Sunday, January 30, 2011

How can the Architects of the Crisis Investigate it?

By William K. Black

The Financial Crisis Inquiry Commission (FCIC) issued its report today on the causes of the crisis. The Commissioners were chosen along partisan lines and the Republicans, one-upping the Republicans’ dual responses to President Obama’s State of the Union address, have issued three rebuttals. The rebuttals follow a failed preemptive effort by the Republicans to censor the report – they insisted on banning the use of the terms “shadow banking system” (the virtually unregulated financial sector that conducts most financial transactions), “Wall Street,” and “deregulation.” The Republicans then issued their first rebuttal last month, their “primer.” The primer, following the lead of the censorship effort, ignored the contributions that the shadow banking system, Wall Street, and deregulation made to the crisis. The combination of the demand that the report be censored and the primer’s crude apologia critical role that the unmentionable Wall Street, particularly its back alleys (the unmentionable “shadow banking system”), and the unmentionable deregulators played in causing the crisis was derided by neutrals. The failure of their preemptive primer has now led the Republican commissioners to release two additional rebuttals to the Commission report. Again, they issued their rebuttals before the Commission issued its report in an attempt to discredit it.

The primary Republican rebuttal was issued by Bill Thomas, a former congressman from California and the vice chairman of the commission; Keith Hennessey, who was President George W. Bush’s senior economic advisor, and Douglas Holtz-Eakin, who was an economic advisor to President Bush on the regulation of Fannie and Freddie and principal policy advisor to the Republican nominee for the President, Senator McCain.

Republican Commissioner Peter Wallison felt his Republican colleagues’ dissent was insufficient, so he drafted a separate, far longer dissent. Wallison is an attorney who was one of the leaders of the Reagan administration’s efforts to deregulate financial institutions and later became the leader of the American Enterprise Institute’s (AEI) deregulation initiatives. His bio emphasizes his passion for financial deregulation.

From June 1981 to January 1985, he was general counsel of the United States Treasury Department, where he had a significant role in the development of the Reagan administration’s proposals for deregulation in the financial services industry….

[He] is co-director of American Enterprise Institute’s (“AEI”) program on financial market deregulation.

Each of the Republicans commissioners was a proponent of financial deregulation and was appointed to the Commission by the Republican Congressional leadership to champion that view. Three of the Republican commissioners were architects of financial deregulation. For example, the Republican congressional leadership appointed Wallison to the commission because they knew that he was the originator and leading proponent of the claim that Fannie and Freddie were the Great Satans that had caused the current crisis. The fourth member, Representative Thomas, voted for the key deregulatory legislation when he was in Congress and was a strong proponent of deregulation.

The Republican commissioners’ desire to ban the use of the word “deregulation” in the Commission’s report is understandable. There was no chance that they would support a report that explained the decisive role that deregulation and desupervison played in making the crisis possible. Wallison was a major architect of three successful anti-regulatory pogroms (primarily, but not exclusively, led by Republicans) that created the criminogenic environments that led to our three most recent fraud epidemics and financial crises (the S&L debacle, the Enron era frauds, and the current crisis). The Republican congressional leadership appointed Wallison to the Commission in order to place the nation’s leading apologist for deregulation in a position where he could defend it. President Bush appointed Harvey Pitt to be SEC Chairman because he was the leading opponent in America of the SEC Chairman Levitt’s efforts to make the SEC a more effective regulator. In each case, “mission accomplished.”

Each of the Republican commissioners was in the impossible position of having to investigate and judge their own culpability for the crisis. The Republican politicians who selected them for appointment to the Commission knew that they were placing them in an impossible position and ensuring that the Commission would either give deregulation a pass or split along partisan lines and lose some of its credibility. The proverbial bottom line is that the Commission would fail to identify the real causes of the crisis and the control frauds that drove it would continue to be able to loot with impunity.

In contrast, only one of the six Democratic commissioners was involved in financial institution regulation or deregulation. None of the Democrats was known as a strong proponent of any particular view about the causes of the crisis prior to their appointment. Brooksley Born was head of the Commodities Futures Trading Commission (CFTC) under President Clinton. She famously warned of the systemic risks that credit default swaps (CDS) posed. Her efforts to protect the nation were squashed by the Commodities Futures Modernization Act of 2000, which deliberately created regulatory “black holes” by removing the CFTC’s authority to regulate many trades in financial derivatives. Enron exploited one of these black holes to create the California energy crisis of 2001. The largest banks and AIG exploited the black hole to trade CDS. While the squashing of Brooksley Born was a bipartisan effort (Senator Gramm and Alan Greenspan were the most prominent Republicans in the effort), it was led by the Clinton administration – Messrs. Rubin and Summers at their arrogant, anti-regulatory worst.

By appointing Born to the Commission, the Democrats were admitting their error and ensuring that one of the Democratic Party’s great embarrassments – passage of the Commodities Futures Modernization Act – would be exposed. The Democrats were fostering rather than seeking to forbid discussion of their dirty laundry by appointing someone with a proven track record of taking on her own party.

In 1999, Born resigned as CFTC Chair. She retired from her law firm in 2002. She did not influence or seek to influence regulatory policy role during the crisis. She was not active in making comments about the causes of this crisis prior to her appointment to the Commission.

The next, nastier stage in the Republican apologia for Wall Street and the anti-regulators has already begun. Bloomberg reports that House Oversight Committee Chairman Issa claims to be:

“looking into allegations of partisanship, mismanagement and conflict of interest at the commission. The California Republican and two other lawmakers sent a letter yesterday renewing a demand for documents on the panel’s spending, its use of media consultants and its staff turnover.”

Issa is a deeply committed anti-regulator. He will not be investigating the allegations of partisanship and conflicts of interest by the Republican commissioners who have exemplified partisanship and who are in the impossible position of having to examine their own culpability for the crisis. He will seek to discredit any report and any expert who explains why financial deregulation and desupervision are criminogenic.

The most important question we must answer about our financial crises is actually a two-part question: why are we suffering recurrent, intensifying crises? To answer it we must find not only the causes of the crises, but also (and even more importantly) why we fail to learn the correct lessons from the crises and keep making even worse policy mistakes. The answer to the second question is dogma. The definition of dogma is that it cannot be examined or changed – except to become even purer. The ever purer anti-regulatory dogma creates the ever more intensely criminogenic environments that produce intensifying crises. The Commission’s report makes that clear. For example, Alan Greenspan claimed that markets automatically exclude fraud. He did so after the most notorious “accounting control fraud” of the S&L debacle (Charles Keating) used him to praise his fraudulent S&L, leading to the most expensive failure in the entire debacle. Greenspan learned nothing useful from the S&L debacle. He concluded that there was no reason for the Fed to use its unique authority under HOEPA to stop the pervasively fraudulent “liar’s” loans that were hyper-inflating the real estate bubble and leading us to a crisis. Greenspan ignored the FBI’s September 2004 warning that mortgage fraud was becoming “epidemic” and would cause an “economic crisis.” This anti-regulatory dogma that Greenspan exemplified spread through much of the Western world, and the resultant crises have done the same.

We are witnessing in the multiple Republican apologias for their anti-regulatory policies an example of why we fail to learn the correct lessons from the crises. The groups most in the thrall of the dogma appoint true believers in theoclassical economics to the body that is supposed to find the truth. These anti-regulatory architects of the crisis then purport to be impartial judges of the causes of the crisis that they helped create. The Republican House leadership now openly threatens to use aggressively its subpoena authority to bash anyone who dares to oppose the dogma and the Republican effort to censor the decisive role the anti-regulators play in causing our recurrent, intensifying crises.

The Commission is correct. Absent the crisis was avoidable. The scandal of the Republican commissioners’ apologia for their failed anti-regulatory policies was also avoidable. The Republican Congressional leadership should have ensured that it did not appoint individuals who would be in the impossible position of judging themselves. Even if the leadership failed to do so and proposed such appointments, the appointees to the Commission should have recognized the inherent conflict of interest and displayed the integrity to decline appointment. There were many Republicans available with expertise in, for example, investigating elite white-collar criminals regardless of party affiliation. That was the most relevant expertise needed on the Commission. Few commissioners had any investigative expertise and none appears to have had any experience in investigating elite white-collar crimes. These Republicans, former Assistant U.S. Attorneys (AUSAs) and FBI agents would have played no role in the financial regulation or deregulation policies in the lead up to the crisis. They would not have had to judge their own policies and they would have brought the most useful expertise and experience to the Commission – knowledge of financial fraud schemes and experience in leading complex investigative and analytical skills.

Friday, January 28, 2011

Inflation: Inevitable...But Not Predictable

By Bill Bonner,
for The Daily Reckoning

Government is not like science or technology – where we build, intentionally, on past experience to create something that becomes better and better over time. Instead, it is rather like an evolutionary development...that often ends with extinction.

Since America’s modern social welfare democracy is not the product of enlightened rational, accumulated decision-making, America’s leaders will be unable to re-design it for the new conditions it faces. Instead, this social welfare democracy will face extinction – like dinosaurs and Neanderthal man...and all previous forms of government...all previous forms of paper money...and all previous monetary systems.

In other words, don’t expect the US government to reduce its deficits and bring its finances under control voluntarily. It will take a crisis...and maybe even a revolution.

Let’s look at the financial situation more closely. As near as I can tell, the Great Correction continues, much as we thought it would. This is “Year 5” of the Great Correction. There is much more to go.

A Great Correction is very different from a recession. It is not a pause in an otherwise healthy economy. Instead, it is a change of adjustment to new circumstances (similar and related to the adjustment needed in government itself). After 60 years of near continuous credit expansion, the economy is finally deleveraging...reducing credit in the private sector.

To give you one small indication of the kind of adjustment that is taking place, let’s look at some good news. US manufacturing is finally picking up. For the first time in 10 years, more people are now joining the manufacturing labor force than leaving it. Of course, this is just what you’d expect. Labor costs are going down. At the margin, America’s competitive position is improving.

But this is not, as the media has advertised, “proof” the economy is recovering. Far from it. It is proof that the economy is not recovering at all. It is going in a different direction...and responding to a different set of circumstances. Much of the last 10 years was spent in bubble territory. During that time the economy was losing manufacturing jobs, not gaining them. The economy is not now “recovering” to the bubble conditions of 2005-2006. It is moving on.

And it’s a good thing. Who would want to go back to an economy that destroyed real jobs in manufacturing while creating phony, unsustainable jobs in finance and housing? Now the economy is simply doing what it should do: it’s adjusting to new conditions. Unfortunately, it will take time. You don’t shift the world’s largest economy overnight. So, the rate of joblessness is likely to remain high for many years as the transition takes place.

