Agreeing and Disagreeing with Kindleberger (and Delong and Eichengreen)

This post is basically to point to the new preface by Brad DeLong and Barry Eichengreen to Kindleberger's The World In Depression 1929-1939. I'm glad the book is being reprinted, and I am in agreement with all of DeLong & Eichengreen's intro. Except this part:

Kindleberger’s second key lesson, closely related, is the power of contagion. At the centre of The World in Depression is the 1931 financial crisis, arguably the event that turned an already serious recession into the most severe downturn and economic catastrophe of the 20th century. The 1931 crisis began, as Kindleberger observes, in a relatively minor European financial centre, Vienna, but when left untreated leapfrogged first to Berlin and then, with even graver consequences, to London and New York. This is the 20th century’s most dramatic reminder of quickly how financial crises can metastasise almost instantaneously.

I don't think this is "arguable". First things first... Creditanstalt was decidedly not a "relatively minor" institution; as Ben Bernanke has noted it was one of the largest (and most well-connected) banks in Europe. Moreover, it wasn't the first major bank to fail. To give just one example, the Bank of the United States (a private bank located in New York) failed in December, 1930 -- one of the largest bank failures in U.S. history, which occurred months before the collapse of Creditanstalt. Indeed, in his monetary history of the U.S. Milton Friedman considered the collapse of the Bank of the U.S. as the pivotal moment that tipped the U.S. from recession into depression. In general, financial instability in the U.S. seemed to precede financial instability in Europe from 1929 on.

The U.S. and much of Europe was already in depression before the collapse of Creditanstalt. Indeed, chronology suggests that Delong & Eichengreen have causality reversed: the Depression (combined with the fallout from losing WWI, including reparations) caused the collapse of Creditanstalt, not the other way around. U.S. industrial production had fallen by nearly 25% before Creditanstalt's collapse. Farms prices were down by 40%. The financial system was decimated. Trade was collapsing. The signal events occurred in 1929, not 1931. By the latter date we are talking about knock-on effects, not first causes.

My view is not particularly controversial. The collapse of Creditanstalt exacerbated a pre-existing panic, but it did not generate one sui generis.

Contagion is powerful, but it tends to operate from the center outward rather than from the periphery inward.* The best read of the collapse of Creditanstalt is that it was evidence of contagion rather than the epicenter of it.

That said, Kindleberger's book is very good in general, as is the new Delong/Eichengreen intro.

*We've blogged about this before, and we have a piece that will hopefully be forthcoming soon that makes this case explicitly. For a simplistic precis see this Foreign Policy piece that Thomas and I recently placed.

P.S. While thinking about this I stumbled across this piece from a 1952 issue of Time which gets nearly every detail wrong in its first paragraph. For starters: Creditanstalt collapsed in 1931, not 1929; it was not controlled by the Rothschilds until after that collapse; Hitler persecuted the bank during Anschluss for that reason, so it not quite fair to say that the bank "served" Hitler. The rest of the article is blocked to nonsubscribers so I (mercifully) can't read it.

The World's Central Banker, Yet Again

Tyler Cowen summons his inner Kindleberger and gets pessimistic:

We are realizing just how much international economic order depends on the role of a dominant country — sometimes known as a hegemon — that sets clear rules and accepts some responsibility for the consequences. For historical reasons, Germany isn’t up to playing the role formerly held by Britain and, to some extent, still held today by the United States. (But when it comes to the euro zone, the United States is on the sidelines.)

It depends on what he means by "on the sidelines". The US Congress is certainly not doing anything about Europe. Short of a Marshall Plan for the GIPSIs I'm not sure what they could do, and there's no way that's happening. But that doesn't mean that the US government as a whole is showing no hegemonic leadership. I've written a number of posts arguing that Bernanke has been acting as the world's central banker during the crisis -- opening swap lines with every major central bank in the world, extending liquidity financing to foreign firms, not provoking currency wars that lead to competitive devaluations, etc. -- and that this has stabilized the core of the global financial system.

I'm not going to re-write all those posts here, but please click through and read them. The Fed has been engaged in hegemonic leadership, and has done pretty well so far. Its job is not to put out every fire everywhere; its job is to keep the center of the system intact. So far, at least, its actions have been sufficient.

