AlphaChat: Underappreciated Moments in Economic History
Underappreciated Moments in Economic History
Cardiff Garcia: Welcome to AlphaChat, the business and economics podcast of the Financial Times. I'm Cardiff Garcia....
First up on the show is Brad DeLong, an economist and economic historian at the University of California at Berkeley. He is also the coauthor of the New Book: Concrete Economics: The Hamilton Approach to Economic Growth and Policy. We are going to be discussing this book in a forthcoming episode of Alphachat-Terbox, our long-form sister podcast segment. But for this I have asked Brad to choose three under appreciated moments in economic history, and to give us the lessons we should learn from those events. I do not know what Brad's chosen. I will be learning along with you.
Brad: Thanks for common on AlphaChat.
Brad DeLong: Thank you very much.
Cardiff Garcia: So what is first on the agenda? What is the first underappreciated event in economic history that you want to share with us?
Brad DeLong: The first is the bursting of the 1825 canal bubble in Britain, centered on London finance. It is the first time we have a business cycle that is truly triggered not by the embarrassment of some dominant banking house and not by some government default--like Charles II Stuart's Stop of the Exchequer or the financial manipulations of Felipe II Habsburg of Spain, whom his bankers called "the borrower from Hell".
Instead, it is the first time we have a wave of enthusiasm in high-tech investment--i.e., canals--leading to lots of overinvestment due to overoptimism (and to the failure of one set of canal builders to realize how much the market for their canal's services would be eroded by the construction of other canals). We then have the crash. And there follows the spillover of the crash to manufacturing as a whole. 1826 sees the first year in which mechanized cotton production falls, ever, by 30%.
It also had powerful consequences for both economic theory and economic policy practice.
He was the originator of Says' Law. He was the first person to ever say that a general glut--a short-of-demand-driven business cycle that led to mass unemployment was not something we had to worry about. Why not? Because, Say argued, nobody made something to sell unless they planned to then use the money to buy, and so while you could certainly have excess supply in some industries that would be matched by excess demand in other industries. Thus people would shift from demand-short to demand-surplus industries quickly: the market would do its job of reallocating resources and tuning the economy to maximum productivity.
1825-26 in Britain convinced Say that he had been wrong.
His subsequent writings do not dismiss general gluts--short-of-demand-driven business cycles--as impossible, but recognize them.
1825-26 was also the first time that central banks engaged in lender-of-last-resort activities in response to a tech crash. The banking house of Pole, Thornton, and Co. was one that had made among the most canal loans and was among those most likely to be highly embarrassed. E.M. Forster's great-aunt's nephew, the very young Henry Thornton, then 25 or so, appears to have been the only non-somnolent partner of the bank in London in December 1825 when the crisis hit. He went to the Bank of England. He lied. He said: "We are solvent but illiquid." And the Bank of England agreed to support him.
That weekend, Sunday morning before dawn, the Governor and Deputy Governor of the Bank of England counted out banknotes (to preserve secrecy) and then wheeled them through the pre-dawn streets of London in the December gloom so that when the bank opened the following Monday morning they could show huge piles of banknotes behind the tellers to suggest that they were in fact well-capitalized.
It tells us a number of things. We see a major move in economic theory, as the patron saint of the austerity point-of-view, Jean-Baptiste Say, abandons the positions he had been pushing since 1803. It shows the origins of large-scale lender-of-last-resort activities in response to a financial crisis produced by a large-scale bursting of a high-tech or other speculative investment bubble.
And it also shows the first case of the bankers successfully manipulating the central bank--inducing it to come to their rescue and so emerge from the crisis whole and even enriched via government support, even though the were the ones whose rash, risky, and inappropriate lending had caused it.
Cardiff Garcia: A fantastic example. I often lament that when we talk about bubbles we tend to stay with modern examples. We tend to get into comparisons between the housing bubble and the dot-com bubble and we talk about the remnants of those bubbles and the damage left behind by them. A lot of the time we ignore the fact that bubbles are as old as many and credit. There are great lessons to be learned.
