There's No Recovery for Central Bankers to Create

Story Stream
recent articles

It is sort of ironic that the last real vestiges of hard money in the United States were silver certificates. Gold had been confiscated and effectively demonetized in the 1930's, but silver survived at the edges. Maybe it was some cosmic revenge of William Jennings Bryan and the Gilded Age inflationists, but for various reasons the last convertible currency in the United States were $1 notes that could be exchanged for silver bullion up to June 24, 1968. That was the statutory limit imposed by Congress in the Act of June 4, 1963, signed by President Kennedy.

There had been another minor silver agitation in the later 1950's and early 1960's, though this time in the reverse direction from that of the 1880's and 1890's. In his 1963 Economic Report to Congress, Kennedy wrote, "I again urge a revision in our silver policy to reflect the status of silver as a metal for which there is an expanding industrial demand." By that time, it had become the judgment of the President that silver "serves no useful monetary purpose." In this case, elimination of silver certificates was necessary because the Federal Reserve was legally prevented from issuing any of its notes in denominations less than $5 - the traditional place reserved and maintained for silver as result of agitation.

These were all 19th century bimetallism relics, where the initiation of silver certificates in the first place was a way for the US Treasury to meets its obligations to monetize silver in paper form rather than exclusively by coin. To remove the requirement meant repeal of the Silver Repurchase Act of 1934, which the June 4, 1963, Act did. And so the silver "agitation" of the 1960's was really a response to the prior century's monetary framework being imposed upon an increasingly modern financial system through the New Deal.

The Act of 1934 was a determined attempt to force the Roosevelt Administration to mobilize new powers granted to it under legislation of the prior year. The Agriculture Adjustment Act of 1933 was a New Deal program aimed at restarting the American farm structure then being "suffocated" by deflationary prices. The first two parts of the law were typical central planning schemes - the destruction and idling of production during a period of extremely low overall production (more money, less work).

The third part of the Agriculture Act was the Thomas Amendment. Drafted by Oklahoma Senator John William Elmer Thomas, this was a monetary shift very much along the lines of what William Jennings Bryan tried unsuccessfully to glorify in his "cross of gold" speech. Once again farmers were the "victims" of deflation and hard money, caught between depression and debt. The answer proffered by Senator Thomas was the same as indicated by Bryan - silver, but not just silver.

In fact, the Thomas Amendment was a sweeping reorganization of the nation's monetary powers and policies. It was left up to the President the unilateral power to decide and even define necessary currency expansion even if through a predesigned process. His first appeal would be to the Federal Reserve's Open Market Desk, authorizing him to direct it to purchase up to $3 billion in treasury bonds or similar instruments. If that should not be sufficient money expansion, the President could then order the Treasury Secretary to issue up to $3 billion in unbacked currency, the 1930's version of Greenbacks, and then reduce the gold content of the dollar by as much as 50%. In terms of silver, the President could decide to accept European WWI debt repayments up to $200 million in silver at a price not exceeding fifty cents per ounce - the basis from which the Treasury could then print additional silver certificates, also at the President's discretion.

Senator Thomas declared that he was in favor of an "honest dollar" but that he could see "no other way of helping the farmer save through cheapening the dollar." It was a preview of the "strong dollar" policy that remains implicitly in effect today; say one thing while trying to bring about its opposite.

At the same time the Roosevelt Administration was radically altering the arrangement of currency printing power at least with regard to initial attempts at keeping actual money in the picture, other efforts were tied to getting the nation's banks to use it. After all, it doesn't do much good to expand the level of currency, backed or unbacked, if it, or even just the power to do it, sits idle. That was the Silver Purchase Act of 1934, intending to force FDR to use these new powers granted to him.

In the area of banking, there were, of course, a great many other changes being undertaken. There was a much easier case to make in that regard, as any layperson could easily observe the banking system as the central pivot in the whole Great Depression collapse. The scope of waves of bank runs had left little doubt that banking reform of some kind was necessary.

One of the most prominent and longest lasting was the Banking Act of 1933, also known as Glass-Steagall (not to be confused with the Banking Act of 1932, also referred to as Glass-Steagall, a Hoover-era version). The most well-known parts of the law were the separation of deposits from investment banks, the firewall deemed necessary to reduce the probability of speculation from ever again so fouling the country's money supply.

There was much more to Glass-Steagall, however, including more than a little emphasis on stoking inflation. The 1933 Act established federal control over deposit interest rates for banks that were members of the Federal Reserve System. Known as Regulation Q, it initially prohibited the payment of interest on demand deposits while authorizing the Federal Reserve to establish ceilings for any interest paid on time and savings deposits at commercial banks. The Banking Act of 1935 expanded this authority to nonmember banks. Mutual savings banks as well as S&L's were exempt until 1966.

