The Last Financial Crisis of the Nineteenth Century
The Situation: June 2008: The Last Financial Crisis of the Nineteenth Century
J. Bradford DeLong; U.C. Berkeley and NBER; brad.delong@gmail.com
Friday’s Macroeconomic News
Sunday’s Macroeconomic News * Tim Geithner, President of New York Fed * A new regulatory framework… * Covering commercial and investment banks, home and foreign… * Federal Reserve to play “central role”
Monday’s Macroeconomic News * Ben Bernanke, Chair of Fed * Said the central bank will “strongly resist’” any waning of public confidence in stable prices. * CBOT futures: a 55 percent chance the Fed will raise the Fed Funds rate from 2 on Aug. 5 meeting (compared with 9 percent Monday morning); a 95 percent chance the Fed will raise by December (compared to 67 percent a week ago)
Inflation since 1964 * In the 1970s, jumps in inflation were followed within months by jumps in core inflation. * Since 1982 not. * The breaking of inflationary psychology? *The breaking of unions with multi-year contracts and escalators?
1844: The Renewal of the Bank of England Charter * Prime Minister Robert Peel * It should be illegal for the Bank of England to make emergency loans… * If they make them in a crisis, we won’t prosecute… * “Suspension” letters…
Karl Marx’s Critique * Karl Marx * You can’t solve a real-side problem--overinvestment, etc.--with financial manipulation * “Peel himself has been apotheosized in the most exaggerated fashion... a massive accumulation of commonplaces, skillfully interspersed with a large amount of statistical data…”
Andrew Mellon Agreed with Karl Marx * Andrew Mellon * Hoover’s Treasury Secretary * Hoover followed Mellon’s advice… * Great Depression * No Fed since has dared let key financial institutions fail
After the Depression, Hoover Did Not Like Mellon Much * Hoover: The “leave it alone liquidationists” headed by… Mellon… felt that government must keep its hands off and let the slump liquidate itself…. “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” [Mellon] insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse… even a panic was not altogether a bad thing. [Mellon] said: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people”…
Implications: What the Fed and Treasury Are Doing * Before the onset of the crisis, the Fed had direct holdings of around $790bn of Treasuries. * As of Wednesday 28th May, the Fed’s liquidity operations had used over half of these ‘available securities’ * Unleashing FNMA to the tune of perhaps $500 billion… * Guaranteeing the unsecured debt of every investment bank in the U.S. * Liquidity tsunami…
Why the Liquidity Tsunami? * Federal Reserve trying to maintain full employment * Without inflation * Needs investment, demand for another leading sector with the housing collapse * Fears Japan in the 1990s (let along U.S. in the 1930s)
Additional Headwinds: Oil * Dealing with the new oil shock * Unlikely to be a “speculative” movement * Asian industrialization and demand simply proceeding too fast * A curb in U.S. demand that produces a fall in global oil prices will see U.S. demand rise again
Additional Headwinds: Oil and the Trade Balance * The non-oil deficit is not that large * Adjustment of the dollar against the Europeans has had a significant role * But the oil deficit is large * Hard to see how the dollar can avoid a big depreciation against Asian currencies…
We Are Not Through with This Dollar Cycle * The dollar has fallen against the Europeans * The dollar has not yet fallen against the Asians * It may fall against the Asians in nominal terms… * We may see a burst of wage inflation in Asia...
We Are Not Through with This Housing-Price Decline * Housing prices don’t behave much like financial assets * It takes a long time for supply-and-demand information to be incorporated into housing price declines * Hard to see how we can avoid another 15%-20% decline in nationwide average housing prices…
Macroeconomic Outlook for Equities * Long-run historical average of 20 * With “normal” productivity growth corresponds to average real return of 5.5% per year * And to an equity premium of 4% per year * Question of why it is so large *Today’s P/E suggest a percentage point lower for average real equity return
What Does This Mean for Asset Prices and Returns? * J.P. Morgan: They will fluctuate… * Global (and local) rebalancing * Asian appreciation * Implies domestic export and import-competing boom * U.S. housing sector declines * With consequences for financial institutions * Equities as a whole seem not unfairly valued…
prof, can you please explain your second comment on slide 16? i don't follow it; otherwise, very nicely put together.
Posted by: howard | June 10, 2008 at 11:59 AM
Very amusing.
To be "fair" though, it needs one more picture, for "balance", Bubbles.
http://finance.yahoo.com/q/bc?s=%5EDJI&t=my&l=off&z=l&q=l&c=
Posted by: Mike | June 10, 2008 at 12:46 PM
one question I have is the effect of uncontrolled leverage ratios on the money supply. We were taught that reserve requirements are higher than necessary, because the Fed wants to be able to better control the money supply. When hedge funds, etc. have these uncontrolled leverage ratios, are they increasing the de-facto money supply, or not? Is there any way that unregulated financial institutions can influence the growth of money and money-like stuff (eg. credit-card limits), and hence fuel inflation and/or asset bubbles?
In other words, could comprehensive regulation of leverage ratios lead to a clamping down on asset bubbles, as long as the Fed doesn't create too much monetary base?
Posted by: roublen | June 10, 2008 at 03:01 PM
Have you gotten this far? The hate is swelling in you now. Take your Jedi weapon, your Diebold machine. Feel the hate for Obama. Oh how you hate him. Feel the emails, the ads, the radio... your so-called friends telling you, beseeching you to the dark side... Hate Barack Hussein Obama... good... good...
Ignore the money, the pain, young Skywalker... ignore the dollar, the debts.. the wars... good... good...
-The Emperor
Posted by: VennData | June 10, 2008 at 09:15 PM
Why do you title your post the last Financial Crisis of the 19th Century when it is current innovative finance that adds the exceptional danger?
Are you saying that this solvency crisis will be contained and no future solvency crisis will hit the United States?
Posted by: christofay | June 11, 2008 at 02:28 AM
Not holding the executives of very large financial institutions liable for their failures is really working out well, isn't it? For the interests of the monied class at the expense of the working taxpayer that is.
Cranky
Posted by: Cranky Observer | June 11, 2008 at 05:08 AM
Sorry, but I'm lost as to how Economists can continue to discuss "inflation" without first defining the term as it correlates to SOME population sampling. Isn't science predicated on observation?
Posted by: bailey | June 11, 2008 at 06:14 AM
Hey, Yglesias, in the "Liquidity Tsuami" slide it should be "let alone," not "let along".
I also question whether a slide that is titled "Karl Marx's Critique" and has a picture of Karl Marx also needs a bullet point that says "Karl Marx." I've always wanted to do a gag where you see the Eiffel Tower and hear accordion music, and then, after a beat, the word "Paris" appears on the bottom of the screen.
And while we're talking gags, maybe your first slide could be titled "Previously on 'The Macroeconomy'"
Posted by: Delicious Pundit | June 11, 2008 at 08:45 AM