US Regime Uncertainly, 1937 and 2008
Writes Bob Higgs:
In an article published in 1997 titled "Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War," I advanced the idea of regime uncertainty in an attempt to advance our understanding of the Great Depression's extraordinary duration and of the highly successful postwar transition to a genuinely prosperous market-oriented economy. The idea is more definite than the hoary but vague idea of "business confidence," though related to it, and different also from the idea of regime uncertainty that some econometricians have used in their macroeconomic studies, though, again, not wholly unrelated.
In my conception, regime uncertainty pertains above all to a pervasive uncertainty about the property-rights regime -- about what private owners can reliably expect the government to do in its actions that affect private owners' ability to control the use of their property, to reap the income it yields, and to transfer it to others on voluntarily acceptable terms. Will the government simply take over private property? Will it leave titles in private hands, but strip the owners of real control and profitable use of their properties? These questions fall under the rubric of regime uncertainty.
Between 1935 and 1940, this matter attained prime importance. So many businessmen and investors lost confidence in their ability to forecast the future property-rights regime that few were willing to venture their money in long-term investments. They constantly sought clarification of the government's designs, but President Roosevelt merely continued to rage against "economic royalists" and to blame a "strike of capital" for the economy's ongoing troubles, including the depression of 1937-38, which played havoc with the general public's confidence in the New Deal. Treasury Secretary Henry Morgenthau tried repeatedly to persuade the president to make a public statement that would reassure investors, and as the president continued to reject his entreaty, Morgenthau became so frustrated that in a 1937 cabinet meeting, he blurted out to his boss: "What business wants to know is: are we headed toward Socialism or are we going to continue on a capitalist basis?" (qtd. in Higgs, Neither Liberty Nor Safety, p. 114). Astonishingly, Jim Farley and even Henry Wallace backed up Morgenthau's insistence that the president spell out what sort of economic system the administration sought to foster.
In his question, Morgenthau encapsulated the wide ranging uncertainty Lammont du Pont expressed in the same year, when he said:
Uncertainty rules the tax situation, the labor situation, the monetary situation, and practically every legal condition under which industry must operate. Are taxes to go higher, lower or stay where they are? We don't know. Is labor to be union or non-union? . . . Are we to have inflation or deflation, more government spending or less? . . . Are new restrictions to be placed on capital, new limits on profits? . . . It is impossible to even guess at the answers. (qtd. in Higgs, Depression, War, and Cold War, p. 16)
I do not know that the regime uncertainty that an increasing number of commentators and others have perceived recently is comparable to that of the latter 1930s -- by now there's not much real capitalism left for the government to destroy, in any event. However, it is clear that the government's frantic actions of the past several months have created a situation in which investors have little confidence about the character of future property rights in the United States. The takeovers of Fannie, Freddie, and AIG, the massive interventions into finanancial markets, the huge bailouts of banks and other financial institutions, mixed with letting Lehman Brothers go down and resisting a bailout for the Big Three auto manufacturers (so far, at least) -- all these actions, and others, imply that a rational investor would do well to attach a huge risk premium to any money he puts into investments even for the intermediate term, not to mention the long term.
One of the clearest expressions of this outlook that I have seen so far was made recently by Lou Jiwei, the chairman and chief executive of the China Investment Corporation, who expressed a lack of confidence in Western financial institutions and said that his giant fund would make no new investments in them in the foreseeable future. As the New York Times reported:
"Right now we do not have the courage to invest in financial institutions because we do not know what problems they may have," Mr. Lou said as part of a panel discussion on the second and final day of the Clinton Global Initiative conference [in Hong Kong].... Mr. Lou said that the sheer pace of new initiatives and new rules issued by Western regulatory agencies was disconcerting and made it even harder for him to choose worthwhile investments. "If it is changing every week, how can you expect me to have confidence?" he asked.
How, indeed?
HT to Steve Hanke for calling Lou Jiwei's statement to my attention.
Comments (9)
Anthony
I think part of the depth of the current recession is being caused by the uncertainty of how Ben Bernanke is going to deal with things. I certainly thought he would have been much more aggressive in debt monetization in situations like the current one, given his infamous statements about helicopter money. But that's not at all what the fed has been doing - they've actually been selling treasuries, in effect swapping treasuries for riskier assets, in some truly unprecedented ways. Surely this is serving to create even more uncertainty - these loans are temporary, and need to be unwound at some point. But for that not to be deflationary we'd either have to see lending go back to bubble levels or the fed would have to engage in a policy of monetization. The bond market is betting on deflation, though it's hard to know if that's real or if it's just fed market manipulation. Personally, I have a hard time imagining the government allowing such deflation (the FDIC would probably have to declare bankruptcy, especially with the new $250,000 commitment, which puts their commi). But then, I'm surprised Bernanke has kept his hands off the printing presses so long.