The other major feature of the Great Correction is the weakness of the housing industry. This too is perfectly predictable. The nation has too many houses – and they’re still too expensive. The figures show that about one in four homeowners is underwater. And there is no reason to think he’ll come to the surface any time soon.

The latest S&P/Case-Shiller numbers show the housing market seems to be entering a second dip. Once homeowners realize this, they are likely to also come face to face with their grim choices. They can default. Or they can wait it out – paying more for housing than the going rate. Many will choose to default, bringing housing prices down further. Some won’t have a choice: they won’t be able to meet mortgage payments.

Housing and jobs are the twin pillars of household wealth in America. The papers are full of stories about what happens to people when these pillars give way. High unemployment rates have lowered household income and forced people to take jobs at salaries far below their peaks. A record number, 43 million, of Americans now depend on food stamps. Children are moving back in with their parents – even adult children. And tax receipts are falling. At the local and state level this is causing havoc. The feds can print money. But California, Illinois and New Jersey can’t. And between the 50 states there is something like $2 trillion worth of unfunded pension obligations.

So far, all of those things were expected. It is a Great Correction, after all. Also expected – but still not fully appreciated – was the reaction of the US government and the Fed. When the crisis began, we calculated that it would take about seven years to bring debt levels in the private sector down to where a new period of genuine growth could begin.

We just looked at the debt levels and guessed about how long it would take to default, restructure and pay them down. There were plenty of other calculations based on different assumptions. But they all came up with about the same answer: between 5 and 10 years.

But we all underestimated the ability of the feds to muck things up. Thanks to federal intervention, it now looks as though this period of transition may take much longer. Obviously, the feds are adding debt while the private sector is getting rid of it. But it goes beyond that. The feds are also propping up the industries that need to be cut down to size – finance and housing – at a cost of over a trillion dollars.

The feds are also trying to engineer a recovery...and promising one. As I mentioned above, a recovery is just what we don’t need. But promising that the economy will return to its previous condition leads people to think that they don’t really have to make major changes. All they have to do is wait. This further delays the transition to a new economy.

Pretending the economy will return to its old pre-2007 self also makes people think that they will be safe in pre-2007 investments. So they stick with stocks and bonds...and eschew the one asset they most need. With all the talk of a “slow recovery” investors don’t suspect that there is anything really wrong...or at least nothing that a few trillion in stimulus spending can’t fix! So, they don’t make the sort of changes that they need to make – in their personal finances and in their investments.

The feds are not only stalling the transition, they are also destroying the currency and the credit of the world’s largest economy. This further confuses the situation and creates huge uncertainties. Investors are nervous. They don’t know what to expect.

They become reluctant to commit to large long-term projects – just the kind the country needs, in other words.

If you can’t trust the value of the money, how can you make a capital investment that will only pay off five years from now? How can you even make a budget or a business plan? Serious investors hold off...or put their money into the growth economies overseas, where the risk/reward ratio is more favorable and the financial authorities are not actively trying to undermine the local currency.

What is in some ways most remarkable is that even five years into the correction, the US authorities still seem to have no idea of what is going on. Ben Bernanke recently told us that we could expect 3% to 4% growth this year. Since he completely missed the biggest financial crisis in 80 years, you have to question his forecasting abilities. But even if he is right about the GDP growth rate, he doesn’t seem to understand what it means.

He admits that 3% to 4% growth is not enough. He’s thinking about employment. At that growth level, you can barely keep up with new people coming into the workforce, let alone reabsorb the 15-30 million who are currently out of work. It is also too slow to keep up with the debt load. The deficit is expected to be about 10% – two to three times more than the anticipated additional GDP. This will mean, grosso modo, an increase in the national debt equal to 6% or 7% of GDP.

You can’t expect to do that for very long. But here is the remarkable thing: so far, there is little official recognition of the dark, dangerous road that the feds are driving down. In the fedsʼ minds, the problem is that the economy is growing too slowly. Three percent isn’t enough. They believe they need more growth...and they believe they can get it by “stimulating” the economy.

It is as though they were driving down a wet country road at breakneck speed. The radio is not working very well, so they step on the accelerator, trying to catch the radio waves before they get away. When this doesn’t work, they go even faster.

This is not the way to make the radio work. It is the way to get in a serious wreck.

Sunday, January 23, 2011

How Much Solar Energy Hits Earth?

Big Oil Does Not Want You To Know This:

If solar power is the purest form of renewable energy known, then how much solar power have we got? The answer to this question, when considered alongside how efficiently we can convert raw sunshine into usable power, helps determine whether or not it is realistic to consider solar energy as a viable alternative to conventional energy sources.

In full sun, you can safely assume about 100 watts of solar energy per square foot. If you assume 12 hours of sun per day, this equates to 438,000 watt-hours per square foot per year. Based on 27,878,400 square feet per square mile, sunlight bestows a whopping 12.2 trillion watt-hours per square mile per year

With these assumptions, figuring out how much solar energy hits the entire planet is relatively simple. 12.2 trillion watt-hours converts to 12,211 gigawatt-hours, and based on 8,760 hours per year, and 197 million square miles of earth’s surface (including the oceans), the earth receives about 274 million gigawatt-years of solar energy, which translates to an astonishing 8.2 million “quads” of Btu energy per year.

In case you haven’t heard, a “quad Btu” refers to one quadrillion British Thermal Units of energy, a common term used by energy economists. The entire human race currently uses about 400 quads of energy (in all forms) per year. Put another way, the solar energy hitting the earth exceeds the total energy consumed by humanity by a factor of over 20,000 times.

Clearly there is enough solar energy available to fulfill all the human race’s energy requirements now, and for all practical purposes, forever. The key is developing technologies that efficiently convert solar power into usable energy in a cost-effective manner.

For energy conversion constants a good website is Energy Conversion, to help elucidate this data.

Top 10 Trends of 2011

The mid-January issue of the Trends Journal will feature our “Top Trends 2011” — The Trends Research Institute’s compendium of the dominant trends for the year ahead. The following synopses of these trends provide insights into some of what to expect.

After the tumultuous years of the Great Recession, a battered people may wish that 2011 will bring a return to kinder, gentler times. But that is not what we are predicting. Instead, the fruits of government and institutional action – and inaction – on many fronts will ripen in unplanned-for fashions. Trends we have previously identified, and that have been brewing for some time, will reach maturity in 2011, impacting just about everyone in the world.

1. Wake-Up Call In 2011, the people of all nations will fully recognize how grave economic conditions have become, how ineffectual and self-serving the so-called solutions have been, and how dire the consequences will be. Having become convinced of the inability of leaders and know-it-all “arbiters of everything” to fulfill their promises, the people will do more than just question authority, they will defy authority. The seeds of revolution will be sown….

2. Crack-Up 2011 Among our Top Trendsfor last year was the “Crash of 2010.” What happened? The stock market didn’t crash. We know. We made it clear in our Autumn Trends Journal that we were not forecastinga stock market crash – the equity markets were no longer a legitimate indicator of recovery or the real state of the economy. Yet the reliable indicators (employment numbers,the real estate market, currency pressures,sovereign debt problems) all borderedbetween crisis and disaster. In 2011, with the arsenal of schemes toprop them up depleted, we predict “Crack-Up 2011”: teetering economies will collapse, currency wars will ensue, trade barriers will be erected, economic unions will splinter, and the onset of the “Greatest Depression” will be recognized by everyone….

3. Screw the People As times get even tougher and people get even poorer, the “authorities” will intensify their efforts to extract the funds needed to meet will be the same: cut what you give, raise what you take.

4. Crime Waves No job + no money +compounding debt = high stress, strained relations, short fuses. In 2011, with the fuselit, it will be prime time for Crime Time.As Gerald Celente says, “When people loseeverything and they have nothing left to lose, they lose it.” Hardship-driven crimes will be committedacross the socioeconomic spectrum by legions of the on-the-edge desperate who will do whatever they must to keep a roof over their heads and put food on the table…

5. Crackdown on Liberty As crimerates rise, so will the voices demanding a crackdown. A national crusade to “Get Tough on Crime” will be waged against the citizenry. And just as in the “War on Terror,” where “suspected terrorists” are killed before proven guilty or jailed without trial, in the “War on Crime” everyone is a suspect until proven innocent…

6. Alternative Energy In laboratories and workshops unnoticed by mainstream analysts, scientific visionariesand entrepreneurs are forging a new physics incorporating principles once thought impossible, working to create devices that liberate more energy than they consume. What are they, and how long will it be before they can be brought to market? Shrewd investors will ignore the “can’t be done” skepticism, and examine the newly emerging energy trend opportunities that will
come of age in 2011….

7. Journalism 2.0 Though the trendhas been in the making since the dawn of the Internet Revolution, 2011 will mark the year that new methods of news and information distribution will render the 20th century model obsolete. With its unparalleled reach across borders and language barriers, “Journalism 2.0” has the potential to influence and educate citizens in a way that governments and corporate media moguls would never permit. Of the hundreds of trends we have forecast over three decades, few have the possibility of such far-reaching effects….

8. Cyberwars Just a decade ago, when the digital age was blooming and hackers were looked upon as annoying geeks, we forecast that the intrinsic fragility of the Internet and the vulnerability of the data it carried made it ripe for cyber-crime and cyber-warfare to flourish. In 2010, every major government acknowledged that Cyberwar was a clear and present danger and, in fact, had already begun. The demonstrable effects of Cyberwar and its companion, Cybercrime, are already significant – and will come of age in 2011. Equally disruptive will be the harsh measures taken by global governments to control free access to the web, identify its users, and literally shut down computers that it considers a threat to national security….

9. Youth of the World Unite University degrees in hand yet out of work, in debt and with no prospects on the horizon, feeling betrayed and angry, forced to live back at home, young adults and 20-somethings are mad as hell, and they’re not going to take it anymore. Filled with vigor, rife with passion, but not mature enough to control their impulses, the confrontations they engage in will often escalate disproportionately. Government efforts to exert control and return the youth to quiet complacency will be ham-fisted and ineffectual. The Revolution will be televised … blogged, YouTubed, Twittered and….

