Greenspan critics: One voice stands out - By Neil Reynolds

( Rothbard - America’s Great Depression (pdf) )

"Another explanation comes from the Austrian School of economics. Austrian theorists who wrote about the Depression include Hayek and Murray Rothbard, who wrote "America's Great Depression" in 1963. In their view, the key cause of the Depression was the expansion of the money supply in the 1920s that led to an unsustainable credit-driven boom. In their view, the Federal Reserve, which was created in 1913, shoulders much of the blame."
-- Austrian School explanations


***

Greenspan critics: One voice stands out

By Neil Reynolds
Friday, April 11, 2008
Source

Anna Schwartz, remarkable woman and revered economist, turns 93 on Monday. She graduated from Barnard College in New York in 1933, in the midst of the Great Depression, at age 18. She got a master's degree in economics from Columbia University at age 19. She went to work as an economist at age 20 (leaving her PhD until the 1960s). Five years into her career, Ms. Schwartz joined the National Bureau of Economic Research, the private, Cambridge, Mass.-based research organization that cites 16 winners of the Nobel Prize for Economics as associates – including her celebrated husband, free-market champion Milton Friedman. Ms. Schwartz still works in the bureau's New York offices where, almost seven decades later, she still puts in five full days a week and still studies the nature and causes of business cycles.

Ms. Schwartz says the Federal Reserve caused the credit crisis that has shaken financial institutions around the world.

She says this market mayhem need not have happened – and specifically blames former Fed chairman Alan Greenspan for it. Mr. Greenspan, she says, took interest rates too low – reducing the Fed discount rate to 1 per cent – and then kept them there for too long.

“It is clear that monetary policy was too accommodative,” she told The Sunday Telegraph earlier this year in a report that described her as defiantly lucid. “It was bound to encourage all kinds of risky behaviour.”

“They [the Fed] need to speak frankly to the market and acknowledge how bad the problems are, acknowledge their own failures in letting this happen. There would never have been a subprime mortgage crisis if the Fed had been alert. This can't be blamed on global events. The Fed failed to confront something that was evident. This is something Alan Greenspan must answer for.” (On the other hand, she says, there is no real risk of another Depression. “This is nothing like the Depression,” she says. “I don't think the economy is going to fall apart.”) As much as anyone, Ms. Schwartz should know. She collaborated with Mr. Friedman in the research and writing of A Monetary History of the United States, published in 1965, a classic analysis of the causes of the Great Depression – for which the two economists blamed ignorant Washington bureaucrats and an incompetent Federal Reserve.

In Ms. Schwartz's analysis of the present crisis, Fed chairman Ben Bernanke took too long to deal with the fundamental problem – the escalation of investor panic. “[Liquidity alone] could not deal with the underlying fear,” she says, “that lots of firms were going to go bankrupt.” Thus the mere cutting of the discount rate couldn't be the only answer. Mr. Bernanke, she says, needed to demonstrate “decisive action.” The Bear Stearns Affair (in which the Fed engineered a buyout of the investment bank) apparently gave him his opportunity and he took it.

Mr. Bernanke is himself known as a serious student of the Great Depression. He has asserted that the Fed had learned the lessons that it taught. In one famous story, Mr. Bernanke confessed Fed responsibility for the Depression at Mr. Friedman's 90th birthday party in 2002. (He died in 2006.) “Yes, we did it,” Mr. Bernanke told the famous economist. “We're very sorry. We won't do it again.”

Sometimes, though, saying you're sorry isn't enough.

Assume that Milton Friedman and Anna Schwartz were right – that the Fed caused the Great Depression (or, at the very least, made it far worse). Assume that Ms. Schwartz is right now – that the Fed caused the credit crises of 2007-08. In these crises, then, we're not looking primarily at market failure. We're looking primarily at regulatory failure. The question isn't: Has capitalism failed? The question is: Has government failed? The question isn't: Can the government save capitalism? The question is: Can capitalism survive the government?

During times of economic stress, many people – especially investors – clamour for government help. In the Friedman-Schwartz analysis, this is a dubious proposition. “Many people want the government to protect the consumer,” Mr. Friedman said. “The much more urgent problem is to protect the consumer from the government.” For our purposes, delete “consumer” and substitute “investor.”

The final question is: Can government ever be required to meet the performance standards that it imposes on all others?

Some investors who lose money in the credit crisis (and who blame their brokers) will probably spend the best years of their lives and large amounts of their residual capital in protracted attempts to recover their losses. They should more properly send the bills directly to the Fed – along with bills for all the ancestral farms that their grandparents were compelled to abandon 70 years ago in the Great Depression.

You could call that a class action in more ways than one – and especially classy with Anna Schwartz as a star witness.

© The Globe and Mail