January 7, 2015; James Grant: The Forgotten Depression

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“The virus of radical monetary intervention is now in the political bloodstream. I don’t think there is any going back, at least not while the current monetary system remains in place. Even six or seven years ago nobody was seriously imagining a turn of events such that the Federal Reserve would print up some unimaginable number of commas and zeroes preceded by a dollar sign. Was that possible?”

– James Grant

Kevin: Our guest today, James Grant, we will bring on in just a moment, Dave, but I want to talk about his book, The Forgotten Depression. Most people have heard about the depression that occurred from 1929 into the 1930s, but the depression that actually is probably more instructive as to how we should react to a depression is the huge downturn, the tremendous depression, that was relatively short, from 1920 to 1921.

David: That’s right. Wholesale prices, consumer prices, farm prices, all declined more than in the great depression, with the stock market selling off close to 50%.

Kevin: What is interesting, though, David, is the entire downturn, huge deflation, wages fell, unemployment went up, like you said, but the whole thing corrected itself and turned into a great boom after 18 months. In fact, it was probably one of the most instructive times to see creative destruction, and then what comes afterward.

David: Which makes it a very inconvenient episode for today’s era of central planners and central bankers who think that, actually, their job is to manage the business cycle. So, The Forgotten Depression: 1921: The Crash That Cured Itself, written by James Grant, is either his ninth or tenth book, and I have to be quite honest here, this is one of those authors which is probably more formative than any other in my library, and in terms of my thinking, both as an investor, and as someone who is interested in finance and economics. His book on Bernard Baruch, his book Mr. Market Miscalculates, just a few years ago; before that, Mr. Speaker, and probably my favorite book going back in time, in terms of when he published them, Money of the Mind; his first book, The Trouble with Prosperity, I could go on and on.

He does a great job of looking both at people who are involved in finance, people who are involved in politics, and of course, his monthly contribution, The Interest Rate Observer. He is a bond man, he is interested in the interest rate world, what moves the interest rate market, and today, to be interested in interest rates is, really, to take an interest in politics, because it is, as he has written many times before, a price mechanism which is controlled, in stark contrast to what was the success story of the 1920s, the price mechanism working on an unfettered basis, on an uncontrolled basis, and that is where the self-healing properties emerged.

Kevin: And it is interesting, Dave, people are willing to pay a pretty penny for that monthly advice from Jim Grant. To pay about $1000 for a subscription to a newsletter shows that there is quality, and people are willing to pay that kind of price. I was showing somebody the other day, Jim Grant’s Interest Rate Observer, and they sort of shook their head and they said, “That can’t possibly be interesting.” But quite to the contrary.

David: That’s what I mean, my favorite book is where he is discussing the history of interest rates in his book, “Money of the Mind.”

Kevin: Well, interest rates are the measure of risk. You probably can’t measure in a better way the whole social history of man.

David: And actually, what you just described, the perfect picture of risk, which makes this such a confusing period of time as an investor, where interest rates are manipulated and held at an incredibly low rate, and thus, don’t give a clear signal, in terms of what risk is, in the economy, and in the marketplace, so you have something of a very fabricated nature.

Kevin: You and I have talked over and over about price mechanism, and the ability of the price mechanism to determine the market and correct itself. That’s what this interview is about. Dave, let’s go ahead and go to Jim Grant.

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David: As a second-generation Grant’s reader and regular conference attendee, I want to thank you for joining our weekly conversation. Each book you have released has had something timely and timeless to say. My personal favorite is Money of the Mind, going back a few years, and I am grateful you have taken the time in your latest book to discuss The Forgotten Depression: 1921, The Crash That Cured Itself. This has always been curiously ignored. Let’s begin with the contrast, if you would, between 1920 and 1921, that depression, and the 1929 to 1933 depression. They highlight a different ideological approach to crisis. Perhaps you can explore that.

James: Yes, indeed, David, 1920-1921 was, on the face of things, well, in the words of contemporaries, it was a debacle without parallel. Commodity prices plunged upwards of 45% over the course of less than a year. The stock market, as measured by the Dow, was sawed in half, industrial production down approximately by a third from peak to trough. Unemployment was not then calculated officially, but it almost certainly was in the double digits. In short, a debacle. The 1929-1933 affair proved to be much worse, but did not match, at the beginning, the severity of the deflation of 1920-1921. The difference in response is most interesting.