10. End of The World! The closer we get to 2012, the louder the calls will be that the “End is Near!” There have always been sects, at any time in history, that saw signsand portents proving the end of the world was imminent. But 2012 seems to hold a special meaning across a wide segment of “End-time” believers. Among the Armageddonites, the actual end of the world and annihilation of the Earth in 2012 is a matter of certainty. Even the rational and informed that carefully follow the news of never-ending global crises, may sometimes feel the world is in a perilous state. Both streams of thought are leading many to reevaluate their chances for personal survival, be it in heaven or on earth…

Saturday, January 22, 2011

Life after Capitalism

By Robert Skidelsky

LONDON – In 1995, I published a book called The World After Communism. Today, I wonder whether there will be a world after capitalism.

That question is not prompted by the worst economic slump since the 1930’s. Capitalism has always had crises, and will go on having them. Rather, it comes from the feeling that Western civilization is increasingly unsatisfying, saddled with a system of incentives that are essential for accumulating wealth, but that undermine our capacity to enjoy it. Capitalism may be close to exhausting its potential to create a better life – at least in the world’s rich countries.

By “better,” I mean better ethically, not materially. Material gains may continue, though evidence shows that they no longer make people happier. My discontent is with the quality of a civilization in which the production and consumption of unnecessary goods has become most people’s main occupation.

This is not to denigrate capitalism. It was, and is, a superb system for overcoming scarcity. By organising production efficiently, and directing it to the pursuit of welfare rather than power, it has lifted a large part of the world out of poverty.

Yet what happens to such a system when scarcity has been turned to plenty? Does it just go on producing more of the same, stimulating jaded appetites with new gadgets, thrills, and excitements? How much longer can this continue? Do we spend the next century wallowing in triviality?

For most of the last century, the alternative to capitalism was socialism. But socialism, in its classical form, failed – as it had to. Public production is inferior to private production for any number of reasons, not least because it destroys choice and variety. And, since the collapse of communism, there has been no coherent alternative to capitalism. Beyond capitalism, it seems, stretches a vista of…capitalism.

There have always been huge moral questions about capitalism, which could be put to one side because capitalism was so successful at generating wealth. Now, when we already have all the wealth we need, we are right to wonder whether the costs of capitalism are worth incurring.

Adam Smith, for example, recognized that the division of labor would make people dumber by robbing them of non-specialized skills. Yet he thought that this was a price – possibly compensated by education – worth paying, since the widening of the market increased the growth of wealth. This made him a fervent free trader.

Today’s apostles of free trade argue the case in much the same way as Adam Smith, ignoring the fact that wealth has expanded enormously since Smith’s day. They typically admit that free trade costs jobs, but claim that re-training programs will fit workers into new, “higher value” jobs. This amounts to saying that even though rich countries (or regions) no longer need the benefits of free trade, they must continue to suffer its costs.

Defenders of the current system reply: we leave such choices to individuals to make for themselves. If people want to step off the conveyor belt, they are free to do so. And increasing numbers do, in fact, “drop out.” Democracy, too, means the freedom to vote capitalism out of office.

This answer is powerful but naïve. People do not form their preferences in isolation. Their choices are framed by their societies’ dominant culture. Is it really supposed that constant pressure to consume has no effect on preferences? We ban pornography and restrict violence on TV, believing that they affect people negatively, yet we should believe that unrestricted advertising of consumer goods affects only the distribution of demand, but not the total?

Capitalism’s defenders sometimes argue that the spirit of acquisitiveness is so deeply ingrained in human nature that nothing can dislodge it. But human nature is a bundle of conflicting passions and possibilities. It has always been the function of culture (including religion) to encourage some and limit the expression of others.

Indeed, the “spirit of capitalism” entered human affairs rather late in history. Before then, markets for buying and selling were hedged with legal and moral restrictions. A person who devoted his life to making money was not regarded as a good role model. Greed, avarice, and envy were among the deadly sins. Usury (making money from money) was an offense against God.

It was only in the eighteenth century that greed became morally respectable. It was now considered healthily Promethean to turn wealth into money and put it to work to make more money, because by doing this one was benefiting humanity.

This inspired the American way of life, where money always talks. The end of capitalism means simply the end of the urge to listen to it. People would start to enjoy what they have, instead of always wanting more. One can imagine a society of private wealth holders, whose main objective is to lead good lives, not to turn their wealth into “capital.”

Financial services would shrink, because the rich would not always want to become richer. As more and more people find themselves with enough, one might expect the spirit of gain to lose its social approbation. Capitalism would have done its work, and the profit motive would resume its place in the rogues’ gallery.

The dishonoring of greed is likely only in those countries whose citizens already have more than they need. And even there, many people still have less than they need. The evidence suggests that economies would be more stable and citizens happier if wealth and income were more evenly distributed. The economic justification for large income inequalities – the need to stimulate people to be more productive – collapses when growth ceases to be so important.

Perhaps socialism was not an alternative to capitalism, but its heir. It will inherit the earth not by dispossessing the rich of their property, but by providing motives and incentives for behavior that are unconnected with the further accumulation of wealth.

Robert Skidelsky, a member of the British House of Lords, is Professor Emeritus of Political Economy at Warwick University, author of a prize-winning biography of the economist John Maynard Keynes, and a board member of the Moscow School of Political Studies.

Marion Maneker says:

Robert Skidelsky, the British biographer of Keynes, concern is that capitalism, having done the job of bringing wealth to large numbers of people in the developed countries, was running out of productive goals.

Skidelsky quickly transitions into a moral argument about the uses of wealth. But there’s another, perhaps more important question to explore here. What if capital itself is running out of places to generate returns.

After all, we’re told that one of the prime causes of the worldwide housing bubble was an excess of capital sloshing around the world. In the US, the financialization of the economy is direct product of over-capitalization.

Finally, the latest driver of the economy, the technology business is rapidly de-materializing uses for capital. Facebook, Apple, Google even Goldman Sachs don’t have their capital invested in things. The money that makes up their capital is mostly invested in human beings.

We don’t know where Facebook plans to spend the billions it is raising. There’s talk of moving to a new corporate campus, of keeping talented engineers on staff and surely they need some server space. Groupon doesn’t seem to need the money they’re raising so much as they’re raising money because this is their time.

Maybe these are just anomalies around specific businesses. But it is troubling that these are the success stories of our time and it’s hard to see where the capital is beyond digits on a screen.

genomik Says:

True. Capitalism has been great for the growth phase of humanity, its teen years. Now we are, by some measures, mature. We need to look to another new system. technology is advancing at an exponential pace. It used to be capitalism advanced tech, now tech sort of has its own inertia. We do not need to throw gasoline on the tech fire. Product cycles are so fast its difficult to have lifespans of many products, and that will increasingly be a problem. How many PhDs are on earth now? 100s of millions?

This is why looking at history has its limitations. Capitalism HAS been pretty good. But the *big picture* is changing. As people get richer they get obese, with weight and many other aspects. What do we need more for? The price is increasingly paid by the environment as well, so we have more money, but if the forests and corals are dead, what will we do with it? Buy gold plated toilets?

As a technologist, I think this is why many of us got into tech. We watched Star trek and saw the replicators that made food etc. There was no money in Star Trek. Just adventure. The future was post capitalism. We are not far away from nanotech, where we can technologically manufacture gold and diamonds from other elements for example – 20 years? Automation threatens to increase unemployment while simultaneously reducing the need to work! These and many other transformative technologies will invert Capitalism. By the way, capitalism itself is hastening the coming of the techs that will undermine it!

While I think Socialism is the heir as the writer says, it may be a new form. When I tell most people socialism is the heir they get emotionally invested and see red. Perhaps a new word could meke it more palatable. Technologism? Stabalism? Social Technologism? SoTek?

Monday, January 17, 2011

The Best Way to Rob a Bank is to Own One

By Bill Black

The new mantra of the Republican Party is the old mantra — regulation is a “job killer.” It is certainly possible to have regulations kill jobs, and when I was a financial regulator I was a leader in cutting away many dumb requirements. But we have just experienced the epic ability of the anti-regulators to kill well over ten million jobs. Why then is there not a single word from the new House leadership about investigations to determine how the anti-regulators did their damage? Why is there no plan to investigate the fields in which inadequate regulation most endangers jobs? While we’re at it, why not investigate the areas in which inadequate regulation allows firms to maim and kill. This column addresses only financial regulation.

Deregulation, desupervision, and de facto decriminalization (the three “des”) created the criminogenic environment that drove the modern U.S. financial crises. The three “des” were essential to create the epidemics of accounting control fraud that hyper-inflated the bubble that triggered the Great Recession. “Job killing” is a combination of two factors — increased job losses and decreased job creation. I’ll focus solely on private sector jobs — but the recession has also been devastating in terms of the loss of state and local governmental jobs.

From 1996-2000, for example, annual private sector gross job increases rose from roughly 14 million to 16 million while annual private sector gross job losses increased from 12 to 13 million. The annual net job increases in those years, therefore, rose from two million to three million. Over that five year period, the net increase in private sector jobs was over 10 million. One common rule of thumb is that the economy needs to produce an annual net increase of about 1.5 million jobs to employ new entrants to our workforce, so the growth rate in this era was large enough to make the unemployment and poverty rates fall significantly.

The Great Recession (which officially began in the third quarter of 2007) shows why the anti-regulators are the premier job killers in America. Annual private sector gross job losses rose from roughly 12.5 to a peak of 16 million and gross private sector job gains fell from approximately 13 to 10 million. As late as March 2010, after the official end of the Great Recession, the annualized net job loss in the private sector was approximately three million (that job loss has now turned around, but the increases are far too small).

Again, we need net gains of roughly 1.5 million jobs to accommodate new workers, so the total net job losses plus the loss of essential job growth was well over 10 million during the Great Recession. These numbers, again, do not include the large job losses of state and local government workers, the dramatic rise in underemployment, the sharp rise in far longer-term unemployment, and the salary/wage (and job satisfaction) losses that many workers had to take to find a new, typically inferior, job after they lost their job. It also ignores the rise in poverty, particularly the scandalous increase in children living in poverty.

The Great Recession was triggered by the collapse of the real estate bubble epidemic of mortgage fraud by lenders that hyper-inflated that bubble. That epidemic could not have happened without the appointment of anti-regulators to key leadership positions. The epidemic of mortgage fraud was centered on loans that the lending industry (behind closed doors) referred to as “liar’s” loans — so any regulatory leader who was not an anti-regulatory ideologue would (as we did in the early 1990s during the first wave of liar’s loans in California) have ordered banks not to make these pervasively fraudulent loans.

