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December 04, 2002

Economics and Art Appreciation Redux

Michael—

In your posting, “Economics and Art Appreciation,” you ask if my study of economics has had an impact on my appreciation of art. The impact, I would say, has been more on my view of intellectual “fashions.”

When I was a junior at our Lousy Ivy College, I took an introductory economics class from a rather famous professor. In the middle of one of his lectures, the professor—a dedicated Keynesian, as were virtually all the academic economists of the mid-1970s—mentioned Milton Friedman’s book: “A Monetary History of the United States” (co-authored with Anna J. Schwartz). The prof pointed out that Friedman’s data suggested that the unusual severity of the Great Depression was linked to the tremendous contraction of the money supply from 1929 to 1933. I sat there thinking: Uh, wait a minute, isn’t the money supply the responsibility of the Federal Reserve? Meanwhile, the prof went on to note that when economic factor data was plugged into Friedman’s monetarist equations, they provided estimates of GNP that were more accurate than those of the then-most-sophisticated Keynesian model—the one the Fed itself used. I must say I sat up straight at that. You mean, I thought hesitantly, that the government—specifically, the Federal Reserve systemscrewed up big time back in the Thirties? And even now they aren’t using the best econometric model? And Friedman’s book was published over a decade ago, in 1963? Hey, wait a minute, I’m counting on these guys to keep the economy on an even keel!

Well, let’s just say that as the decade of the 1970s continued, I wasn’t provided a whole lot of reassurance that the powers-that-be had the whole economic situation under perfect control. To be fair, a stint of working on an advertising account for one of the Big Three automakers just as quickly deflated any notions that I had of great—and infallible—minds guiding the fortunes of Big Business. But the advantage of starting my adult life in the 1970s was that I got “wised up” regarding the likelihood of authority figures making my life a paradise—i.e., don’t count on it.

However, as I went on to start my own business and began hiring employees in the 1980s, I noticed that most people I knew were still quite content with the notion of authority figures—whether in either the public or private sectors—making decisions for them. And while they might grumble about the President’s economic performance, they all, to a person, worshipped the Federal Reserve and its chairman.

Every so often I would ask them about the role of the Federal Reserve in the Great Depression, just to tweak them about their “Fed” idolatry. I never got anything but blank looks. Nobody—and they were all intelligent, college educated people—had ever heard of the “Great Contraction” of the money supply in the Depression, or even the failure of the Federal Reserve to act as a lender of last resort to the 5,000 banks that collapsed in the first few years of that lovely era. It dawned on me that if I hadn’t sat through that surprising econ lecture I wouldn’t have heard of this stuff either—it’s not like it was bandied about the newspapers or TV on a regular basis.

One day, leafing through a volume of Depression-era history at the bookstore, I began to realize that it wasn’t just the average Joe who had never heard of this incident. The author of the volume I was reading obviously hadn’t heard of the Great Contraction, either. Of course, this could have been a fluke. So in the interests of science (and this ‘blog), yesterday I went to my friendly neighborhood Barnes and Noble where, as an experiment, I bought four U.S. history books off the shelves, and looked up their comments on the “causes” of the Great Depression.

I took them by date of original composition. Allan Nevins’s, Henry Steele Commager’s and Jeffrey Morris’s “A Pocket History of the United States” was originally written in 1942. Well, what did authors who must have been eyewitnesses think about the origins of the Depression?

What were the causes of this panic [the Crash of October 1929] and the long depression that followed? It is neither very satisfying nor very illuminating to say that depression is a normal part of the business cycle, though where government does not step in to control the excesses of individualistic enterprise that is correct enough…[T]he persistent agricultural depression, the continuous industrial unemployment, and the uninterrupted tendency toward concentration of wealth and power in many great corporations produced a national economy fundamentally unhealthy. [Emphasis added]

I must admit this sounded familiar—it was pretty much the sort of thing that was presented to me as accepted wisdom when I was in high school. As an adult, however, I found the Nevins/Commager/Morris “disease” theory of the Depression a bit vague—what was supposed to be the infectious agent? Why hadn’t the patient keeled over decades earlier, it being fundamentally unhealthy and all? And why had profits and revenues increased so vigorously throughout the Twenties if things were so bad?Okay, I thought, this was written a long time ago (although a look at the title page suggested it had been revised as recently as 1992); no doubt more recent books will be more up-to-date. But there was obviously more to this illness metaphor than I realized, for it cropped up again in the next book in my list, Howard Zinn’s “A People’s History of the United States,” written originally in 1980:

The stock market crash of 1929, which marked the beginning of the Great Depression of the United States, came directly from wild speculation which collapsed and brought the whole economy down with it ...Capitalism…was still in 1929 a sick and undependable system. [Emphasis added]

Hmmm, Zinn’s understanding of the mechanisms of the Depression didn’t seem to have advanced very far in the 38 years since Nevins and Commager had written their history or even in the 17 years since Friedman and Schwartz had published their study of U.S. monetary policy. Zinn’s theory was still that a combination of the stock market crash and a really bad head cold had apparently plunged America into years and years of economic hard times.

