Search Central Banks For Our Lost Dynamism

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In light of recent events in the world of central banking and finance, I find myself increasingly drawn back to an extremely obscure episode that never amounted to much by itself. It might be fair to say that I have spent an inordinate amount of time researching this topic, commensurate with nothing other than what might fairly be called obsession; though I am reticent to take that license and instead prefer to keep it in the realm of "passionate" rather than crossing some psychiatric boundary.

What became known as the ter Meulen plan or scheme grew out of the exigencies of a largely destroyed economic and political system in Europe after the Great War. And thus its position in history accords with what I see as the nexus or pivot under which all modern economics and monetary science would swing. Of course economic and financial evolution does not follow in discrete jumps, but rather a slow and enduring erosion of the ancient order under the guiding hand of the modern ideal of philosopher kings. Thus the ter Meulen plan, named after an even more obscure Dutch economist who floated the idea originally, is not itself fruition but rather a marker of the powerful undercurrents as they were transforming first conventional thought and then convention itself.

There is no doubt that it all began in the latter part of the nineteenth century, influenced mostly by European "advancement" and philosophy but no less courted here in America. In my mind, the first full and open expression, in a mainstream form, was William Jennings Bryan's "cross of gold" speech that attacked not just the political stylings of the Gilded Age, but the very system that nursed an agrarian society into industrial global power. Gold was not, for these people, the bedrock property upon which human advancement was placed, but rather the exploitive means through which poverty was perpetuated.

When Bryan cursed the gold standard, it was ostensibly thought to be on the behalf of poor and indebted farmers in the South and Midwest. And that is true, to some extent. But the major idea planted elsewhere and nurtured in the soils of silver agitators was the idea of control. Gold represented the market and the "invisible hand" of capitalism that seemed to doom the poor to permanent station. Of course, that idea ignored everything we know of mobility and innovation (families are always rising and falling in America), but to the individual "caught up" in such circumstance it heralded an answer to the seeming destruction of the "right" to make a living.

The poor farmers of that age were simply the agents of systemic change that benefited all human existence. The relentless march of innovation had beset small farms against the might of economies of scale - farms with the ability to gain and capture credit could invest in new equipment and produce food at lower and lower prices; the very "deflation" that steers to the exact road toward sustainable prosperity and true wealth. To that individual farmer falling on the other side of the growth equation, however, that is unfair and even hostile. If you cannot compete with the upward surge of economic advance then you end up broken and forced to follow another line.

There is much sympathy in that brutal reality, as in the case of Gilded Age farmers it was also a matter of lineage. Farms that were bent and broken under the seemingly unyielding hammer of falling prices provoked popular uprising at what they could actually see of it all - gold-based mortgage credit and its Eastern banker power base. Losing a family farm that had been passed down for generations was not solely an economic issue to be glossed over in the highlights of "progress"; it was to be factored in the larger scheme, packaged almost exclusively in emotion, particularly when its occurrence becomes far more than a rarity.

Anyone who offered even the slightest twinkle of an answer was to be received in heroic fashion. Since it was pointless to fight against the march of market progress and the messiness it always engenders, relief via monetary intrusion was couched as much more sensible and, more importantly, attainable. By the time of Bryan's famous speech in 1896, some good proportion of popular opinion was ready to throw off the golden shackles of capitalism in favor of more "control", or at least an alternative.

It was not enough of a popular proportion at that time, though, as Bryan was easily defeated. But in the intervening two decades, such elitism had achieved more than measures of respectability both here and abroad. It was no longer the goal to add competition to gold-based money, the idea was furthered that markets themselves could and really "should" be guided by the "brilliant" hand of experts - it ought not be invisible any longer. That was the idea behind the Federal Reserve and its first appearance in 1913, though that aspect was purposefully downplayed into the far more nebulous and mechanical idea of currency elasticity. The die had been cast, and evolving monetary thought ran exactly in that direction - that money and markets were to be separated if poverty were to be "vanquished."

The European economies were decimated alongside so many communities that had been obliterated by casualties and death on an industrial scale. To pay for the slaughter, most left the gold standard so that the major currencies were all left floating for the first time in Western history. A business in Britain intending to import goods from Austria was not going to accept payment in the form of the new Krone that had been introduced in the aftermath of the collapse of the Austro-Hungarian empire.

And with good reason, the Krone was often a confused mess of a currency, with former Austro-Hungarian notes overstamped with a German language notation. The linkage to convertibility in gold was also never fully certain, and the Krone eventually had to be replaced by the Austrian Schilling.