Brad DeLong: As soon as you have large-scale credit where the borrower no longer knows the lender--where the fact that borrowings have been good for so long that you think you do not need to check whether borrower is in fact good for it--the value of being able to borrow in the future is so high that who would risk their reputation? When everyone stops checking the quality of the debts they own, and when the debts they own circulate as money, as assets widely perceived to be safe, then you are looking for a crisis. At some point it will become clear that things you thought were safe really were not safe at all. After all, the debts of Felipe II Habsburg of Spain--Master of the New World, owner of all the gold of the Aztecs and the Incas, proprietor of the mountain of silver that was Pitosi in Peru--how could he possibly get himself embarrassed? Well, he gave away enough land grants and pensions to the nobles of Spain, and he spent so much on the Wars of the Counterreformation in their attempt to suppress the insurgency of the fundamentalist religious terrorist fanatics who were the sixteenth-century Dutch--Protestant religious fanatics then--that he managed to get himself bankrupt.
Cardiff Garcia: Wonderfully insightful. What is your second example?
Brad DeLong: My second example is something I just learned about this week. One of our Berkeley graduate student, Gillian Brunet, is studying World War II for her dissertation.
World War II in the U.S. has always been of great interest as it sees the rapid movement of an economy from a depression-economics economy with lots of slack to an inflation-economics economy with excess demand pressure.
First Franklin Roosevelt gets worried about Nazi Germany. He starts trying to assemble alliances. He fails miserably.
France and Britain draw a line in the sand, saying: "We will declare war on you if you attack Poland!" Hitler responds: "What could you do about it? Poland is on the other side of us Germans from you. Don't make empty threats." So Hitler attacks Poland. Behold! He finds that--contrary to all the canons of game theory--Britain and France actually meant it. This is unusual. Until 1944, when it was clear that the United Nations had the war won, France and Britain were the only countries that ever declared war on Nazi Germany. Other countries waited until the Nazi tanks had actually crossed their border--or, very rarely, until the Nazis had declared war on them--to enter the conflict. France was the only country that shared a land border with Nazi Germany that ever dared make the decision not to try to hide but rather to take the fight to the Nazis and put their country in harm's way.
Thus after World War II in Europe starts in September 1939, Franklin Roosevelt wants to build as much military hardware as he can and send as much as he can to aid France and Britain in their fight. But it is not until the end of 1941, the Japanese attack on Pearl Harbor, and Hitler's declaration of war on the U.S. that total mobilization begins.
Starting in 1942, therefore, the U.S. was a war economy: dedicated to defeating Hitler and Tojo no matter what.
The question is: how did this transformation take place? How do you go from a slack economy to an inflation economy? And what happens to standard macroeconomic patterns and correlations as you do?
It turns out--and this is the thing I learned this week--that only a little bit of central planning allows you to do an enormous amount to redirect economic activity without having runaway inflation and your price level quadruple as you try to send the market very strong price signals that war material is now very highly valued. All the federal government had to do was send an executive order shutting down the civilian uses of those assembly lines capable of producing tanks and airplanes and trucks. Demanding that they be redirected to military vehicles. In the aftermath, a huge chunk of industrial capacity switched over effectively immediately to serve the needs of the Pentagon-to-be. And the funding emerged as well without extraordinary inflation, for everyone who would have bought a car in 1942 or 1943 saved the money instead and loaned it to the government by buying war bonds. Thus the same money flowed from consumers to factory workers--but through the government, and directing the workers to build tanks instead of cars.
You thus managed to switch a lot of production over very quickly without much inflation by just using the right teeny amount of central planning. Possible applications to what we may decide to do in the next decade or two with respect to global warming--if something very bad happens, and it becomes the moral equivalent of war for us rather than something to simply leave as a mess for future generations.
Cardiff Garcia: And your final example of an under appreciated event from economic history?
