Booms and busts before the Fed era?

Miscellaneous History
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In discussing the problems caused by the Fed’s manipulation of the money supply and the resultant boom and bust periods I run across a number of people who claim that though things are not perfect now, they are far better than they were before the Fed came into existence.

I’m not very familiar with the economic history of the era, though I’ve heard that it really wasn’t a true “free market” era then either. Any insights as to what went on and why, particularly with a view to discussing why the Fed is not a necessary entity going forward would be appreciated.

Here’s an exchange from a couple of other folks, for instance, on another discussion forum. Statements from “John Galt” (JG) will be in quote marks. Responses from an economist using the handle, “Vox Rationalis” will be labelled (VR)

Think Twice Before You Join the Deflationist School of Thought

JG: “How about the bigger booms and bigger busts that the Fed was responsible for pushing?”

VR: Completely untrue. Please see 1807-1810, 1815-1821, 1837-1843, 1873-1879, 1882-1885, and 1893-1897.

JG: “Do you really think Ben Bernanke can set the price of money better than 300 million people with distinct values?”

VR: I think the Fed has proven over the last 60 years that it is far better at regulating the money supply than the private sector was before the Fed existed.

Panics/Recessions Before the Fed
What was wrong with the previous gold standard?
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I know of no logical justification for why there should be a central planning comittee to fix the price of loanable funds, but not one to fix the price of other economic goods, like potatoes. I know of no logical justification for why a money warehouse should be allowed to engage in bailment fraud and operate while insolvent, but for example a personal property storage company should be prohibited from commiting similar fraud.

It is not scientific to empirically infer theories based on the historical behavior of complex systems, when those theories have no hope of being reproduced or falsified. One cannot recreate the economy and market participants of 1807 in a laboratory. What little I know of these time periods though, is that the Fed was preceded by the analagous First and Second Banks of the United States which collapsed once they were exposed to market forces. I believe the Second Bank politically fought with Andrew Jackson and intentionally tried to harm the economy through manipulation of the money supply. From wikipedia on Nicholas Biddle,

“In early 1833, Jackson decided to pull the government’s funds out of the Bank… This put the Second Bank [of the United States] on the defensive. It had lost its biggest depositor, by far… To fight back, Biddle decided to shrink the money supply and cause a recession in 1834 in order to force Jackson to accept a re-charter bill. The Bank demanded that old loans be repaid. It made no new loans.”

I’m guessing that many of the panics were also caused by insolvent entities using criminal, fraudulent accounting similar to Enron and like what we have going on this very day.

It is a deduced truth of economic science that expansion of credit leads to a bust. If you enjoy having business cycles with credit expansion followed by busts then economic science indicates that the Fed should be retained.

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I suggest you read Maniacs, Panics and Crashes by Charles Kinderberger, Extraordinary Popular Delusions and the Madness of Crowds by Mackay and, if you want to understand the events that led to the creation of the Fed, the Panic of 1907 by Bruner.

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Also from wikipedia: “The Panic of 1907… there were numerous runs on banks and trust companies”

Non-criminal companies in the free market do not commit fraud. I cannot make a “run” on 7-11 by going there and finding that the Cheetos promised to me, are not in fact there.

I guess one point in favor of the Fed, is that by helping to prop up Ponzi schemes, it makes the economy seem more stable.

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What happened in the Panic of 1907 (If I remember correctly) is that the Knickerbocker Trust went belly up after a run and then there were a series of runs on banks (because it was believed that insolvency of one meant the insolvency of another), obviously they couldn’t pay out all the deposits and so J.P Morgan stepped in with a handful of other bankers and recapitalized the failing banks one by one until the panic subsided. Before the Fed, the Treasury was apparently loosely designated as lender of last resort, but after the panic of 1907, it was decided that they wanted there to be a specifically designated lender of last resort with the power to print money. So the Federal Reserve was created in 1913 for just that purpose and with those powers.

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I have another question, myself. My economics teacher stated in class (she’s pretty much Neo-Keynesian) that recessions have gotten much shorter and shallower than they used to. Is there any truth to that? And if so, why?

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Thanks for the reply. baxter

I know of no logical justification for why there should be a central planning comittee to fix the price of loanable funds, but not one to fix the price of other economic goods, like potatoes.

That’s pretty much how it seems to me. I’m thinking that the historical record backs up that contention and if so, I’m hoping to discover how it does (or doesn’t as the case may be).

It is not scientific to empirically infer theories based on the historical behavior of complex systems, when those theories have no hope of being reproduced or falsified. One cannot recreate the economy and market participants of 1807 in a laboratory.

I think that is true, and yet I think that we can still learn from history even if it doesn’t give us scientific proofs of things.