As you have noted, the federal government’s response to the troubles of 1920-1921 was, in a nutshell, to do nothing. They were still wet behind the ears. The Federal Reserve board actually raised, rather than reduced, interest rates, in the face of falling prices. 1929-1930 was a very different story. Then President Herbert Hoover, who had been the Commerce Secretary under President Harding in 1921, but now raised to the White House, himself. Hoover resolved not to do nothing, but on the contrary, to intervene, with the full power of the bully pulpit at his disposal. The White House had called the leading industrialists together and exacted from them a pledge not to reduce wages. Wages had fallen along with prices in 1921. And that was the crystalizing difference, in my opinion.

One of the paradoxical sources of strength in the earlier business cycle downturn was the resiliency to the downside, the flexibility to the downside, of wages, as well as prices, because wages fell, not so much, but as they fell, as prices did, the manufacturer’s profit margins were not destroyed, but were recouped long about the bottom of the cycle. In 1929, 1930, and onward, wage rigidity condemned businesses to eviscerated profit margins, with the result of much greater unemployment than would have been the result otherwise.

David: So there is the crux. Labor, in that 1929 to 1933 period, were shifting the burden to capital, instead of labor, versus 1920-1921, you had that politically unpalatable issue of lowering wages, and the farther we go in history, we see that it becomes even more politically unpalatable. So, there is, even by the time of Hoover, the decision to not adjust. We have the price adjustment. They won’t adjust in labor. Rueff and others have pointed out that that is a critical element in recovery.

James: Yes.

David: Now, wage deflation – let’s fast forward to the current context, if you would, just a moment, because wage deflation, if that was the key contrast between 1920-21 and the 1930s, how should we understand labor and wages in the context of, say, the last six years?

James: Of course in 1920-1921 there was no federal safety net and one saved, or one relied on friends, family, charity, or one did without, but there was nothing like the literally scores of income maintenance programs that the federal government now sponsors, nor was there anything like the great disability industry that exists today. People took the wages on offer or they didn’t work. The labor force then was heavily unionized, much more heavily unionized than today, so it was not prehistoric, by any means.

You mentioned the French economist, Jacques Rueff, who identified wage rigidity as the great incubus that brought low the British economy in the early 1920s and he contended that the dole, really, was the problem with British stagnation after World War I. Well, if that was the case, certainly we today in America confront a problem, I would say, greater than the British did many long years ago. It is a problem, but it is also a social choice. We choose to support incomes, we choose to allow people to remain out of the labor force while they reconnoiter and perhaps intellectually retool or get new training. But in any case, we do not force people into the labor market to take wages on offer. It’s a very big difference.

David: Well, if 1920-21, as you describe it, was unmanaged, or unmedicated, the last encounter between crisis and, say, a laissez-faire response, the financiers and capitalists of that generation were comforted by the market’s self-healing mechanisms, and as you have pointed out in your book, they were weaned on the ideas of laissez-fair economics. What has the current generation been weaned on, and would federal passivity have a different effect, based on those differing expectations?

James: The current generation, of course, was weaned on the idea of a proactive, interventionist government response. You know, a sparrow shall not fall to earth without the Federal Reserve taking cognizance of that fact, and adjusting its dynamics, stochastic general equilibrium models, to make allowances, or so it seems. I dare say that society today, without preparation, would be certainly taken aback by a decision from on high that the government really ought to abide by Murray Rothbard’s advice. Murray Rothbard being the late, great laissez-faire economist who contended that the only – the only, mind you – acceptable response to a business cycle downturn was for the government to do nothing.

Having been indoctrinated, or certainly educated, in the tenets of interventionism, I think that pure federal passivity would be a very cold bath, but I think it would be a rather wholesome one. If there is a lesson that comes out of the historical episode I wrote about, perhaps that lesson is that the price mechanism is one of the great social contrivances that is a much more powerful and benevolent mechanism for the ordering of activity and the coordination of activity and the allocation of resources, than many people, or perhaps most people, give it credit for being.

David: Focusing on the price mechanism, really, is returning to Adam Smith’s unseen hand of the market, which we have replaced with the seen hand of government, in the tradition of FDR, Wilson, and Hoover. There is sort of a cadre of leaders in the United States that has set the current tone. What you are suggesting is that perhaps Harding set the better tone?

James: Yes, the results certainly would point in that direction. By the way, it wasn’t just Harding. Wilson – the dates of this business cycle downturn are from early 1920 until the summer of 1921. It was over and done with, at least as to the top and the bottom, over and done with in a year-and-a-half. And much of that time was during the last year or so of Woodrow Wilson’s second administration, and he was not an apostle of laissez-faire, but was a practitioner of that by dint of the stroke that incapacitated him. The same stroke incapacitated his administration. The White House was really in the hands of his wife, and she, without realizing it, was a practitioner of the doctrines of the classical economists. The government balanced the government and didn’t try to implement anything in the way of stimulus, and ironically enough, Woodrow Wilson, who was a great one for statism, also was a great accidental advocate, or at least, a practitioner of, laissez-faire.