With all that currency uncertainty there was the problem of gold distribution. The Allied Powers had intended to receive war reparations not in currency but in gold (governments then appreciated the risk of devaluation even if new theories were busily trying to harness that "ability"). Gold rushing to England and France meant little left for new commerce, particularly in the defeated States. It was a monetary shortage that certain elements of these certain financial undercurrents were sure would derail the global economic recovery.

The idea of ter Meulen was to essentially create a new global currency, though inferior to gold and still linked to it, through a supranational technocracy. Under the aegis of the League of Nations, an international commission drawn from the International Chamber of Commerce, the British and American Bankers Associations and others would "value" the various functions of national governments, and do so in terms of gold. The idea was to place a common worth on identified and consistent streams of revenue in each country so that they could act as collateral on issued bonds.

Once the commission had valued, in gold, each of these individual national "assets", they would be pledged in the form of government notes, which would then further be used as collateral in world trade. Thus the British importer would be satisfied, so it was believed, that it would receive ter Meulen bonds from the government of the Republic of Austria to hold in lieu of future payment from the private Austrian company on the other side of the transaction. If the Austrian company defaulted or did not live up to terms, the collateral bond could be liquidated by an international agent in gold, thus paying off the liability in total.

In other words, it was an international scheme to use asset-backed government bonds as a new trade currency in a world that might be both persistently "short" of enough gold and where currency terms might never fully settle. The matter was pursued with great vigor particularly in England, but also in the United States by newly appointed Commerce Secretary Herbert Hoover.

In a letter to Sir Drummond Fraser, who was at the time the most vocal proponent of the scheme in Britain and who had come to the US in 1921 to increase support for it, Secretary Hoover outlined his own thoughts on the matter:

"Economic recovery of the States in eastern and southeastern Europe (and consequently a considerable fraction of our own and of world commerce) is dependent upon each State erecting (1) a balance in taxation and expenditure; (2) currency reorganization and stabilization; (3) wise control of their exports and imports; (4) credits for reproductive purposes.

"It is hopeless to expect that private capital will extend credits for exports to these States upon any systematic basis until the first three have been complied with."

If that sounds exactly like the modern IMF and its role in national "fiscal emergencies" today, it is exactly that idea. But the impetus here is more important, in my view, in that Hoover makes plain that the "private economy" will not, even cannot, act without government action of this kind. The private economy is not enough to create the conditions for recovery, clearly held back by liquidity, i.e., money supply problems.

The timing of all this is not coincidental, either, as the US economy was at that moment captured once more in depression. Economists of that age, especially those that had found voice in the new Federal Reserve system, were absolutely certain that the US economic recovery would be stifled without a resolution to the European and trade currency issue and gold shortage. In the very same issue of the monthly Federal Reserve Bulletin (December 1921) in which the Hoover letter to Fraser was published, the body declared authoritatively (and right at the beginning):

"Current developments are making it increasingly clear that economic recovery must await restoration of foreign trade, and that improvement in foreign trade will involve two factors - a rectification of currency and exchange conditions as between countries and a decided improvement in budgetary conditions abroad. These two elements in the problem are, of course, not independent one of another, but call for joint and if possible simultaneous correction."

Though it was an imperfect and unfinished thought at that point, you can hear the predecessor echo of these cries of systemic dissatisfaction all the way nearly a century hence in the one guiding statement of the Bernanke era:

"Since the gold standard determines the money supply, there's not much scope for the central bank to use monetary policy to stabilize the economy.... Because you had a gold standard which tied the money supply to gold, there was no flexibility for the central bank to lower interest rates in recession or raise interest rates in an inflation."

That was then-Chairman Bernanke's rationalization for the development of modern theory and capabilities, delivered concisely in a speech at George Washington University in March 2012. Hoover did not say this exactly in his enthusiastic reception of the ter Meulen outline, but you can see the contours of this thought expressed between the lines of what he really wanted the US government to do. He just did not take that next step, though he was clearly expressing heavy dissatisfaction with the monetary shackles of gold strictures. Hoover wanted authority to create "money" to workaround the gold exchange standard internationally so that trade would not be tied down to the immovable supply of gold that was then out of reach of governments inside the property regime of private citizens.

It would be up to the next generation to accomplish exactly that, to put into action everything that was being first expressed openly in the ter Meulen episode. In light of the Great Depression, governments began to demand just such "flexibility" as they the free market became for them not the means to achieve such a massive rise in the human condition, but an enemy of "the people" caught up in the messy nature of constant change.