I’m guessing that many of the panics were also caused by insolvent entities using criminal, fraudulent accounting similar to Enron and like what we have going on this very day.

That wouldn’t surprise me. Some use that as a justification for a central bank. I’m not sure if that really follows, though I can see where it might point to the need for some governmental authority to oversee things to make sure there’s a fair and level playing field and everyone plays by the rules. The structure and main rules should probably be set up by Congress, however, or so it seems to me. I’m not very confident in their abilities to do a decent job of that, however.

It is a deduced truth of economic science that expansion of credit leads to a bust. If you enjoy having business cycles with credit expansion followed by busts then economic science indicates that the Fed should be retained.

That is my understanding of things as well. I thought Roger W. Garrison’s Power Point presentation of the business cycle as shown on YouTube was excellent and seems to make a lot of intuitive sense. But then when an economist challenges that assertion as having been disproven, or at least contradicted somewhat by the historical record – ie. by asserting that business cycles were worse when there was no central bank, I’d like to get some feedback as to whether that person has a point even if only to a certain extent, or if they are in fact blowing smoke. That’s pretty much why I’m here asking this question.

Thanks again for your feedback. I obviously have quite a bit of reading to do if I’m to get up to speed on the historical record from that time period (or others).

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Tom Woods was just asked this question in San Diego. See here: http://www.youtube.com/watch#!v=PrxGJ3PKYbA&feature=related

He mentioned that American banking laws/regulations which prevented consolidation contributed significantly to bank failures in the pre-central banking era. In Canada and other countries, there were virtually no bankruptcies because banks had more flexibility.

In addition, some of those 19th century statistics are total bunk. The 19th century had much better growth than the 20th century. Many of the years which people claim are recessions are really boom periods where there is deflation because more goods are being produced. In modern times, deflation is an effect of a recession, and sometimes observers forget that back then, deflation could also be a sign of prosperity.

He also recommended George Selgin upcoming paper “The Fed’s Dismal Record” and the corresponding Mises talk: http://mises.org/media/4639. Also check out Woods’ talk, Monetary Lessons from America’s Past: http://www.youtube.com/watch?v=91OIBnrjzLU

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bloomj31: I suggest you read Maniacs, Panics and Crashes by Charles Kinderberger, Extraordinary Popular Delusions and the Madness of Crowds by Mackay and, if you want to understand the events that led to the creation of the Fed, the Panic of 1907 by Bruner.

From your suggestions, it sounds like you think that the creation of the Fed was a necessary, or at least a “good” thing? I looked them up and set up a reserve for the first book, Manias, panics, and crashes: a history of financial crises, by Charles P. Kindleberger. Was “Maniacs” a Freudian slip? :wink:

My library also had “Extraordinary Popular Delusions & the Madness of Crowds” but there was a little bit of a waiting list and I think I can probably get a general feel for theme of the book from the Amazon reviews. It’s probably a very interesting book, but I don’t think it gets to the heart of what I’m looking for and it looks like I’ll already have quite a bit of reading on my plate, so I’ll take note of the implication but put off reading it for now.

The Panic of 1907 had some interesting links such as:

NPR’s Lessons from Wall Street’s ‘Panic of 1907’ which includes an Excerpt: ‘The Panic of 1907’ by Robert F. Bruner and Sean D. Carr and you can listen to the program online.

and a 20 page article from the Federal Reserve entitled: “Panic of 1907”, by the Federal Reserve Bank of Boston

Those would appear to me to be the mainstream view of economists and the media as to what transpired in the past and showed a dire need for the Federal Reserve system. I’m suspecting, however, that there will be an alternative view that some will give here and I’d like to examine that as well.

Thanks for the recommendations. I hope they’ll help to give me some insight into that era.

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baxter: Also from wikipedia: “The Panic of 1907… there were numerous runs on banks and trust companies”

Thanks for the recommendation and links, but I’m getting a “Page Not Found” error.

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I don’t know if it’s necessary or good. It was created to do a job and that was to be the lender of last resort. However, booms are possible wherever there’s a credit or monetary expansion. That’s what I think you’ll see in those books. The business cycle predates central banks.

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bloomj31: What happened in the Panic of 1907 (If I remember correctly) is that the Knickerbocker Trust went belly up after a run and then there were a series of runs on banks (because it was believed that insolvency of one meant the insolvency of another), obviously they couldn’t pay out all the deposits and so J.P Morgan stepped in with a handful of other bankers and recapitalized the failing banks one by one…

It seems to me that this may have been a failing of the fractional reserve banking practices that were apparently in effect at the time. I wonder if higher reserve requirements, or a separation of banks into those that held customer deposits in trust for a fee (without lending them out) and banks that invested the money/lent it out, but the customers were aware that they might have limited access to it – ie. limits on the size of withdrawals, or on time frames when they could get it back, with interest of course in things such as a CD.