David: It is interesting, because in your book there is a difference, perhaps, with most heroic tales. We’re looking for a man of action in most heroic tales, and yet in yours, it is the man of inaction that is to be celebrated.

James: Yes, constructive inaction. We ought to have more of it. I think the papers would make much more pleasant reading if they were much more constructive in action. Nice silences are noise for governance.

David: By contrast we have economists who today are assumed to be some sort of engineers, at least by the central banks of our day, steering, offering guidance.

James: Ah yes, the wise ones.

David: Let’s discuss presumption in economics because this control and guided process has the air of experience to it, and yet, we also have the confession of Ben Bernanke, or just the telling acknowledgement that they are learning as they go. How is it that we put so much faith in people orchestrating events, at the fed, at the ECB, at the Bank of Japan?

James: Beats me. (laughs) Nobody reads my stuff, that’s why. It is one of the miracles of the age. I think that in 50-100 years’ time, I don’t know, perhaps in ten months’ time, but at some point in the future, when retrospect offers a clearer view of events than the immediate lines of sight do, come that moment of revelation, people will say, “Do you mean to tell me that they (perhaps we) turned over the ship of state to former tenured economics faculty? They did what?” That’s what it comes down to.

I often think that one of the secrets of success of the Woodrow Wilson and Warren G. Harding episode in the early 1920s was the absence of many of the government data with which we are now bombarded almost, it seems, by the minute. Remember a man named Cowperthwaite, who was the financial secretary of Hong Kong in the 1960s. I think later, Sir John Cowperthwaite ruled that he didn’t want any confounded macro-economic data being collected for the colony lest someone try to employ those statistics in the service of government intervention and I think the constructive ignorance with which the government would-be policymakers operated in the early 1920s was part of the secret of the quick resolution of the troubles of 1920-1921.

David: Is that period, 1920-1921, ignored by students of political economy?

James: Yes! It is. And it is still ignored because Amazon has run out of the book. (laughs) It is an obscure period, and I think, for one reason, the very fact to which you alluded a few minutes ago, which is that there was no dashing man of action. A kind of pathetic invalid, is not, except for Gene Smith’s book When the Cheering Stopped, regarded as the stuff of heroic historical narrative – nothing like all the stories and the film clips of the brain trust getting on trains and going to Washington to straighten out the affairs of the Republicans in 1933. That would make a much better historical narrative.

So, it has been ignored, and I think also, in fairness to the heavy ideological content, and political content of historical writing, the free market side of 1920-1921 does not fit the conventional view of events. It rather jars with the narrative of the early 1930s. If this 1920-1921 affair shook out as I contend it did, then one ought to, one must, reappraise the 1930s, which Amity Schlaes did in her book The Forgotten Man, but that reappraisal would seem to be not on the imminent agenda of our historians.

David: Well, we have, certainly, an ideological paradigm today that doesn’t match the 1920 and 1921 data, and maybe that paradigm is largely informed by Keynes. Transitioning just for a brief moment to inflation and deflation, Keynes tracked on monetary reform argues for the benefits of inflation and the drawbacks of deflation. Are the drawbacks really centered on the overleveraged, the indebted, and the central planner?

James: Well, the advantages at which you hinted, the advantages of deflation, I think Keynes rather undersold, and those advantages – Walmart, for one, has built a rather successful model around, which is everyday lower and lower prices. Silicon Valley, too, has taken that idea of lower prices to heart. To me, the relevant fact of the matter is that during periods of great technological advance, the past prices have fallen, they have dwindled. They did so in the final couple of decades of the 19^th century, and they certainly did not go up in the 1920s. As recently in America as the early 1960s and for 12 full months between 1954 and 1955, the CPI, the Consumer Price Index, actually showed year-over-year declines, and nobody objected to those.

Go back and look at the newspapers in the mid 1950s and the early 1960s and there was no talk of deflation, although certainly in the mid 1950s people had a belly full of the real thing only a generation earlier, so you would expect that if falling prices on the order of 1 percent or 1½ percent year-over-year were a clear and present danger to the republic, somebody would have raised his voice, but there was really very little made of it. So, I contend that a lot of the talk about deflation is misplaced. And I think what many shoppers want is progress, which is another word for productivity-led lower prices.

David: The problem with deflation seems that the implicit increase to wages is not taxable, and this circles back around to 1913, where under the Wilson Presidency we had the emergence of two things, not only the Federal Reserve, but the income tax, and it seems that inflation promotes a perpetual increase in taxation. These sort of hand-in-glove measures put in place in 1913 have defined the way forward for central banks.