One of the problems was the existence of a “regulatory black hole” — most of the nonprime loans were made by lenders not regulated by the federal government. That black hole, however, conceals two broader federal anti-regulatory problems. The federal regulators actively made the black hole more severe by preempting state efforts to protect the public from predatory and fraudulent loans. Greenspan and Bernanke are particularly culpable. In addition to joining the jihad state regulation, the Fed had unique federal regulatory authority under HOEPA (enacted in 1994) to fill the black hole and regulate any housing lender (authority that Bernanke finally used, after liar’s loans had ended, in response to Congressional criticism). The Fed also had direct evidence of the frauds and abuses in nonprime lending because Congress mandated that the Fed hold hearings on predatory lending.

The S&L debacle, the Enron era frauds, and the current crisis were all driven by accounting control fraud. The three “des” are critical factors in creating the criminogenic environments that drive these epidemics of accounting control fraud. The regulators are the “cops on the beat” when it comes to stopping accounting control fraud. If they are made ineffective by the three “des” then cheaters gain a competitive advantage over honest firms. This makes markets perverse and causes recurrent crises.

From roughly 1999 to the present, three administrations have displayed hostility to vigorous regulation and have appointed regulatory leaders largely on the basis of their opposition to vigorous regulation. When these administrations occasionally blundered and appointed, or inherited, regulatory leaders that believed in regulating the administration attacked the regulators. In the financial regulatory sphere, recent examples include Arthur Levitt and William Donaldson (SEC), Brooksley Born (CFTC), and Sheila Bair (FDIC).

Similarly, the bankers used Congress to extort the Financial Accounting Standards Board (FASB) into trashing the accounting rules so that the banks no longer had to recognize their losses. The twin purposes of that bit of successful thuggery were to evade the mandate of the Prompt Corrective Action (PCA) law and to allow banks to pretend that they were solvent and profitable so that they could continue to pay enormous bonuses to their senior officials based on the fictional “income” and “net worth” produced by the scam accounting. (Not recognizing one’s losses increases dollar-for-dollar reported, but fictional, net worth and gross income.)

When members of Congress (mostly Democrats) sought to intimidate us into not taking enforcement actions against the fraudulent S&Ls we blew the whistle. Congress investigated Speaker Wright and the “Keating Five” in response. I testified in both investigations. Why is the new House leadership announcing its intent to give a free pass to the accounting control frauds, their political patrons, and the anti-regulators that created the criminogenic environment that hyper-inflated the financial bubble that triggered the Great Recession and caused such a loss of integrity?

The anti-regulators subverted the rule of law and allowed elite frauds to loot with impunity. Why isn’t the new House leadership investigating that disgrace as one of their top priorities? Why is the new House leadership so eager to repeat the job killing mistakes of taking the regulatory cops off their beat?

Bill Black is an Associate Professor of Economics and Law at the University of Missouri – Kansas City (UMKC). He was the Executive Director of the Institute for Fraud Prevention from 2005-2007. He has taught previously at the LBJ School of Public Affairs at the University of Texas at Austin and at Santa Clara University, where he was also the distinguished scholar in residence for insurance law and a visiting scholar at the Markkula Center for Applied Ethics.

Thursday, January 13, 2011

World moves closer to food price shock

Thanks to the Federal Reserves monetary policy.

The world has moved a step closer to a food price shock after the US government surprised traders by cutting stock forecasts for key crops, sending corn and soyabean prices to their highest level in 30 months.

The price jump comes after the UN’s Food and Agriculture Organisation warned last week that the world could see repetition of the 2008 food crisis if prices rose further. The trend is becoming a major concern in developing countries.

EDITOR’S CHOICEIn depth: Global food crisis - Jan-12.David Pilling: The price of peas in China - Jan-12.Delhi onion sellers strike against raids - Jan-12.Arab states act to restrain food costs - Jan-12.Food supply woes fatten Cargill earnings - Jan-12.Tunisian protests escalate online - Jan-12..
While officials are drawing comfort from stable rice prices, key for feeding Asia, they warn that a sustained period of high prices, especially in grains such as wheat, would hit poorer countries. Food price hikes have already led to riots in Algeria and Mozambique.

“Stocks of corn and soyabean are at incredibly tight levels ... and the markets are surging to incredibly strong prices,” Chad Hart, agricultural economist at Iowa State University, said.

Dan Basse, president of AgResource, a Chicago-based forecaster, added: “There’s just no room for error any more. With any kind of weather problem in the upcoming growing season we will make new all-time highs in corn and soy, and to a lesser degree wheat futures.”

Agricultural traders and analysts warn that the latest revision to US and global stocks means there is no further room for weather problems. The crops in Argentina and Brazil, to be harvested soon, look fragile due to dryness.

Traders are particularly concerned about the cost of vegetable oil, key for developing countries such as China where an emerging middle class is buying more frying oil. The US Department of Agriculture said the ratio of global stocks-to-demand would fall later this year to “levels unseen since the mid-1970s, reflecting an accelerated pace of vegetable oil” consumption for food and fuel.

In Chicago, the price of soyabeans rose as much as 5.2 per cent to $14.20½ a bushel, the highest since late 2008. The USDA said that domestic stocks-to-demand would drop to the lowest point in nearly half a century.

Corn prices jumped 5 per cent to $6.37 a bushel, the highest level since July 2008.

The USDA said that by August the ratio of US corn stocks-to-demand would fall to a surprisingly thin 5.5 per cent, the smallest cushion in 15 years.

The US is the world’s largest corn supplier, meeting more than half of global import needs. Corn is an important ingredient in animal feed, and the tightening market partly reflects stronger appetites for meat in emerging markets. Record ethanol production in the US will also swallow up nearly 40 per cent of the US crop.

The boom in agricultural prices has lifted the outlook of the agribusiness sector in the US. Cargill, the world’s largest trader of food commodities, said its profits had tripled year-on-year during the second quarter of its fiscal year.

The shares of Deere & Co, the world’s largest manufacturer of tractors and combines, surged 2.3 per cent, approaching an all-time high. But food companies such as Nestlé fell as analysts said they would struggle to pass rising wholesale costs to consumers.

Sunday, January 9, 2011

Free Banking and Private Money

Inflated: How Money and Debt Built the American Dream

The following is chapter one from Chris Whalen's new book.

The book is developing a cult following amongst the Gold and anti-Fed cognescenti, the “inflationati,” and others. Whalen’s background as a former NY Fed analyst and Bear Stearns banker puts him in a good position to look at the history of Inflation and the inherent growth at any cost bias bult into the American system.

In his December 1776 pamphlet The Crisis , Thomas Paine famously said,“These are the times that try men’s souls.” He then proceeded to lay out a detailed assessment of America’s military challenges in fighting the British. But after the fighting was over, America faced the task of creating a new, independent state separate from British trade and especially independent from the banks of the City of London.

The story of money and debt in America is the chronicle of how a fragment of the British empire broke off in the late 1700s and supplanted and surpassed Great Britain in economic terms by the end of WWI. Though Britain for centuries was the dominant economic system in the world, America would come to lead the global economy by the early twentieth century. The English pound was not the first great global currency, nor will the dollar likely be the last. Mankind has been through cycles of inflation and deflation more than once, going back to before Greek and Roman times. The story of money in each society is a description of the ebb and flow of these states in economic as well as social terms.

The latest version of this repeating narrative features a still very young country called America, which has used money and the promise of it to build a global economic empire, but one that may now be in question after almost a century of relative stability. When the 13 colonies reluctantly declared independence from Great Britain in 1776, the young nation had no independent banking system and no common currency, even though most colonists knew the political and financial traditions of Europe. The Articles of Confederation the infant nation adopted in 1777 did not even give the central government the ability to levy taxes to retire the war debt. European banks and governments met the capital needs of the young nation via loans and even provided what limited physical means of exchange were available aside from pure barter. Pawnbrokers were the predominant source of credit for individuals, and businesses obtained commercial credit from banks, mostly foreign. Foreign coins and some colonial paper money were in circulation, but barter was the most common means of payment used by Americans from the start of the nation’s existence through the Civil War.

1 Sidney Homer and Richard Sylla wrote in the classic work A History of Interest Rates :

The American colonies were outposts of an old civilization.Their physical environment was primitive, but their political and financial traditions were not. Therefore, the history of colonial credit and interest rates is not a history of innovation but rather a history of adaptation.

2 The first American government had no credit and was dependent upon private, mostly foreign banks and wealthy individuals for financing. Upon winning independence, the colonies formed states and issued colonial currency. Bonds were issued when possible, with individuals and even the government of France subscribing in the earliest days of the young nation. The Bank of North America was established in Philadelphia by the Continental Congress in 1782 and became the first chartered bank in the United States. Creating a new bank under the control of the American government was an effort to gain some independence from private banks and also from foreign states.

David McCullough’s Pulitzer Prize-winning biography, John Adams, presents several scenes where the ambassador of the new American government went literally hat in hand to the capitals of Europe seeking hard currency loans to finance the most basic needs. The tireless Adams was able to secure from foreign banks huge sums that sustained the colonial war effort. But as Adams knew too well, his family and other Americans suffered horribly due to inflation and scarcity in those early years. “Rampant inflation, shortages of nearly every necessity made the day-to-day struggle at home increasingly difficult,” McCullough relates. “ ‘A dollar was not worth what a quarter had been,’ Abigail [Adams]reported. ‘Our money will soon be as useless as blank paper.’ ”

3 This need was acute since the U.S. government lacked the power to tax or the means to collect it. Nor would the American people tolerate higher taxes, because of the unhappy experience with Britain. The leaders of the American revolution had led a political revolt against unfair taxes,thus they were not in a position to then raise taxes to pay for the war. Adams was neither an apologist for debt nor for inflation. He believed that having a national debt was a good thing because it created relationships with other nations that would help the infant nation survive and grow. In his prolific correspondence with Thomas Jefferson, Adams showed the sharp contrast between on the one hand wanting to create a constituency among financial powers for America’s national debt while on the other hand expressing his opposition to having private banker and banks. In fact, Adams advocated creating a single national bank to serve the needs of the country, with branches in the individual states. Adams wanted to prohibit the states from chartering banks themselves and to have one single, national institution, perhaps under public control.

Ron Chernow wrote in his excellent 2004 biography, Alexander Hamilton, that Adams viewed banking “as a confidence trick by which the rich exploited the poor.” He quoted Adams similarly saying that “every bank in America is an enormous tax upon the people for the profit of individuals,” suggesting that one of the more conservative founders of the United States would have preferred banks to be run as a giant collective, not-for -profit utility. Adams differed significantly from Alexander Hamilton on these issues, even though like Hamilton he also was of New England mercantilist stock. Hamilton was a great advocate of private banks and debt, and believed that that finance was the key both to state power and economic growth. Chernow confirms that Adams wanted one state bank with branches around the nation, but no private banks at all.

