom).

I knew Bernanke in grad school and would never never have expected such views. But maybe I'm the one who has shifted.

David R. Henderson writes:

@Mark Brady,
You’re welcome. Wow! Even you learned a lot. And I’m positive that you knew more about this than me. Had you known Bagehot’s views about central banking? I had had no idea.
@AJ,
Thanks. One of my best posts and almost all I did was cut and paste? Hmmm. :-) Well, as I said to my wife-to-be on our first date, in 1981, walking through the Castro district of San Francisco, when I was 25 pounds lighter and had great and different-colored hair and the guys were ogling me, not her, I’ll take compliments any way I can get them. :-)

David, on the spurious Mellon quote please see my "Did Hayek and Robbins Deepen the Great Depression?," Journal of Money, Credit, and Banking 40 (June 2008): 751-68.

Jim Glass writes:

It is of course easy to show that gold will be inferior on this score to an ideally managed fiat standard. But so what?

So ... Great Depression.

So ... due to an external shock the demand for money rockets up, causing deflation to accelerate to a 13% annual rate just as it did in 2008 quarter 4 -- the worst since the big plunge of Great Depression I. But unlike in our 2008, the gold standard bars the Fed from rapidly increasing the money supply by enough to meet that explosion in demand for it to stabilize prices, stopping the big deflation. Great Depression II.

The question is, how do the price movements under gold compare to those under actual fiat standards? Has Bernanke compared the post-Sutter's Mill inflation to that of, say, the Fed's first five years, or the 1970s?

Classic straw man. With the gold standard the problem isn't inflation, it is deflation. Has Selgin compared the deflation record of the fiat money era to that of, say, 1929-33?

And let's not hear "That wasn't the gold standard, that was the Fed's mismanagement". That was the Fed mismanaging the problems *of the gold standard*.

Moreover, it was the gold standard that transmitted the Great Depression all around the world, to all the nations on the gold standard -- but *not* to those not on it. The Fed wasn't mismanaging the money of every nation in the world (well, of all those on the gold standard, but only them!).

Moreover, it wasn't just the Fed. France massively hoarded "sterilized" gold to control domestic inflation, and in doing so put strong deflationary on the whole gold-standard world. That's what set up the Fed's mistakes to be so costly. France was as culpable as the Fed.

And let's not now hear: "But all that was an aberration, not way the gold standard should have been run..." Sure, maybe an "ideal" gold standard wouldn't have had those faults -- but why should anyone be more impressed by an "ideal" gold standard than Selgin is by "ideal" fiat money? It's the real thing that counts.

France's domestic anti-inflation steps would have had zip effect on anyone else but for the gold standard, and the Fed's mistakes wouldn't have been transmitted to anyone else but for the gold standard.

No matter how badly a nation mangles its own money policy, it doesn't screw up everyone else in the world if they are using fiat money. One country's mistake *can* screw up the entire world with the gold standard. Without the gold standard, the Great Depression, as we know it, could not have occurred.

The gold standard boils down to a universal single currency/fixed exchange rate system. The closest thing to that today is the Euro. How's that working out?

Reality: The whole world abandoned the gold standard to escape the Great Depression. They succeeded in escaping in the order that they left it. *That's* the reason no nation in the world has any interest at all in going back.

Daniel Klein writes:

Hear, hear, great post!

Incidentally, Walter Bagehot heaped scorn on Adam Smith's The Theory of Moral Sentiments, in his 1876 essay "Adam Smith as a Person."

Here are two samples:

"But this usefulness of his Scotch professorship was only in the distant future. It was something for posterity to detect, but it could not have been known at the time. The only pages of his professional work which Adam Smith then gave to the public were his lectures on Moral Philosophy ... These formed the once celebrated Theory of Moral Sentiments, which, though we should now think them rather pompous, were then much praised and much read."

"But a mere student of philosophy who cares for no sect, and wants only to know the truth, will nowadays, I think, find little to interest him in this celebrated book."