James: Yes, although in 1913, don’t forget, nobody knew about World War I, at least nobody was talking about it, and the gold standard was still in effect in its classical glory, and there was no thought, really, about an age of perennially rising prices and therefore steadily progressing bracket creep in the income tax. I daresay it was not a conscious decision by the Wilsonians, but certainly that is the way it has worked out.

David: Stable purchasing power from 1650 to 1930, one ounce of gold bought you approximately the same basket of goods. That is astounding. A basket of commodities from 1650 to 1930 did not really change as it was priced in gold, and so we have this notion of “sound money.” Is it a reality of modern politics that sound money can’t be returned to?

James: Well, it certainly seemed that way. There was an election in the United States this past fall, and Jeff Bell was the Republican candidate in new Jersey. He ran against Cory Booker, who was a candidate of no particular distinction. Jeff ran on a program of reinstitution of the gold standard and lost by about 20 percentage points, so the idea of significant monetary reform, of restitution of the gold standard and some form of sound money, this idea, I think, is not for this moment, politically. And I think the reason is that the Ph.D standard, which is how we at Grant’s Interest Rate Observer refer to the regimen in place, the Ph.D. standard has been a great boon to the asset-holding portions of the community.

The past five or six years have been a wonderful time, if you had access to what amounted to free money. So, Jeff Bell in New Jersey was running against not only Cory Booker, but against the stock market, and that’s a very hard thing to do. So, I don’t know about the future of the politics of sound money, but as to the present, I think it is rather a nonstarter. My personal opinion is that serious monetary reform awaits the implosion of the Ph.D. standard, which I believe will happen, but as I have proved to my readers over the years, I don’t know when.

David: (laughs) Well, as we wrap up, maybe borrowing from lessons from the past, allowing them to echo into the future, how do you see the long-term outlook for equities, bonds, the gold market, the dollar, 5, 7, 10 years out? Again, no one has a crystal ball, but is there anything that we can learn from the past that might shed light on where we go next?

James: Well, in partial and wholly unsatisfactory answer to that brilliantly cosmic question, David, here is my pronouncement as to the present day, with reference to the past, and that is that the virus of radical monetary intervention is now in the political bloodstream, and I don’t think there is any going back, at least not while the current monetary system remains in place. Even six or seven years ago, nobody was even really seriously imagining a turn of events such that the Federal Reserve would print up some unimaginable number of commas and zeroes preceded by a dollar sign. Was that possible?

Well, it happened, and it is happening the world over, and furthermore, not only has it happened, but it is evidently a success in the terms of the central bankers. They point out that there is no inflation. They love to rub the noses of the critics in the fact that at the checkout counter, you cannot see anything gone wrong. Well, we haven’t got enough time to enumerate all the things that have gone wrong with this regime, but suffice it to say that it appears to have been a great success in financial engineering. Only the other day, the Chicago mercantile exchange, which is the sponsor of free markets around the world, awarded its, if you please, David, Financial Innovation Award of 2014, to none other than Ben Bernanke, the former Chairman of the Fed, for his (David laughs) leveraging his historical knowledge into these great deeds of intervention.

So, it seems to me that the great question, certainly for gold investors, but I daresay for all investors, not just gold investors, on second or third thought, bond investors maybe even more so. The great fact is that this precedent is now in the books, on the record. It works, say they. So, the next time there will be a bear market, of course, there will be a recession, of course. The next time what will they do? What will they do for an encore?

And it is likely to be still more audacious because, after all, we have shown, have we not, that audacity is not only what sells, but also what works. So, I am a believer in the financial, as well as the monetary utility of gold. I think gold will come back into its own in a very big way. What we try to do at Grant’s is to look for things that are unloved, and assets that are over-hyped, and to be long and short, and hedged, and alert, and not to make unforced errors, which is something we do every third or fourth year. I guess that ends my speech on the future.

David: (laughs) Well, we appreciate you joining us in today’s conversation, and again, from a second generation Grant’s reader, we appreciate all that you have done, going back many, many decades. There were two people that my father gave me as a mandate to read: Alan Abelson, and Jim Grant. He said, “You don’t want to miss these two fine and distinguished gentlemen. Pay attention to what they say, read them,” I think he even said, “religiously.”

James: (laughs)

David: And I’ve done that. So, I appreciate it, and look forward to the next Grant’s conference. I hope that some of our listeners will also entertain looking at Grant’s Interest Rate Observer as a regular staple, and certainly, The Forgotten Depression: 1921; The Crash That Cure Itself.

James: David, I thank you. It’s been a delight. So long.

David: Bye-bye.