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NewLiberty: Tom Woods was just asked this question in San Diego. See here: http://www.youtube.com/watch#!v=PrxGJ3PKYbA&feature=related

Thanks. I’ll try to check out those resources tomorrow.

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Naevius: I have another question, myself. My economics teacher stated in class (she’s pretty much Neo-Keynesian) that recessions have gotten much shorter and shallower than they used to. Is there any truth to that? And if so, why?

Others here can probably answer that question far better than I can, but I take that claim with an exceptionally large grain of salt. In fact, I think that the Austrian case is that the boom and bust cycles are caused by an expansion of the money supply which causes the boom period. The boom, however, is unsustainable and inevitably results in the bust.

See Professor Roger W. Garrison giving a power point presentation on the Austrian Theory of the Trade Cycle on this YouTube clip:

www.youtube.com/watch?v=zhoFOyy7rbo

I think a lot more people probably felt that former head of the Fed, Alan Greenspan, “The Maestro” had mastered the art of smoothing out the business cycles during his so called “Great Moderation”, but many now came to realize that he (& Bernanke) were actually setting the stage for the financial crisis of 2008ff and “The Great Recession” we are currently struggling with.

See the warnings of William White, the chief economist for the Bank of International Settlements several years before the crisis hit:

“Never Even A Whisper” at Fed’s Open Market Committee Meetings

or Austrian advocate, Peter Schiff’s prescient and spot-on warnings starting in 2004: Bernanke: Denying the Obvious

Bernanke was wrong & Peter Schiff was right

Why You’ve Never Heard of the Great Depression of 1920 | Thomas E. Woods, Jr.

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Another set of assertions by Vox Rationalis (VR:) in reply to “John Galt” (JG:)

"<< VR: Please see 1807-1810, 1815-1821, 1837-1843, 1873-1879, 1882-1885, and 1893-1897.

JG: Recessions."

VR: "You didn’t look, did you? Because if you’re calling all of these mere recessions, you almost certainly don’t know anything about them. If you need me to prioritize, I will: start with 1873 (the 5-year “Long Depression”), then move back to 1837, which was 5 years of recession out of 6. Now go back to the 6-year 1815 depression. Now go and look at the boom-bust cycles and panics that happened between the Long Depression and 1907. Recessions every few years, including at least three larger than any post-WWII recession except perhaps 1980-1983.

Like I said, it’s not even close."

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Jeff: If you can tell me were his comments occur, I will personally disabuse VR of his misconceptions.

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Milton Friedman provided a good book on the matter.

I think it was called “A monetary history of the United STates”

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VR is way off about the length and severity of many of these panics/depressions/recessions. I think the biggest myth is that the panic of 1873 was a “Long Depression”. Rothbard, in “A History of Money and Banking in the United States” (http://mises.org/books/historyofmoney.pdf)points out that from 1869 to 1879, real GNP increased at 6.8% per year while GNP per capita increased at 4.5% per year. The money supply grew at 2.7% per year and prices fell by 3.8% per year. From memory, I think Rothbard also argues that the panic of 1873 was not what we would think about as a recession, but more of a mass bankruptcy of unsound and overinflated banks. Anyway, the data I’m citing is on page 154 of his book. I think the data speaks for itself as to whether the panic of 1873 was really as bad as people like VR make it out to be.

I don’t remember what Rothbard has to say about some of the other panics, but I don’t believe any of them were truly as long as VR says they are. From what I recall, the panic of 1819 started in 1819, not 1815. Also the downturn he says lasts from 1837-1843, I believe were 2 separate panics between which business activity returned to normal, but I could be wrong about that. In any case, both these episodes (1819 and 1837) came after periods of highly corrupt central banks, so I don’t think this hurts the case for freedom at all.

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Selgin: “Jeff: If you can tell me were his comments occur, I will personally disabuse VR of his misconceptions.”

Thanks. I imagine you could do a lot better job than could I.

Here’s the Comment Section

Here’s the article the commenters were responding to: Think Twice Before You Join the Deflationist School of Thought

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“I have another question, myself. My economics teacher stated in class (she’s pretty much Neo-Keynesian) that recessions have gotten much shorter and shallower than they used to. Is there any truth to that? And if so, why?”

Quite false, the Great Depression lasted 16 years, nothing in the XIX century compares to that. The whole 80’s were one big recession in Brazil.

Show her this : http://en.wikipedia.org/wiki/Depression_of_1920-21

Then ask her to explain it. It should be fun.