Indeed, the whole of orthodox scholarship in the current age is devoted cultishly to these kinds of views, rooted unmovably in only the Great Depression itself. The volumes upon volumes of research dedicated to the collapse stands in stark contrast to the paltry attention given to the decade before. It wasn't just the open words and conversations about going beyond gold that made the 1920's such a landmark period, it was the parallel evolutions in banking and finance that allowed such talk to progress toward and into action.

Where Bernanke contends central banks were unfairly shackled by gold in the 1930's collapse, he makes no mention, ever, of how those shackles were mysteriously missing in the 1920's. The Federal Reserve and the Bank of England regularly conspired to "overrule" the gold exchange standard during that decade, manipulating interest rates in both countries to such a high degree that depression persisted in Britain while "inflation" raged here - particularly in the form of asset bubbles. Where was this mythical "cross of gold" that impaired prudent central bank function in the great bull rush of the latter 1920's?

As is almost always the case, the "markets" danced with the central bank cheating in close tandem because it is always fun on the way up (a timeless theme). But the serious business of paying the piper on the way down is done via brutal market discipline. The overly reckless and imprudent that copped to the "easy money" of the gold sterilization programs in the 1920's were ruined by the re-imposition of market forces via the market's sole determination to restore the gold harness in the 1930's. That it destroyed so many in the collapse and spread so far and wide is proportionate to just how badly and fervently central banks in that era ignored gold movements because they were beginning to act like Hoover had wished.

So we are fed the story by orthodox practitioners that the Great Depression was a result of the gold standard, or if not that harsh at least that gold "inflexibility" made it much worse than it had to be. And yet the whole of orthodox scholarship is conspicuously silent on how central banks "enjoyed" so much of the same flexibility during the 1920's as they took up the last link in the chain of theoretical evolution into the technocracy overriding the market for money.

So much has changed, and yet so little has. The current age of economic dissatisfaction and persistent recession can no longer be blamed on flexibility, or any lack of it. Every major central bank on the face of this earth has engaged in flexibility of historic proportions, including the ECB and its momentous experimentation in elasticity with nominally negative rates. And through it all, no recovery is even on the horizon. They promise as much every year, and every year ends with "just wait until next year."

Now, however, we are reaching a new stage of descent that may surpass everything seen thus far. There is a new movement to downgrade economic "potential" as an excuse for the lack of recovery despite years and trillions of interventional flexibility. Recently, both the Federal Reserve and the CBO have significantly downgraded their assessments of the longer run potential of the US economy, essentially blaming the victim.

It is beyond reprehensible to engage in such behavior without acknowledging the primary restraint upon the global economy - and it isn't gold. The global economy has become grotesquely financialized by intentional policy, which has tellingly recreated much the same mess as total war did for the currency situation in 1921. Debt is ubiquitous throughout the world, and banks are given a pedestal upon which they are indemnified from market retribution for carrying out the business end of central bank flexibility, and yet that does not factor in the equation for orthodox sensibilities surrounding potential growth.

At least those Gilded Age farmers that were being displaced from their livelihoods were offered tremendous new opportunities for advancement and mobility as innovation's constant ring meant exactly that for those willing to take some risk. Today, there is nothing such as that, which central banks are beginning to openly acknowledge, only the bleak future of stagnation (at best!). And so these two circumstances spread across more than a century are actually related by this transgression, linked together at the pivot in the 1920's.

It was the farmers' cumulative lament railing against the dynamic economy, and for the assumed relief provided by technocratic monetarism. And I think that relief has actually proved itself successful after all this time, succeeding in bringing such beneficial dynamism to a near or complete halt. Now that it has done so, its practitioners are utterly bewildered and confused as to the broad spread of that same antique lament, becoming busy in procuring and offering convoluted and contradictory reasons for it all. Yet that was ultimately the point - to create economic equality for the Gilded Age farmer meant removing the forces creating his poverty.

Central banks have killed the innovative and dynamic function of the economy under the heavy hand of flexible financialism and the curse of currency instability and its negative and dragging force of redistribution, thus placing us all in the same immediate circumstances as those long-gone farmers. To keep those at the bottom from becoming left behind meant stifling the whole works, appealing to the lowest common denominator. That was ultimately what this was all about, but now they blame the death of such dynamism on us as well so as to keep the ideology consistent and therefore viable to this century-old and regrettably diseased status quo. Failure is a part of life; only central banking denies as much for itself and everyone else.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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