4 The charter of the Bank of North America lapsed in 1790 and two years later, the State of New York chartered The Bank of New York,which is the corporate predecessor of the company now known as Bank of New York/Mellon. Supported by New York’s powerful merchants, the bank was first organized in 1784 and was led by Hamilton, a New York lawyer and Revolutionary War general who became the first Treasury Secretary and a future leader of the United States. So important was the Bank of New York to the local economy that much of the region’s commercial activity was financed by this single institution for decades as the number of banks and thus competition grew slowly. The formation of the bank was not just a financial event, but a very significant political milestone as well that greatly elevated the power of New York.

5 There was no real money nor any payment system in existence for the country. All trade had been financed by English and other foreign banks up until the Revolutionary War. Now the United States had to create a new financial system to replace these relationships, a process that would take more than a century. The demise of the Bank of North America came as a political battle raged over whether the federal government should assume the debts incurred by the states and cities during the war against Britain. The final agreement from the southerners to support the assumption of state debts was tied to the compromise over moving the location of the capital city from New York to Philadelphia temporarily and eventually to an entirely new capital on the Potomac River to be called Washington. But this “compromise of 1790” engineered by Jefferson and Hamilton did not deal with the issue of a national bank.
The Bank of the United States
President George Washington chartered the First Bank of the United States in 1791. This was the government’s attempt at creating a permanent central bank of issue for the infant nation. Madison and Jefferson opposed the bank, but Adams ironically led a sizable majority in the Congress that favored the measure. McCullough described Adams’s views on banks and economics in John Adams :

Adams not only put his trust in land as the safest of investments, but agreed in theory with Jefferson and Madison that an agricultural society was inherently more stable than any other — not to say more virtuous. Like most farmers, he had strong misgivings about banks, and candidly admitted ignorance of “coin and commerce.” Yet he was as pleased by the rise of enterprise and prosperity as anyone.. . .

6 The First Bank of the United States had just a 20-year charter. While it was a bold and novel innovation, the bank only provided credit to established merchants. During the presidency of Thomas Jefferson, the agrarian and other interests not served by the Bank successfully pushed for the establishment of state-chartered institutions to serve the need for credit of a very rapidly growing nation. The state chartered banks also created alternative sources of political power in the states. The First Bank’s charter was not renewed due to the intense attacks by the advocates of Jeffersonian cheap money principles, who taking the lesson of King George III and his taxes, rightly feared that a “central bank” would be dominated by the central government. Even or, worse, it could be dominated by the bankers and merchants in New York and New England commercial centers such as Boston.

7 In 1811, the First Bank of the United States was resurrected bythe New York merchants who controlled it and chartered a new by the State of New York. Today the successor to that corporation is knownas Citibank N.A., the lead bank unit of Citigroup Inc. Now two of the largest banks in the new nation were located in New York. This point was not lost on representatives of the other states in the union and especially the Jeffersonian faction in the Congress, who represented agrarian interests dependent upon New York banks for trade credit The decision not to renew the First Bank of the United States left the United States to fight the war of 1812 against Britain with no means to finance the military struggle, much less the general operations of the federal government. Then Treasury Secretary Albert Gallatin,who was no advocate of public debt, made careful plans to borrow up to $20 million via the First Bank to finance the war, but instead was forced to seek loans from abroad because the First Bank was disolved.
Along with Hamilton, Gallatin was one of America’s first great financial geniuses, and a talented bond salesman to boot. He is memorialized by a large marker in front of the Treasury building in Washington, having also served as Commissioner for the Treaty of Ghent, as well as minister to both France and Great Britain. Because America’s position with the nations of Europe was that of debtor and former colonial possession ,Gallatin’s financial expertise was invaluable. His role recalled the invocation of Hamilton and also of Adams of the virtue of increasing the number of nations willing to hold the American government’s debt. As the nation reeled from the financial disaster of the War of 1812 ,a heated debate continued in the Congress regarding the need for a common currency and a new bank of issue for that currency. Notes issued by banks in New York, for example, could not be used at face value to settle debts in other states. The problem of the scarcity of adequate medium of exchange had existed since colonial times and often made it difficult for creditors to secure payment from customers, even if the customer wished to pay!
By 1814, the federal government itself was unable to pay its bills and was on the brink of financial collapse. Treasury Secretary Alexander Dallas was forced to suspend payments on the national debt in New England due to a lack of hard currency, a necessary move since all Treasury debts had to be paid in gold or silver. Following the capture of Washington by the British in that year and the default on the national debt, the United States was on the verge of financial and political dissolution.

8 The creation of the Second Bank of the United States was the American government’s next attempt at establishing a central bank, an effort that came only after significant political debate and negotiation. Many Republicans fought the resurrection of the Bank of the United States, fearing that its size and ability to do business across state lines would give it monstrous political power that would prove uncontrollable. There was also a strong suspicion by representatives of southern colonies that the Second Bank would be controlled by New York business and financial interests. But after the destruction of the Federalist Party following the War of 1812, the Republican majority in the Congress eventually chartered the Second Bank of the United States, albeit with very limited powers.

The first time the measure to create the Second Bank came up before the Senate in February 1811, it was defeated by the tie breakingvote of Vice President George Clinton of New York, who was empowered to cast the vote in his role as presiding officer of the Senate. He justified his action because the “tendency to consolidation” reflected by the proposal for a national bank seemed “a just and serious cause for alarm.”

9 The subsequent proposal to charter the Second Bank was no tpassed by the Congress until 1815, but then was vetoed by President Madison. A year later the Congress reconsidered the matter. This time,the bill passed the Congress and President Madison signed it into a law. The late Senator Robert Byrd, the West Virginia Democrat who was one of the longest serving members of the body, wrote in his1991 history of the Senate that the early debates regarding a central bank “were far from over and would surface again within the coming decades to alter significantly American political history.” Byrd also notes that coincident with the authorization for the Second Bank, the Congress for the first time dared to provide themselves with an annual salary. Previously, members of the Congress had been paid $6 per day or about $900 per year. War time inflation had greatly reduced the purchasing power of this per diem compensation, so the Congress voted itself a $1,500 per year annual salary. The decision was a political disaster and led to the defeat of two-thirds of the members of the House in the following election.

10 Ironically, many Republicans who supported the Second Bank considered themselves heirs to the libertarian legacy of Thomas Jefferson. When they finally supported the proposal, however, they were following the plan of Alexander Hamilton of New York and other supporters of a strong central government and the virtue of private banks for supporting economic expansion. These same Republicans, who essentially held a one-party lock on the Congress during that time, opposed funding for interstate roads and canals, and even the railroads, to help the struggling economy. The Republicans of that era doubted that the central government had the power under the Constitution to fund internal improvements, yet they did support the central bank. The fact was that the United States was changing as fast as it was growing and with that change was losing many of its libertarian attributes.
The nation’s founders, whether federalist or anti-federalist, found the process bewildering. Susan Dunn, professor of Humanities at WilliamsCollege, wrote: Jefferson and Madison’s Republican Party championed the enter prising middling people who lived by manual labor. But the year before he died, Jefferson felt lost in a nation that seemed over run by business, banking, religious revivalism, “monkish ignorance,”and anti-intellectualism. . .The Founders’ revolutionary words about equality, life, liberty, and the pursuit of happiness, along with their bold actions, had unleashed a democratic tide — one so strong that within a few decades manyof them found themselves disillusioned strangers living in anegalitarian, commercial society, a society they had unwittingly inspired but not anticipated.

11 Following the creation of the Second Bank of the United States,the American economy grew rapidly and more private banks were created, but the largely powerless federal government provided virtually no finance to support this growth by funding public improvements. The Congress preferred to leave this task instead to the cities and states which, naturally enough, turned to borrowing rather than taxation to finance economic growth. By 1840, the total debt of the states amounted to some$200 million, a vast sum by contemporary standards given that total U.S. gross domestic product or GDP was just $1.5billion. Much of this debt was issued by banks chartered by the states and was held by foreigners.

12 Though the Founders had made provision under the Commerce Clause of the Constitution for trade between the states free of tariff, there was no provision for a common currency or banking system tying the nation or even the individual states together. A similar problem is evident today in the European Union, which has a common currency, the euro, but no real economic integration. To provide some liquidity, state-chartered banks issued various forms of notes to the public in return for some future promise to pay in hard money— that is, gold. There was no common means of exchange nor any back stop for banks, which from time to time needed emergency infusions of funds. Panics occurred when public unease about particular financial institutions, companies, or the markets caused deposit runs on individual institutions that could grow into a general financial crisis that affected regions or even the entire country.
Crises of just this sort would become the hallmark of the U.S. economy for the next century. In 1809, for instance, the Farmer ’s Exchange Bank in Gloucester, Rhode Island, failed— one of the first significant bank failures in the United States. There was no Federal Deposit Insurance Corporation or Federal Reserve System to provide support or even organize the orderly liquidation of the bank. This task fell to state and local authorities. The demise of the Farmers Exchange Bank illustrated the types of financial schemes and public panics that would trouble the United States for decades to come.
Financial pioneer turned confidence man Andrew Dexter, Jr., writes: James Kamensky, “challenged the notion sof his Puritan ancestors by embarking on a wild career in real estate speculation, all financed by the string of banks he commandeered and the millions of dollars they freely printed. Upon this paper pyramid he built the tallest building in the United States, the Exchange Coffee House, a seven-story colossus in downtown Boston. But in early 1809, just as the exchange was ready for unveiling, the scheme collapsed. In Boston, the exchange stood as an opulent but largely vacant building, a symbol of monumental ambition and failure.”

13 A democratic society and a free market economy cannot exist without both great ambition and equally great failure. However, in the American experience, financial fraud and the tendency of politicians to use debt and paper money, rather than taxes raised with the active knowledge and consent of the voters, are common elements from colonial times right through to the present day. The collective failure of the Subprime Debt Crisis of 2008 is a larger reprise of the types of mini crises that occurred in the United States centuries before this period, crises that were limited by the relatively primitive state of communication and transportation.