The next history book from the shelves of Barnes and Noble was written almost two decades later; I thought this one surely must have heard about the “Great Contraction.” And, by golly, David M. Kennedy, author of the 1999 Pulitzer Prize-winning book “Freedom from Fear,” had actually read his Friedman:

American banks [at the end of 1930] bled profusely from two wounds: one inflicted by domestic runs on deposits and the other by foreign withdrawals of capital. Unfortunately, the rules of the gold-standard game, as Hoover and most American bankers understood them, dictated that the latter problem take precedent over the former. In theory, American central banking authorities should now undertake deflationary measures; in practice, they did. This forced deflation in the context of an already deflated economy…To staunch the outflow of gold [caused by European depositors wary of the apparently fragile U.S. banking system], the Federal Reserve System raised its rediscount rate, as gold-standard doctrine dictated it should. In fact, the Fed moved with unprecedented muscularity, bumping the rate by a full percentage point in just one week’s time. What the banking system as a whole needed, however, was not tighter money but easier money…so that it might meet the demands of panicky depositors.

Hmm, this didn’t make the U.S. economy sound like a basket case; more like a patient with a doctor who decided the cure for a cold was a good case of pneumonia. Apparently the scholarly caucus had finally digested Friedman’s little nugget. Getting a bit restless, I decided to extend my search to the Internet, where this conclusion was even more strongly reinforced by looking at a survey of economists and economic historians conducted by Robert Whaples of Wake Forrest University:

…there is a consensus among both groups [economists and historians] that "throughout the contractionary period of the Great Depression, the Federal Reserve had ample powers to cut short the process of monetary deflation and banking collapse. Proper action would have eased the severity of the contraction and very likely would have brought it to an end at a much earlier date."

But just when I thought that having the “Great Contraction” mentioned in a Pulitzer Prize-winning book and showing up on a survey of economists and historians meant that the word had now officially gone forth, and would be acknowledged everywhere, I picked up my fourth history book and found...no mention of the “Great Contraction” whatever. Instead, according to “The Everything American History Book” by Loriann Hoff Oberlin, issued in 2001, the causes of the Great Depression included bathtub gin:

The 1929 stock market crash plunged the country into despair…[A]lthough the stock crash was one reason for the Great Depression, it was by no means the only cause. During Prohibition, bootlegging made money for organized crime figures and even more respectable businessmen (such as Joseph P. Kennedy), but it did little for the national economy. [Emphasis added]

Hey, you can’t rule a theory like this one out—it gives a whole new meaning to Lord Keynes’ comment about “animal spirits.” Maybe in another fifty years or so we’ll see this become the new consensus theory about the Depression.

Cheers,

Friedrich

posted by Friedrich at December 4, 2002




Comments

It looks as if the average historian has roughly the same amount of economic knowledge as the average artist. I'm sure that the reasons for the ignorance in both cases are the same (and were glossed by Michael in his earlier posting) but they're far less excusable in the case of the historians – they NEED a basic grounding in economics in order to understand their subject. The fact that the most recent book is also the most economically illiterate, judging by its failure to differentiate between the government's fiscal accounts and the nation's economy as a whole, is even more depressing.

I would also like, for the benefit of fellow Keynsians out there, to note that one doesn't need to agree with Friedman or monetarism in general in order to agree with Friedrich's general point. In fact, as Friedrich notes, a Keynsian model also predicts a sharp contraction of GNP when the Fed hikes interest rates in the face of a liquidity crunch. (Duh.) And of course Friedman's models fit the actual data incredibly well: they were created with those data in mind. Monetarism's predictive abilities have been less fabulous.

Either way, though, the lessons haven't really been taken to heart. Argentina for most of 2001 looked just like America in the early 30s: there was a horrible recession, exacerbated by an overvalued currency and ruinous flows of money out of the economy. But the powers that were bent over backwards to pay off the foreigners in full rather than try to stimulate the domestic economy by lowering interest rates and de-pegging the currency. And who thought that this policy was really very clever indeed? Why, the US Treasury and the Federal Reserve.

Posted by: Felix on December 4, 2002 10:41 AM



Wow, two guys who can write clearly, knoweledgeably, and straightforwardly about economics. Speaking as someone who'll never be anything more than a fan of the subject(but an appreciative one!), can I say I'd love to see both of you do more of such writing? With the occasional arts focus, of course.

For what it's worth, I happen to have dinner with a businessman who knows Argentina well the other night. From his point of view, much of what ails Argentina's economy has to do with culture. He says there's a corrupt ruling class that runs the country for its own sake in ways Anglo nations can't begin to imagine -- and that they're infinitely more interested in securing their slice of the pie than in increasing the size of the pie. He also says that Argentines tend to avoid thinking about the long term even more than most people do. As long as they're getting by, why worry? And heck, whatever's lousy today may vanish next month. So making any kind of semi-fundamamental reform becomes next-to-impossible. They fake their way by day to day, allow as best they can for the massive corruption, and hope for the best.

He says all this as someone who loves Argentina, by the way.

Posted by: Michael Blowhard on December 4, 2002 11:43 AM






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