Among the rationales for Regulation Q was a purported government interest in increasing bank profits, thus quelling speculation. It was believed and argued that by allowing competitive rates for money, banks were reducing the margins for profit in intermediation, and therefore were subjecting themselves to greater profit pressures leading to more risk-taking behavior. Without competition for demand deposits in competitive interest rates, it was believed banks would take a more seasoned, reasonable approach to lending rather than what might have prevailed prior to the Great Crash.

Largely, however, Regulation Q was aimed at getting smaller banks to lend. The correspondent banking system meant that country banks often held large balances with city banks who then held large balances with central reserve city or money center banks. The call market and the related level of street loans made in the late 1920's left little doubt about such vulnerability, as these seemingly idle balances at whatever interest rate were the primary monetary excess for the stock market as well as the massive bottleneck that amplified the crash, in money as well as equities, on the way out.

By reducing or even eliminating the interest paid on deposits, it was proposed that smaller banks would be of less incentive to hold larger, idle balances with the upper levels of each correspondent tier (while simultaneously depriving money center banks the fuel for such speculative excess). Every bank at every level had to hold some funds in this manner, of course, through the necessary business of an increasingly national payment system. What was at issue was the tendency of especially country banks to hold much larger balances than was perhaps needed (or at least as judged by the bureaucracy in DC).

Such liquidity margin was certainly of no problem in the 1920's, as money and monetary flow were unimpeded. In the context of the early 1930's, New Dealers thought every avenue should be explored to get money moving, especially in the interior and the agriculture interior that country banks largely served. If there was no competitive interest rate motive for keeping idle correspondent balances via Regulation Q, supporters of the law believed that country banks would hold less idle money and start lending again.

This should all sound very familiar to our 21st century ears, as the silver agitation as well as Regulation Q and other parallel efforts are nothing more than QE and NIRP tactics. If the way out of deflation was expansionary money supply and the legislated costs forcing financial agents to use it, then inflation is the answer; indeed to economists and mainstream policies demanded by the long tradition of inflationists it is the only answer even today.

Throughout the 1920's, country banks had held between 5% and 7% of their total asset base in the form of deposits at other banks, these correspondent balances. At the end of 1933, not long after the Banking Act (1933) was passed and Regulation Q imposed, that proportion was above 7%, the highest it had been since the end of 1924. On November 1, 1933, the initial rate ceiling was set at 3%, above the average rate banks had been paying in 1932 and 1933; 2.8% and 2.6%, respectively. Congress and economists, as usual, were viewing their new laws and regulations as if the world would return to pre-crisis stature if through nothing else than their sheer legislative will. Regulation Q was not meant for what the 1930's were, rather what the 1930's were "supposed" to be.

Deposit rates, however, kept falling away from the ceiling. In 1934, the average paid was 2.4%, and closer to 2% by the end of that year. T-bill rates had already fallen close to zero, while short-term Treasuries were all less than 1% in yield. Even commercial paper rates were closer to zero than the first Q ceiling. So in February 1935, the Fed reduced the rate ceiling to...2.5%, where it would remain into the 1950's. The average deposit rate, as with all other rates, continued to fall throughout the entire length of the Great Depression.

Country banks no matter the persistent decline in deposit rates continued to increase their holdings of idle correspondent balances. By the end of 1935, the proportion had doubled to just about 14%. By the end of the decade, country banks were keeping more than 16% of their assets in deposits at other banks. And it wasn't just country banks, either. Commercial banks had experienced a sustained increase in their deposit base due other banks, going from about 18% to 21% of total deposits throughout the 1920's and early 1930's to almost 30% by the end of the decade.

Economists will argue that though many policies may have failed they were overall successful in the aggregate. Deflation ended and the economy recovered. The full record shows otherwise. Prices may have risen from the bottom, and even unemployment fallen, but these are not the same things as a full recovery. Getting back up again is not at all equivalent to reestablishing the prior trend. That is what distinguishes depression from mere recession; the latter is a temporary interruption in an otherwise undisturbed trend of continuing economic potential; the former is something else entirely, and it is always a monetary phenomenon.

That is why economists and policymakers have taken such an interest in the money supply, to the point of demanding not just control but full, monopoly (pun intended) control to the exclusion of any other options. The rigid (relatively) structure of the gold standard meant that central banks and governments had no flexibility with regard to what was deemed necessary in combating periodic bank panics and the depressions that developed from them. Thus, silver agitation, in all periods, as well as money supply authority were the means of breaking free from these hard money constraints.

But it also created a lasting vested interest in minimizing any potential recurrence. In other words, having totally shattered Bryan's golden cross policymakers are now on the hook for depression, and entirely so. If another were to occur, there would only be one place to blame; no more gold excuses, no more whining about the limitations of power.

The comparison of Regulation Q's intentions, initial settings, and then the actual trend of interest rates during the Great Depression and into WWII is instructive in this regard. It remains, again, conventional wisdom that top-down monetary control, especially the gold devaluation, dollar default, was successful in reflation of recovery. The behavior of money rates as well as credit market rates argues conclusively otherwise. As Regulation Q intended to get country banks lending again, they not only resisted but continued to do so year after year after year.