State Debt Defaults

By the mid-1830s, the United States was in the midst of an economic boom characterized by inflation and speculation in public land sales, as well as road and canal projects. Many of these projects were badly needed but were often poorly conceived or entirely money losing investments. The several American states employed borrowing to finance needed improvements in order to avoid increasing taxes, and they even used sales of public land as a means to reduce debt. States along the Atlantic coast, where the economy was more developed and other sources of revenue such as tariffs were available, generally avoided costly property taxes, while less developed inland states could not sustain their governments with low property taxes and ran into financial trouble. The low or no property tax regimes in many western states are a legacy from the colonial period. This resulting unequal development became even more acute because the areas needing investment and often growing the most rapidly were precisely the western statesand territories that were starved for cash, not so much for investment but simply as a means of exchange.

14 In some of these states, the need for money was met in a primitive way by discovering and extracting gold and silver from the ground. During the 1830s speculation in land also flourished, with state chartered banks providing the paper to fuel the rising land values. This investment bubble had the effect of making the states look fiscally sound because of rising land prices. Some inland states even suspended property taxes due to supposed “profits” on bank shares, which often comprised a large portion of state investments. But the illusion of wealth and public revenue would fade with the Crisis of 1837, when many of these state banks failed, the equivalent of a nation’s central bank failing today. The Crisis of 1837 was the fourth and most stunning depression in the U.S. up to that time and the first financial crisis that was truly national in scope.

15 Between 1841and 1842, Florida, Mississippi, Arkansas, Michigan, Indiana, Illinois, Maryland, Pennsylvania, and Louisiana ran into serious fiscal problems and defaulted on interest payments. The first four states ultimately repudiated $13 million in debts, while others delayed and rescheduled their debts, in some cases years later. Alabama, Ohio, New York, and Tennessee narrowly avoided default during this period.
16 Because manystates used state-chartered banks as vehicles for borrowing, the public naturally became alarmed when the states ran into financial problems and public programs established during prosperous times could no longer be funded.

In the early 1800s, paper money issued by private, state-chartered banks generally traded at a steep discount to the face value when converted into precious metal, especially when it was issued by banks out-side of the state or local market where is was presented for payment. The notes used at that time generally promised to pay the bearer of the note a certain amount of physical gold or silver upon demand. The experience of banks failing was all too common for Americans in that period. There was deep suspicion in the marketplace when a note from a far away, state chartered bank was presented for payment. This was one reason that payments by and to state and federal agencies were done only in metal coins, not paper, and most contracts of the day like wise specified metal as the consideration. In the 1840s there was no telephone, no internet or even telegraph, and no local clearing house for banks to use to validate the authenticity of paper money issued by private banks. No surprise, then, that people in America and around the world preferred the security and certainty of gold and silver coins to paper money, even when the banks issuing the paper were backed by sovereign states. The suspicion of paper money was part of a broader suspicion of bankers and the economically powerful that flowed through most of American society.
Fleeing the religious and economic oppression of European society, Americans came to the New World for a fresh start and also an opportunity to live free of the stratified economic system of Europe, where even in the eighteenth century opportunities for advancement where few. Two centuries later, Western Europe remainsa far less dynamic market for new businesses and banks than the far younger U.S. market. Having money that was independent of political authority granted individuals a level of freedom from inflation that was a key part of the American ideal. Thus when the states began to falter financially, the cohesion of the entire nation was threatened. MostAmericans still identified themselves with their home state or town rather than as citizens of the United States. The political fact of union among the states had still not quite been settled because of the issue of slavery, but the overall fragility of the state run financial system contributed to the mounting political pressures on the nation.
As many states fell into default on their obligations during the1840s, repudiation of debt by state chartered banks was a hotly debated subject. In Arkansas, for example, Governor Archibald Yell explicitly urged debt repudiation in his 1842 message to the state legislature, which had created various state chartered banks as vehicles for funding state expenditures via borrowing. Such was the political uproar against banks and debt generally that the Arkansas state legislature passed a constitutional amendment in 1846 to liquidate all state chartered banks and prohibit the creation of any new banks in that state.

17 In Pennsylvania, starting in the mid-1830s the Commonwealth had chartered the United States Bank of Pennsylvania to cover fiscal short falls with debt. By 1839, the bank had defaulted on its obligations several times, but the response from the state legislature was to authorize more borrowing — a charming reminder that the present-day problems of federal deficits are not a new phenomenon. Despite rising deficits, the Commonwealth of Pennsylvania delayed making any meaningful fiscal reforms until the mid-1840s, by which time it was in default on its debt. In payment on the Commonweath’s $40 million in debt, its citizens were forced to take scrip bearing 6 percent interest because the state was broke.
18 In essence, Pennsylvania began to issue its own currency when it could not borrow or would not tax in sufficient amounts, a phenomenon that has reappeared in the United States in the twenty first century. As the states, most notably California, NewYork, and Illinois, struggle today under mountains of debt, unfunded pension obligations, and other expenses, issuing scrip has again become a popular alternative to tax increases. By 1840 many American states had gained a well deserved reputation in Europe for not repaying loans, although the U.S. government managed to service the federal debt in good order. From $75 millionin debt in 1791 to a peak of $100 million after the War of 1812, the Treasury paid down the federal debt to a mere $63 million in 1849. The U.S. government only paid down its debt once in the 1830s and then only by the accident of having a fiscal hawk named Andrew Jackson as President. In general fiscal restraint at the federal leve lwas the rule in the first century of the nation’s existence. Since the Federal government was not really involved in financing the economic growth of the nation, the remarkable stability of the federal debt contrasts with the spend thrift behavior of the states, counties and cities.

States such as Louisiana defaulted on loans, evaded their debts and delayed settlement with creditors until the twentieth century. Many foreign investors had believed, incorrectly, that the success of NewYork and other Atlantic states in building profitable canals and other commercial infrastructure would be repeated in the western and southern states and territories. The states themselves, especially in the south and west, seemed genuinely to have believed in the growth story. But in fact, looking at both the federal and state debts, the United States was a heavily indebted, rapidly developing country with neither organized financial markets nor even a common currency, and with a seriously dysfunctional central government. When the overheated economy and related financial crisis first started to boil over in the late-1830s, many European banks refused to lend further to the U.S. government or the various states, putting intense pressure on the small nation’s liquidity and political unity. This stress was relieved by the issuance of various types of fiat currency nd debt securities. In states such as Michigan and Indiana, the number of banks dwindled as first private institutions and eventually the state-chartered banks were wound up and closed. Regarding the financial situation in the Midwest, Willis Dunbar and George Maynoted in their book, Michigan: A History of the Wolverine State:

The speculation in Michigan land values of the early thirties, for example, was fantastic. The enormous note issues of the banks were obviously out of proportion to their resources. And the internal improvement programs adopted by the states were far beyond their ability to finance. The nation was importing, primarily from Great Britain, much more than it was exporting, and piling up a steadily mounting debt to British exporter sand manufacturers. A day of reckoning was inevitable.
19 Washington had not played a direct role in encouraging the accumulation of debt by the states. The national Congress refused to support any needed infrastructure improvements such as roads, canals,and port facilities, and the failure to make progress on the more basic issue of a national currency made the situation in the American financial markets inherently unstable. When added to this structural deficiency the renewed political ascendancy of Andrew Jackson and the proponents of the Jeffersonian, anti-federalist view of banks and currency, set the stage for not merely a crisis at the end of the 1830s— but for a catastrophe. When the crisis finally occurred, it turned out to be one of the worst economic and financial meltdowns seen in Western society up to that time and was compounded by unresolved political issues in Washington.

By the middle of 1837, unemployment was widespread and thousands of companies and banks had failed as the money supply contracted. This was due in part to events in Washington and, more important, to a growing antipathy toward banks and paper money among the public. Bad paper money was literally shunned by the mass population, an dthe issuance of bonds likewise dried up. By the start of the 1840s, only official U.S. minted coins and other types of specie were in broad circulation as Americans avoided privately issued paper notes and debt.
20 In effect, all of the float or credit in the economy was gone. Americans were forced to operate on cash or barter terms. Imagine leaving one’s house every morning needing to generate cash or goods via sales, services, or barter every day in order to survive. Most Americans in the 1840s lived with no access to cash or credit, except as provided by commercial exchanges with other people.

The Age of Andrew Jackson

Much of the terrible suffering experienced by the country in the late 1830s owed itself to one factor more than others: the rise a decade before of Andrew Jackson, the Tennessee war hero and political outsider. The arrival in Washington of this former Indian fighter and hero of the War of 1812, known as Old Hickory, signaled the end of the political dominance of Virginia in American politics. Jackson had lost his first bid for the presidency to John Quincy Adams of Massachusett sin the election of 1824, even though the Tennessee native won a larger proportion of the popular vote and also the plurality of votes in theElectoral College. But Jackson still lost the election. In the so called “Corrupt Bargain,” Senator Henry Clay, a Whig from Kentucky and long-time enemy of Jackson, threw his support to Adams in the vote in the U.S. House of Representatives, ensuring the election of Adams but also making the election of Jackson in 1828 a virtual certainty. Clay was appointed Secretary of State by President Adams as the quid pro quo for his support in the House. Clay himself sought the presidency on four occasions, but he repeatedly underestimated the popular support for the man who had defeated the British Army at New Orleans in spectacular fashion— albeit several weeks after theUnited States and Britain had agreed to peace. News traveled slowly in those days. Jackson’s succession to the presidency in 1828 followed an unremarkable political career, but was notable as the first time that a southerner swept into power in Washington on a wave of popular support. In a sense, Jackson was the first modern president because his victory marked the earliest instance where an American presidential candidate was actually chosen by the popular vote rather than as the result of the internal selection process dominated by the nation’s founders and their descendants. In fact, to complete the picture of upset, Jackson’s running mate, John C. Calhoun of South Carolina, had served as Vice President under the incumbent President John Quincy Adams.