Brad DeLong: Let me--I know we will do this next time--talk about Steve Cohen's and my book, Concrete Economics: The Hamilton Approach to Economic Growth and Policy. That subtitle is there because Alexander Hamilton is perhaps the only American who has, personally, made a real difference. That subtitle is also there because we are trying to sail as close as possible to the Lin-Manuel Miranda "Hamilton" boom in order to sell books, without ourselves becoming an intellectual-property misappropriation test case.
Our big overall thesis is that American economic policy has been remarkably good over the past two centuries--up until something happens around 1980. After that, the U.S. as a whole begins investing in the wrong industries: Health-care administration bureaucrats, financiers making lots of money by encouraging small investors to trade and then benefiting from the price pressure, people using quirks in the capital-structure fact that pension beneficiaries have cash-flow but not control rights to expropriate pension funds and then put the remaining obligations to the underfunded PBGC, the focus on sharply raising income inequality because our extremely-valuable overclass has been so underpaid since 1929 and won't do their managerial and entrepreneurial jobs properly unless much more highly recompensed. These are not the industries of the future in any good sense. But these are the industries that America has been investing in increasingly since 1980.
Before 1980, we invested in other things: aerospace, computers, highways and suburbs, high-tech manufacturing of whatever day--electric power, internal combustion engines, machine tools, interchangeable parts, high-pressure steam engines. We invested in producing a comparative advantage in resource-intensive technological-frontier manufacturing, even though the British Empire's Navigation Acts had left us with a strong comparative disadvantage in such industries. And so even back before the Civil War the British Parliament is sending over Commissions of Inquiry to ask: just how is it that New England productivity in these sectors of manufacturing has gotten so damned high? How did they accomplish this leap-frogging in machine-tool and even some aspects of textile technology?
The answer is precisely that Americans were not terribly ideological back before 1980 where the economic policy rubber hit the road. People back then overwhelmingly believed that the world was a mixed and complicated place where circumstances altered cases. What you need was to look down, around, up: to ask what was most likely to work out well now on the ground, rather than what conforms to some simplistic overarching ideological view of the world which explains everything in terms of some small set of simple principles you can count without taking off your shoes. An ideology allows you to live your life confident and smug. But it is also probably wrong.
Back around 1790 or so the ideologists were the Jeffersonians. The Jeffersonians believed that small yeoman farmers were good--ahem, Monticello?--and the only guarantee of middle-class prosperity and political liberty as well. Manufacturing, banking, urbanization, commerce in excess, a government investing in what was then high-tech--those are sources of corruption and very dangerous threats to freedom. Jefferson, at the end of the eighteenth century, said: Look at London, that corrupt resource-extracting machine, it's taking the British down the road that in ancient Rome led to the collapse of the Roman Republic and to rise of tyrants like Julius Caesar. Our only chance is to cut ourselves off and to make our politics and our economic organization as far from Britain's as we can.
Hamilton said: Hey, wait a minute. What works? Let's see what industries are actually producing jobs for workers that pay high wages. Let's see what are the opportunities for economic development here. Let's see where there is a possibility for the government to exert a helpful nudge. And when Jefferson's successors got into office and had to deal with the realities of power--well, they followed Hamiltonian policies: because they worked.
James Madison in opposition had argued very eloquently that the First Bank of the United States had been unconstitutional.
James Madison as president enthusiastically signed the bill creating and then had his attorney general aggressively defend the rights and powers of the Second Bank of the United States.
Cardiff Garcia: One of the themes of the book is that the debates of those early years about the country's foundational economics have reappeared again. Brad, thanks for being on AlphaChat. We are going to be discussing Brad DeLong's book with Steve Cohen, Concrete Economics: The Hamilton Approach to Economic Growth and Policy, on an forthcoming episode of Alphachat-Terbox, our long-form sister podcast.
But before we let you go, Brad, can you give us a longform recommendation?
Brad DeLong: Two books I am recommending right now are Martin Wolf's The Shifts and the Shocks and Barry Eichengreen's Hall of Mirrors. I think that if you read these two books you know what you need to know and more than 99.9% of the world knows about the current pickle that we are in: how we might get out of it, and why should be depressed (unless you are both already rich and willing to bear substantial risks in order to grab for returns).