If We Seek Recovery, Emancipate Prices

The ultimate effect of shielding men from the effects of folly is to fill the world with fools. - Herbert Spencer

At one time in America, long, long ago, failure was not rewarded nor was it punished; it was simply allowed to happen. Andrew Mellon, the long tenured Secretary of the Treasury under Harding, Coolidge, and Hoover, gave some sage advice in the Great Depression's early stages. "Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate...it will purge the rottenness out of the system. High costs of living and high living will come down. Values will be adjusted, and enterprising people will pick up from less competent people." He was ignored, and the depression turned great.

Mr. Mellon would likely be appalled at the Federal Reserve's response to our current economic downturn, at its refusal to allow prices to adjust, all to fight a beast called "deflation". Deflation, properly defined, is a reduction in the money supply, an event that triggers a widespread fall in prices. Falling prices are what bring the components of a moribund economy back into harmony, it allows demand and supply to meet at their proper levels, and it is a positive benefit to savers. Savings, accumulated capital, is the backbone of all economic growth.

Instead of allowing this deflation and its cleansing process, the Federal Reserve labors to create an economic world where prices always rise; a task logically absurd on its face and a shambles in its practice. We've just seen in the not too distant past the collapse of the Soviet Union due to its ultimately fatal urge for central planning, yet we applaud Federal Reserve officials who wish to centrally plan a constant rise in prices for an entire economy. This applause proves America's War on Drugs has been an utter failure. We're all either insane, or stoned, to urge anyone to centrally plan anything at this stage in our knowledge of economics.

The very thought of allowing prices to freely adjust is anathema to a modern central banker, and we see each day their desperate (and so far successful) efforts to arrest their fall. It was not always so. The deflation experienced at the start of the Panic of 1920 was not only left be, but positively welcomed by Federal Reserve officials. With prices allowed to adjust the economy was growing again within two years. Today, news reports are full of constant warnings regarding deflation, and Federal Reserve officials show nothing but a deep fear of it. Japan and her decade plus economic malaise is held up as the poster child of what a nation, ravaged by deflation, can be reduced to.

Yet, Japan's "deflation spiral" has been anything but - average annual price inflation since 1985 has been a positive 0.5%. The Bank of Japan has striven from the word go to prevent any fall in prices, so far with success. Whatever they are stuck in, it is not a deflationary environment. It is, though, a zombie economy and a warning to us. As in the U.S. during the Great Depression, the refusal of Japan's monetary authorities to allow prices to adjust as necessary to clear their markets has hindered its economy's ability to recover. They are like a shopkeeper who, seeing an excess of inventory, raises the price of his goods, confident that'll do the trick.

With all due respect to Mr. Bernanke, in his analysis of the Great Depression (see his Essays on the Great Depression) he fails to understand that the deflation during the Depression's early years was an effect from the inflation that preceded it during the 1920s, the deflation was not the cause of the 1930s downturn, which he erroneously accuses it of being. Because of this, he believes that deflation and bankruptcy are horrific and must be prevented from occurring; he seems unaware of their indispensability to any economic recovery. From his fatal error we have crafted the doctrine of "Too Big to Fail".

It is rarely noted that the entire idea behind "Too Big to Fail" mimics the hoarder, with their mindset that never, ever, wishes to throw anything away - no matter the stench it gives off and the nest of rats that have made it their home. Right now, from Wall Street to Main Street, the air is pungent with failure, the airwaves are full of failures, and the economy groans under the weight of bailing them all out.

Using the inhuman length of the Great Depression as our guide, we would be wise this go round to abandon all such efforts and try another tack: to emancipate all prices from political control. We must allow the liquidation of all the unsound investments, allow freely floating prices to guide us where they may, to just let the chips fall wherever they deserve to. It is high time our much ballyhooed free market is able to again be just that - free.

Andrew Mellon - ignored, vilified, and suffering under incessant political trails by FDR - would die on Long Island in 1937, seven years into but long before the Great Depression would finally come to an end. While the man himself is long gone, the idea he offered, that of allowing prices to freely float in order to purge the rottenness out of our system has yet to be given any respect. Maybe, three plus years into our own economic calamity, we can finally give his idea a try.