The 1828 presidential campaign was a vicious affair, as might be expected when an established order is ended. Jackson was opposed by most of the nation’s newspapers, bankers, businessmen, and manufacturers, especially in the Northeast, but still won 56 percent of the popular vote in 1828. Thus began the Jacksonian Age.
21 The period of Andrew Jackson’s presidency was in political terms one of the most difficult in American history, with northern and southern interests competing with new western states for political advantage, even to the point of secession from the Union. Against thi scontentious political backdrop, Jackson and Congress fough tbitterly over many issues, but none of more consequence for the economy andthe U.S. financial system than the renewal of the Second Bank of the United States. With its charter set to expire in 1836, Jackson began in 1830 to attack the Second Bank and proposed instead that a new government bank be set up as an arm of the Treasury. The Whigs led by Clay decided to reauthorize the Second Bank early and were able to get the measure passed by both houses of Congress during the summer of 1832, but the legislation was vetoed by President Jackson on July 10, 1832. He objected to the bank as being unconstitutional, aristocratic,and, most important, because it failed to establish a sound and uniform national currency. The lengthy written discussion of President Jackson’s objections to the Second Bank is one of the great libertarian statements against big government and the power of moneyed interests in American history. It also predicted many of the problems caused by the creation of the Federal Reserve System 80 years later. The final paragraph of the Jackson veto message reads: Experience should teach us wisdom. Most of the difficulties our Government now encounters and most of the dangers which impend over our Union have sprung from an abandonment of the legitimate objects of Government by our nationa llegislation, and the adoption of such principles as are embodied in this act. Many of our rich men have not been content with equal protection and equal benefits, but have besought us to make them richer by act of Congress. By attempting to gratify their desires we have in the results of our legislation arrayed section against section, interest against interest, and man against man, in a fearful commotion which threatens to shake the foundations of our Union. It is time to pause in our career to review our principles, and if possible revive that devoted patriotism and spirit of compromise which distinguished the sages of the Revolution and the fathers of our Union. If we cannot at once, in justice to interests vested under improvident legislation, make our Government what it ought to be, we can at least take a stand against all new grants of monopolies and exclusive privileges, against any prostitution of our Government to the advancement of the few at the expense of the many, and in favor of compromise and gradual reform in our code of laws and system of political economy.

22 Even then, the supporters of a central bank were numerous and out-spoken. Ralph C. H. Catterall, the great historian of the Second Bank, said of Jackson’s veto: Jackson and his supporters committed an offense against the nation when they destroyed the bank. The magnitude and enormity of that offense can only be faintly realized, but one is certainly justified in saying that few greater enormities are chargeable to politicians than the destruction of the Bank of the United States.

23 But Claude G. Bowers, a historian sympathetic to Jackson, defended his action: Even among the ultra-conservatives of business, the feeling was germinating that Jackson was not far wrong in the conclusion that a moneyed institution possessing the power to precipitate panics to influence governmental action, was dangerous to the peace, prosperity, and liberty of the people.
24 The veto of the reauthorization of the Second Bank was not the end of the matter, however. The debate over the bank and the nature of money played a significant role in the 1832 landslide re-election victory of Jackson against the party formerly known as the Whigs ,and now called the National Republican Party under Henry Clay.

That debate would continue for years as the Senate censured Jackson for his efforts to remove the government’s funds on deposit with theSecond Bank. But Jackson was adamant that the bank had to go and he was willing to let his political fate be governed by that one issue. In September 1831, President Jackson told Treasury Secretary Louis McLane that he did not intend to pull down the bank merely to set up a new one.
25 Despite Jackson’s strong view on the matter, he could not disregard many voices, even in his own cabinet, who supported renewing the charter of the Second Bank. Yet Jackson remained strong in his conviction that the central bank was a monster that was unconstitutional and concentrated power “in the hands of so few persons irresponsible to the electorate,” wrote Marquis James. The great biographer of Jackson continued: “Nor was this all. With deep and moving conviction, the message gave expression to a social philosophy calculated to achieve a better way of life for the common man.”

26 In one of the examples of how personal political battles contributedto the economic problems of the nation, Nicholas Biddle, the head of the Second Bank and a foe of Jackson, fought the President to the last in defense of the Second Bank. When Jackson gave notice that the Treasury would no longer deposit its cash in the Second Bank, Biddle started to withdraw funds deposited with state banks around the country in an effort to discredit Jackson. Specifically, Biddle would present notes drawn upon state banks and demand payment in gold, a move that had the effect of draining liquidity from those communities and generating enormous anger at Biddle and the Treasury. So great was the antagonism generated by Biddle’s attempt to hurt theU.S. economy (and thereby wound President Jackson politically) that almost a century later, when the U.S. Congress debated the creation of the Federal Reserve System, the state bankers still referred to the predations of Nicholas Biddle and the Second Bank as a reason for opposing the legislation. Biddle was one of the great financial minds of the early days of the United States, but he was also a formidable political operator who was not afraid to use the media and lobbying on Capitol Hill to defend his institution. Together with Clay and other supporters of the Second Bank, they mounted a vigorous but ultimately futile defense.

The economy eventually slowed and the financial markets began to weaken as the Second Bank withdrew hard currency from theeconomy, but President Jackson struck back. In the fall of 1833, he directed that the Treasury with draw its deposits from the Second Bank, a move which began his famous confrontation with Henry Clay and the Senate, and doomed the Second Bank of the United States to extinction. Both Clay and Biddle, it seems, believed that hard economic times would help their battle with Jackson and the Democrats, who used the fight over the bank to win the 1832 election. Both men miscalculated badly and Jackson won re-election with 76 percent of the vote, the largest margin since George Washington and James Madison. The pro- Jackson forces likewise prevailed in the 1834 mid-term contest— even as Biddle did his best to “bring the country to its knees and with it Andrew Jackson.”

27 The political battle over the Second Bank of the United States between Clay and Jackson distracted the country at avery crucial juncture of American history. The United States would go nearly three quarters of a century without a central bank of issue for its currency until Congress established the Federal Reserve System in 1913, but the immediate impact was the most severe economic crisis the nation had seen since its beginnings. When the Second Bank closed its doors in March of 1836, the United States was left with no common currency and what credit the bank had provided to the economy was withdrawn. There was no central provider of liquidity for banks, nor any deposit insurance. Only the private shareholders of state-chartered banks were available to supportthe liquidity and soundness of private depositories. This lack of a currency system and of a mechanism for managing the liquidity needs of banks had been felt earlier in the century, when the Second Bank of theUnited States called in its loans in 1819 and triggered the Panic of that same year in the ensuing scramble for liquidity. But as with most public issues, the national Congress was largely indifferent to the needs of the nation, preferring instead to defend regional and states’rights from threats, real and imagined. The defeat of the Second Bank of the United States was not the end of Jackson’s reactionary agenda. President Jackson refused to allow the resources of the federal government to be used for financing the construction of roads and canals, and instead retired the national deb tand distributed the surplus accumulated in the Treasury. By attacking the Second Bank and at the same time pursuing a very conservative fiscal policy, Jackson created the circumstances for the Great Panic of 1837. Since there was no central bank, the withdrawal of public debtby the Treasury amounted to a deflationary reduction in the nation’s money supply. In addition, the retirement of the federal government’s debt encouraged states and their banks to issue paper currency in large amounts, which fueled land purchases and speculation. Done in the midst of a growing speculative bubble based on land purchases, the Jacksonian fiscal measures helped to reduce liquidity in banks and worsen the lack of credit in an already cash strapped society. Yet even with what amounted to a tight money policy from Washington over eight years of Jackson’s presidency, the speculation that gripped the nation during the early part of the 1830s was just coming to a boil when Jackson left office in the early part of 1837. As one of his last official acts, Jackson issued the Specie Circular, another hard money and anti-debt initiative, which required that purchases of government land be paid for in coin or specie rather than bank paper. By requiring that payments for taxes, duties, and/or the purchase of federal land be made in gold coins, the Treasury was in practical terms draining reserves from the banking system and causing it to shrink. This compounded the fact that the Second Bank of the United States under Biddle had been calling in its loans. This third fiscal action by Jackson, following the closure of the Second Bank and the retirement of the government’s debt, was implemented by his successor, President Martin Van Buren, and further exacerbated the liquidity crisis in the United States.

The Panic of 1837

As Jackson travelled home to Nashville in the spring of 1837, he observed that bank notes were trading at a steep discount to face value and farmers were paying 30 percent for credit— all the results of his earlier executive orders. Some bankers, traders, and particularly land speculators clamored for President Van Buren to “strike down the iniquitous Specie Circular ” requiring that hard money be used in the purchase of federal land or payment of federal taxes. But Jackson wrote to Van Buren: My dear sir, the Treasury order is popular with the people everywhere I have passed. But all the speculators, and those largely indebted, want more paper. The more it depreciates the easier they can pay their debts. . .Check the paper mania and the republic is safe and your administration must end in triumph.

28 Unfortunately for President Van Buren, Jackson’s devotion to hard money was at odds with the needs of a growing nation. With the drain of currency caused by Jackson’s Treasury order, as he called the Specie Circular, and the resultant increased stress on the economy, a lack of confidence in the state banks was wide spread around the United States. The resulting financial crisis in 1837 caused many banks to fail over a period of several years. This panic was followed by a sharp economic contraction around the world that would last until 1841. To no surprise, President Van Buren was defeated in the next general election. One of the more significant and mischievous contributions that President Van Buren made to the country’s financial development was the creation of an independent Department of the Treasury. In 1837, in a special message to Congress, President Van Buren proposed that the finances of the federal government be formally “divorced” from those of the state chartered banks. This proposal caused considerable political controversy. The Congress passed The Independent Treasury Act of 1840 and then repealed it in 1841. In 1846 Congress adopted the same proposal again. The official goal of the legislation was two fold: to ensure the independence of the banks in the country and also to support the value of the currency. Neither of these goals were met. In practical terms, the Treasury became a “bank of issue” and a de facto central bank, refusing to accept notes issued by private banks and issuing its own notes in competition with the state banks. The creation of the Independent Treasury had a negative impact on the U.S. economy by draining reserves from the banking system and effectively reducing the supply of money available to Americans for commerce.

By segregating the gold reserves of the government in the Treasury’s own vaults and not keeping these funds on deposit with private banks, the Independent Treasury served to exacerbate the structural deficiencies in the U.S. economy for decades afterward. In the years up through the Civil War and there after, the fiscal operations of the Treasury were an important factor in the ebb and flow of the supply of money available to support the American economy. By the 1840s, hundreds of banks existed in America and all of them were printing private bank notes and making loans based solely on their own resources, mostly gold and foreign currency held as reserves. With the demise of the Second Bank of the United States in 1836, only state-chartered banks existed and the United States remained dependent upon limited minting of specie, foreign currency, and barter as means of exchange. During this period, known as the Free Banking Era, state bank chartering standards were not very stringent,and many new banks were formed and failed, but the free banking era was also one of great expansion in the U.S. economy. The Federal Reserve Bank of San Francisco described the period: State Bank notes of various sizes, shapes, and designs were in circulation. Some of them were relatively safe and exchanged for par value and others were relatively worthless as speculators and counterfeiters flourished. By 1860, an estimated 8,000 different state banks were circulating “wildcat” or “broken” bank notes in denominations from ½ cent to $20,00. The nickname “wildcat” referred to banks in mountainous and other remote regions that were said to be more accessible to wild cats than customers, making it difficult for people to redeem these notes. The “broken” bank notes took their name from the fre-quency with which some of the banks failed, or went broke.