As none other than Milton Friedman declared in the late 1990's, the 1930's were consistent with nothing but tight money conditions in the real economy no matter how much reflation occurred. The economy was growing, but it wasn't growth. The level of employment in 1939 was but equal to the peak in 1929, despite a decade's worth of population expansion along the way. Factory employment in September 1939 was 7.6% below September 1929; factory payrolls were 13.8% less in comparison of the same two months.

Again, this should all sound frighteningly familiar. Employment around the world has never recovered despite this "recovery." Central banks are mystified as to why inflation won't respond to their repeated and theoretically impressive prodding. And most damning of all, interest rates in the 2010's have behaved as if it was the 1930's again, not in terms of the size of the collapse but an almost perfect replica of the global economy's inability to restore growth. The yield curve and money rate shriveling, all around the world in stunningly remarkable proportions, are not additional "stimulus", they are signaling a depression.

To answer the stubborn and lengthening global malaise, economists propose raising the inflation target for each various jurisdiction. As QE, NIRP, or remonetizing silver yet once more, these are programs designed for recession not depression. Economists are assuming, indeed they must assume, that rules and conditions of the economy in 2016 are like those of 2006; just as their predecessors did in 1933 in thinking that it would be 1928 in short order.

There is at the very least a growing realization even among economists that their policies aren't working; it only took nine years. It is the byproduct of the threat to survival; after having remained consistently optimistic to the point of shouting down anyone who challenged the recovery narrative, increasing popular unrest is creating political unrest that will, if unchecked, threaten even the longstanding cherished place of orthodox economists who have remained on such pedestals since the 1930's. Thus, there can be no depression because if we all admit what is increasingly obvious that would leave no doubt as to just who has been at fault.

Former Fed official Kevin Warsh writes earlier this week in the Wall Street Journal:

The groupthink gathers adherents even as its successes become harder to find. The guild tightens its grip when it should open its mind to new data sources, new analytics, new economic models, new communication strategies, and a new paradigm for policy.

He is of the growing chorus of even former insiders and members of past authority who are calling for letting go of the ideological rigidity set in place during the New Deal. Warsh takes no prisoners, charging, correctly, that a "numeric change" for the inflation target is "subterfuge", a case that I and many others have been making for years. Pretending everything is fine delays the recovery, not aids in it. The world is in deep trouble, entirely too familiar to anyone with passing knowledge of the aftermath of the Great Depression, and it is way, way past time for a real and actual accounting. Unfortunately for economists and central bankers, that will mean realizing this depression, which points to a systemic and ongoing global money problem.

From there it will only get worse for them (thus, their stubborn reluctance). Once all that is accepted, and the condition of the world is finally realigned with theory and policy such that it all makes sense again, people will begin to start asking questions about how and why this could happen. How could it be that the Federal Reserve and all the rest were so deficient in their money expertise and capacities? What they will find will be nothing short of stunning, an institutionally entrenched effort decade after decade to suppress and intentionally set aside monetary evolution because of nothing more than perceived threats to the status quo where they sit on top.

The entire premise of activist central banking will be revealed as false; indeed it has already been revealed so by its own actions. If the gold standard were to blame for all prior depressions, the appearance of another one without the gold standard totally undermines the justifications that previously appeared to support activism all these years; leaving them, as Warsh charges, as nothing more than rationalizations.

The confusion over depression stems from assumptions about the crash; not every depression need be preceded by cataclysm. What happened in 2008 was nothing like the proportions of what happened immediately after 1929. What followed each crash, however, is entirely too alike to just dismiss. Take any economic account you wish and you will find similar patterns. Even the unemployment rate which gives Janet Yellen the only plausible platform for continued denial is itself a product of this depression configuration. There are barely more jobs now than in 2007, almost nine years past the last "cycle" peak. The only way the unemployment rate falls so far is if, contrary to the 1930's, the statistic is made to exclude huge swaths of the labor force deemed by bureaucratic rules to be outside the labor force. To "explain" this inequity such that it is not so clearly a depression, economists are forced to convince themselves that 2008 was the perfect time for Baby Boomers to retire.

Central bankers cannot create the recovery because there is no recovery for them to create. Their monetary understanding of the modern age is limited by their ideologically driven intentions to not understand. The world now knows through wasted time alone that something big is off, that the global economy is not right. Once the people begin to settle terms, properly categorize, and then start making sense of this disaster and mess, only recriminations will be left. That is why even central bankers are starting to panic, offering the increasingly ridiculous (as if NIRP weren't enough) and absurd because the standard denial is now long past its expiration.

Maybe there is still some magic left to be extracted from William Jennings Bryan, a lifeline from the 19th century to economists of the 21st. Can silver really be far behind the 4% inflation target now making the rounds?

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

Show commentsHide Comments

Related Articles