If everyone went to the bank today and demanded all their FDIC insured deposits in cash, how many trillion dollars would the government have to print? There's no way out of this besides inflation or default. The uncertainty is which one is going to happen first.
Published: December 6, 2008 10:20 PM
Bruce Koerber
The FED will save the world economy!
The FED has moved on! It is not interested in saving the world economy. It is interested in driving everyone into a frenzy so a new world fiat currency can be proposed and coercively instituted.
The FED, just like the U.S. Presidency, is a tool of the unConstitutional coup that has its eyes on the prize - worldwide monetary hegemony with no competing currencies!
Look how far we are away from that goal. The only way to get there is by destroying the dollar and then destroying all dissenting nations! Who on this planet is safe from the horrible consequences of their plan? Total impoverishment of all, the rich and the poor. Total fear-driven warmongering to justify the wars needed to secure vital resources and to topple rogue nations.
What insanity! First of all there is no way the Chinese will ever surrender to these imperialistic designs and there is no way a U.S. controlled alliance of any kind could ever conquer China.
We need to stop the usurpers of our Constitutional Republic and bring back sanity and enable America to fulfill its destiny. America's destiny is to be an example of a classical liberalism society for other nations to emulate.
Published: December 6, 2008 10:29 PM
GH
"There's no way out of this besides inflation or default. The uncertainty is which one is going to happen first."
I agree. I just don't understand how default leads to deflation...
Published: December 7, 2008 10:47 AM
Sigmund
Confidence and the rights of property are issues of concern. The cause of the decline and uncertainty at hand is the money supply. The dollar has become a reserve currency because Saudi Arabia/OPEC agreed to price it in dollars. Concurrently, the US went off the gold/silver standard. The dollar, and every other currency, are fiat currencies. A curosity, how do you debase a fiat currency? As a consequence, a dollar is only worth what it will buy. If you hold a dollar beyond the needs of your budget, your rational choice is to either spend it, or invest/speculate with it. A fiat currency motivates toward consumption. A law that promotes the purchase of housing by individuals whose income will not support the purchase of a home leads to fraud and mortgage defaults. Not understanding what you signed is an excuse that is an indictment of our educational system and our moral values. The Treasury and the Federal Reserve do not have a good way out in their efforts to forestall a deep global depression. The future looks like hyper inflation, the real question is; How does the body politic protect itself?
Published: December 7, 2008 10:52 AM
Inquisitor
Kakugo, is that guy pro-free markets at least? He isn't just blaming greedy speculators is he?
Published: December 7, 2008 12:26 PM
Peter Medway
The Rule Of Law, which is partly discussed here in terms of Government actions regarding investments, is an Economic Resource which, like other Resources may be mined and depleted. The past decades have seen a mining and depletion of the Rule Of Law. How much of the Rule Of Law Resource remains? Or, possibly, how much can be depleted before a critical point of no return is reached?
This, to me, is at the crux of the misnamed Credit Crunch. What we have really is a Trust Crunch. No one wants to invest/lend because the Trust System, governed by the Rule Of Law, has collapsed.
All of the above should be obvious to any analyst objectively examining the US Economic and Political Systems. The critical question now is: How will Trust (The Rule Of Law) be restored and MAINTAINED in a recovered economic system?
I see no indications in any of the appointments, actions by the incoming Regime that it intends to restore the Rule of Law.
Published: December 7, 2008 2:28 PM
AME
The fact that the state has bailed out creditors surely sends them the message that their risks are underwritten. Had the state taken the wiser course and done nothing, property rights would have been more certain, albeit they would have been rights in insolvent businesses.
Published: December 7, 2008 3:55 PM
fundamentalist
This is an extremely important concept. Coupled with the principle that the demand for goods does not equal the demand for labor, it becomes even more important. Capitalists demand labor, not consumers. Aggregate demand has little to do with employment. If capitalists have to worry about the fate of their investments, part of which is the demand for labor, they won’t invest and labor will suffer.
Published: December 8, 2008 9:46 AM
Anthony
"I just don't understand how default leads to deflation..."
Specifically I was talking about the default of the FDIC, which surely would cause a run on every single bank in the country. If everyone pulled all their money out of the banks, M2 would equal M1 would equal M0. Surely that would be deflationary.
Published: December 8, 2008 11:23 PM