29 In reaction to the collapse of the Second Bank of the United States, New York became the first state to adopt an insurance plan for bank obligations. Between 1829 and 1866, five other states adopted similar deposit insurance schemes in an attempt to stabilize their banking systems. But these modest early attempts at enhancing bank safety and soundness were not effective in controlling the emission of paper currency and forestalling liquidity crises such as the great Panic of 1837.

The Congress authorized a Third Bank of the United States in 1841, but President John Tyler vetoed the measure, leading to rioting outside the White House by members of his own Whig Party.
30 The idea of a central bank issuing paper money was sufficiently popular in Washington and among the business circles that exerted influence in the lobbies of the Capitol. But Tyler, who succeeded to the presidency upon the death of William Henry Harrison, who died after just a month in office, vetoed the legislation creating a Third Bank of the United States twice during his term on states’ rights grounds. The defeat of the Third Bank of the United States also marked yet another political defeat for the Republican leader Henry Clay. As before, Clay had personally championed the idea of a central bank, and as before, he had lost. With the death of Harrison, a retired general and respected member of the Whig Party, Clay believed that a new central bank was assured. But the populist opposition to the idea of a central bank, or even any banks at all, was too strong. President Tyler instead used the bank issue to assert his political independence from Clay and the Whig leaders in Congress. When Tyler ’s Whig cabinet resigned over the veto of the bank legislation, Tyler was left with only the venerable Daniel Webster as Secretary of State. Webster knew the political and economic issues in the debate over a central bank as well as any member of the Senate. H ehad opposed the First Bank in 1814, but then helped John C. Calhoun fashion a compromise that eventually passed by the Congress. Years later, acting in his capacity as a lawyer, Webster represented the SecondBank before the Supreme Court in McCulloch v. Maryland , when the high court upheld the implied power of Congress to charter a federa lbank and rejected the right of states to tax federal agencies. The ruling in McCulloch v. Maryland also recognized the implied powers clause of the Constitution, an evil event that greatly expanded the power of the Congress generally and especially regarding money and debt. “A disordered currency is one of the greatest political evils,” Webster is reported to have said in one of the great arguments ever made by an American for sound money. He continued: A sound currency is an essential and indispensible security for the fruits of industry and honest enterprise. Every man of property or industry, every man who desires to preserve what he honestly possesses, or to obtain what he can honestly earn, has a direct interest in maintaining a safe circulating medium; such a medium shall be a real and substantial representative of property, not liable to vibrate with opinions, not subject to be blown up or blown down by the breath of speculation, but made stable and secure by its immediate relation to that whicht he whole world regards as permanent value.

31 Tyler and Webster appointed a new cabinet comprised of southerners and without any supporters of Clay, whose political era essentially ended with this last battle in the nineteenth century over a central bank. As discussed in the next chapter, Washington remained largely oblivious to the financial problems facing the nation’s economy until the Civil War. Tyler’s advocacy for states’ rights also meant a strong resistance against using federal revenue to bail out the states from their debts. Clay was particularly keen on giving the new, heavily indebted western states the right to revenue from public land sales, a measure Tyler refused to support. Even though Martin van Buren was defeatedin 1840, the influence of Jackson and the public’s strong distrust of banks generally gave President Tyler the will to oppose a measure strongly supported by his Whig Party. The Whigs subsequently expelled Tyler. When he left office in 1845, the government received taxes and paid interest in specie, but the rest of the economy was fueled by the rapid growth in paper currency that was, to one degree or another, convertible into gold or silver.

The Gold Rush

The debt crises in the various states of the mid-1840s would quickly be forgotten in 1848 when gold was discovered in California. With in months of the discovery, tens of thousands of people were headed west, overland across the Great American desert, by sea around Cape Horn , or through the jungles of Panama and Nicaragua. The tiny Spanish port of San Francisco was turned almost overnight into a boom town of some 25,000 inhabitants and continued to grow to bursting and beyond with the vast influx of humanity from all corners of the globe.

By 1870, the population of San Francisco had reached nearly 150,000 ,but this statistic only begins to describe the huge movement of people and resources from the Eastern United States to the other side of the continent. So great was the influx of humanity into California that the territory was organized into a state, held a constitutional convention,and petitioned Congress for statehood in less than two years. California was admitted to the Union as a free state via the Compromise of 1850, the fastest process of accession to statehood of any U.S. state. The production of gold from the mines of California served to stimulate economic activity in the United States and around the world ,resulting in increased imports from Great Britain and other nations, and a steady increase in prices. The influx of new supplies of gold increased the money supply of the United States which, by definition, was still governed by the amount of gold in circulation. But a great deal of gold would eventually leave the United States for destinations such as Britain and other countries to pay for imported goods. More important, the Gold Rush pushed wages and prices higher, even after the initial surge of migration from 1848 to 1852 slowed. Long after the allure of the Gold Rush had faded, wages and prices in distant California remained higher than in the rest of the United States.
32 But despite the idealized view of the Gold Rush, the fact was that most of the 49ers who made the trip to California did not become rich. Making the trip to California to pan for gold was akin to playing the lottery, which meant that the vast majority of participants were losers in financial and human terms. A significant portion of the participants in the Gold Rush died attempting to reach California or due to violence in the gold fields. Those who ventured north to the Yukonin pursuit of gold faced even steeper odds, as described so beautifully by Jack London in books such as Call of the Wild and White Fang. The more enduring, long-term impact of the Gold Rush was to create an alternative to the Puritan, conservative notion of hard work and saving that characterized the early days of the United States with the“American dream” of instant wealth achieved quickly via opportunism and speculation. More than simply a description of the social and economic changes that occurred in California as a result of the discovery of gold, the Gold Rush and eventually the American dream became synonymous with the ability to get a fresh start in life and, with hard work and most important, luck, earn enormous wealth. From the 49ers in the 1850s to oil prospectors half a century later to movie producers and technology start-up companies in the twentieth century, the get-rich-quick image of the American dream became an important fixture in the nation’s psyche that would color public attitudes toward money, debt, and the role of government. The American dream was not merely about helping all Americans meet their wants and needs, but to meet them immediately. As H.W. Brands wrote inhis classic work, The Age of Gold:

“We are on the brink of the age of gold,” Horace Greeley had said in 1848. The reforming editor wrote better than he knew. The discovery [of gold] at Coloma commenced a revolution that rumbled across the oceans and continents to the ends of the earth, and echoed down the decades to the dawn of the third millennium. The revolution manifested itself demographically, in drawing hundreds of thousands of people to California; politically, in propelling America along the path to the Civil War; economically, in spurring the construction of the transcontinental railroad. But beyond everything else, the Gold Rush established a new template for the American dream. America had always been the land of promise, but never had the promise been so decidedly— so gloriously— material. The new dream held out the hope that anyone could have what everyone wants: respite from toil, security in old age, a better life for one’s children.

33 The Rise of Bank Clearinghouses Another significant development in the history of the American monetary system prior to the Civil War that deserves attention is the creation of private clearinghouses around the country to help banks manage their payments and liquidity. In 1853, when the Clearing House Association began operations in New York, it was located in a single room in the basement of 14 Wall Street. Created even before theNational Banking Act was enacted by the Congress a decade later, the New York Clearing House was a mechanism designed to reduce the cost of clearing claims between banks in the same city. Twice a day, the banks would total their debits and credits with each member of the clearinghouse, and then settle the difference in cash— or special notes drawn on the clearing member. This basic, non-specie extension of credit between the members of the association was another response to the demise of the Second Bank of the United States and effectively made the clearinghouse a quasi central bank to its members.

34 The advent of clearinghouse models in many cities around theUnited States during the mid-1840s and 1850s was an important development, a uniquely American model of mutual risk taking and liquidity sharing that provided an important degree of efficiency to the financial markets without government support. But the credit that could be provided to members was limited by the willingness of the other party to take the special currency, created for members of the association, known as “loan certificates.” The clearinghouse in one city did not yet interconnect with its counterpart in another city. This left the movement of credit from one market to another, one city to another, to the limited channels of correspondence between individual banks. But the fact of the private bank clearinghouses provided an important source of liquidity for banks that was not available from other sources. JP Morgan, it must be said, was not a member of the New York Clearing House until well into the twentieth century and instead cleared all of its transactions with other banks “over its own counters,” in the market vernacular of the day. This essentially meant that the House of Morgan wanted the other banks in the New York market to stand in line like everyone else in the lobby of JP Morgan. It also meant that the most prominent and creditworthy bank in the UnitedStates was not part of the collective clearing mechanism in the most important city in the country and thus only extended credit to other banks on its own terms. While the clearinghouse model served to provide liquidity to member banks during the crises of the nineteenth and early twentieth centuries, it was not nearly a sufficient solution to the problems of liquidity that dogged the U.S. markets during economic downturns. There was always a competitive aspect to the relationship among clearinghouse members, to paraphrase Charles Goodhart, a chief economic adviser to the Bank of England. The case of the Building & Loan Society in the Frank Capra film It ’s a Wonderful Life featuring James Stewart epitomizes the example. When a solvent bank required short term liquidity support, the other members of the clearinghouse might be tempted to with hold their aid and thereby kill a competitor. Goodhart notes, however, that the politically controlled central bankis not the solution to this problem of competitive conflict, since the prejudices and conflicts of the political world are far worse than even those found in the banking sector. The political corruption and incompetence displayed by the Fed and Treasury during the financial crisis of 2008 seemingly supports Goodhart’s judgment. It is, after all, the legal and regulatory limitations imposed by government that created the problems of liquidity and risk with which private banks must contend, argues Richard Timberlake of CATO Institute: Governmental dispensation of monopoly powers over note issue, governmental imposition of legal reserve requirements, governmental prohibition of post notes and option clauses, governmental prohibitions of interstate and (often) intrastate branching— insum, governmental interference with all of the machinery of banking that would have allowed banking to function as free enterprise, was what made the problem that the clearinghouse institution successfully abated.

35 The clearinghouse model in the United States was an attempt by private industry to address the problems of liquidity and payments tha tburdened the young country in the mid -1800s. Unfortunately, the already fragile U.S. financial system would next be thrown into the stress and uncertainty of the Civil War, a terrible period that altered the nation’s financial system forever.