Joe Eagar writes:

I'm not sure I buy this. Of course central bankers are always going to assign themselves credit when it comes to financial stability. That's no surprise.

I'm also not sure I buy the notion that output was just as stable under the gold standard. I suspect that if you exclude the 60s and 70s, output is probably more stable post-WWII than during the 19th century; modern interest rate feedback rules seem to work quite well.

And finally, while free banking works great in theory and in small historical examples, there is no evidence that it can scale to the level of a modern developed economy. Remember that Canada eventually *did* create a central bank.

Joe Eagar writes:

Not that I'm against free banking. To a certain extent, the private sector tends towards that model--the "shadow banking system" is a case in point. But we don't understand how to make it work, yet, and more research is warranted.

George Selgin writes:

Jim Glass imagines that he has answered my complaint about Bernanke. He hasn't. Concerning the gold standard and the Great Depression, even David's excerpts from my own brief post make clear that the gold constraint wasn't binding on the Fed. That other central banks, and the Bank of France in particular, behaved badly (which here means really means not cooperating to sustain that impossible house-of-cards knows as the interwar "gold exchange" standard) is also not "the gold standard's fault." The classical gold standard is, in any event, what I refer to in my remark; and that standard was long gone by the 1930s. And referring to that standard, which was actually in place before WWI, isn't the same as referring to an "ideal" gold standard. It is not, in other words, like referring to the "ideal" fiat standard Bernanke must have in mind in condemning the price-destabilizing effects of gold supply shocks!

As for deflation: the mild aggregate-supply deflation of much of the classical gold standard era was not a source of any general stagnation; Mr. Glass would know this (and would know where to read further on the matter) had he read my original post, instead of just reading David's excerpts--always a good practice when pretending to offer a "slam dunk" rebuttal of someone's arguments. Were Mr. Glass to look for examples of the sort of bad (demand driven) deflations that do suggest that a faulty monetary system is in place, he'd have to stick to the early 30s or (for the U.S.) to come closer to current events by referring to the pure fiat-money deflation of 2008-9!

In brief Mr. Glass argues like most knee-jerk anti-gold types: he thinks the target easier to hit than it is, and proceeds to shoot himself in the foot while pretending to hit it.

For the record, I am probably no more a fan of trying to revive the gold standard than Mr. Glass is. But unlike him I know the difference between sound arguments for not trying and unsound ones, perhaps because I'm willing to recognize that not all frequently-repeated arguments against gold are sound. So spare me the glib remarks, Mr. Glass: I've seen them before, and know them to be, from long experience, an almost sure sign that 'm about to get some "lessons' from someone who hasn't done his homework.

George Selgin writes:

Joe Eager: you need to read Bordo and Redish on the reasons why Canada created the Bank of Canada. That step had nothing to do with the inability of fr4ee banking to meet the needs of a "modern developed economy."

George Selgin writes:

For "aggregate-supply deflation" in my reply to Glass read "aggregate-supply driven deflation."

Ken B writes:
One of my best posts and almost all I did was cut and paste? Hmmm. :-) Well ...I’ll take compliments any way I can get them.

Will comparison to a communist do? Someone said of Brecht, 'Of course he steals, but he steals with genius.' :)

Andrew M writes:

I will readily admit that my understanding of the monetary system is limited. However, the gold debate is something that has caught my attention recently. I agree with most (if not all) of the points raised by Professor Selgin and quoted here.

With that said, I see two potential problems with a return by the United States to the gold standard:
1. What are the ramifications to the US economy caused by a unilateral adoption of the gold standard? This would prevent fixed exchange rates from the rest of the world, and could might reduce our international competitiveness in the world economy.
2. What is the price that is set for gold? Assuming that we remain on a central banking system, wouldn't the market for gold in the private sector wreck some havoc on the official market for gold being ran by nations and their central banks?

Again, I am not very familiar with the free-banking and pro-gold literature and these concerns might be unwarranted.

Ken B writes:

Reason has a video of a talk by Peter Schiff on The Bernank

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