Note that in the op-ed Cowen more than once sounds a lot like an IPE scholar who has read no IPE literature. That is, he's asking the right questions but fumbles for answers to them. I have other things to write about the piece, but I'm going to break them up into pieces over the next day or two. Consider this a teaser.

Bernanke, Not Borg

Krugman has a good NYT Magazine article on Bernanke. They have an interesting personal history -- as Chair of the Econ department at Princeton, Bernanke hired Krugman (over some opposition I believe) -- and also an interesting intellectual history -- they were both working on the Japan deflation in the late-1990s, with Krugman concluding that Old Keynesianism was still relevant because of its emphasis on the liquidity trap, while Bernanke concluded that the Bank of Japan was merely timid, not impotent.

In the article Krugman argues that Chairman Bernanke has not followed the advice of Professor Bernanke. He offers three possible explanations for this.

The Bernanke Conundrum — the divergence between what Professor Bernanke advocated and what Chairman Bernanke has actually done — can be reconciled in a few possible ways. Maybe Professor Bernanke was wrong, and there’s nothing more a policy maker in this situation can do. Maybe politics are the impediment, and Chairman Bernanke has been forced to hide his inner professor. Or maybe the onetime academic has been assimilated by the Fed Borg and turned into a conventional central banker.

The Ludlum-esque title is unnecessary, as the addition to the pile of "Krugman's Mystical Creatures" (confidence fairy, bond market vigilantes, etc.), but I believe Krugman's framing is correct and I think the second explanation makes the most sense: Bernanke is politically constrained (see here). So naturally Krugman concludes that Bernanke's been assimilated into the Borg, thus continuing our long-running streak of disagreeing on almost everything.

Today Krugman finds support for the Borg view in these words from Bernanke:

We have, uh, we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable, in that we’ve been able to take strong accommodative actions in the last four or five years to support the economy without leading to a, [indiscernible] expectations or destabilization of inflation. To risk that asset, for, what I think would be quite tentative and, uh, perhaps doubtful gains, on the real side would be an unwise thing to do.

In some ways Krugman's selection of Bernanke's comments are a bit disingenuous -- Bernanke starts by pointing out that the U.S. in 2010-12 is very different from Japan in the late-1990s, particularly since one was suffering from deflation and a recession while the other just has unemployment a few percentage points higher than it would like -- but more problematic is his interpretation of them. When Bernanke starts talking about the "credibility" of the Fed there is no a priori reason to think that he's only talking about credibility with markets. He's also talking about credibility with Congress, and in particular a Congress that is incredibly hawkish on inflation lately* and routinely threatens Bernanke in a number of ways.

The Fed likes its authority. It wants to keep it. It likes it's "independence". Ironically, it will only keep it if it does what Congress wants it to do (i.e. "There is no technocracy" + "There is no central bank independence"... common themes around here). That means not throwing away its credibility for inflation-control in pursuit of dropping the unemployment rate by a point or two. Note that this is also why Bernanke would like to see more fiscal stimulus: that would effectively prevent Bernanke from having to make a difficult choice. But if he's forced to make that choice, he'll the choose the path that doesn't jeopardize his authority.

Note: after I wrote the above, but before publishing it, I came across this excellent post by Greg Ip. Highlights:

This means, judging from the projections, that 13 of the FOMC’s 17 members want to tighten sooner than he does, and none want to tighten later. ...

The second problem is that even if Mr Bernanke’s views prevail while he remains chairman, the odds are that he no longer will be after January, 2014. He is unlikely to be reappointed even if Barack Obama is re-elected (even if wanted the job, a big if, he probably couldn’t be confirmed), and certain not to be if Mitt Romney wins.

But all that's irrelevant. Instead, Bernanke's been captured by the Borg.

*Some of the reasons for that may be found in this excellent post by Steve Randy Waldman. I hope to have more to say about it soon, but for now it's worth reading that one in its entirety. The takeaway is that the coalition of political interests that would be harmed by higher inflation is much larger (and much more politically active) than the coalition that would benefit from it.

Craziest Thing I Read Today

Matt Yglesias, who usually is not crazy:

Ben Bernanke isn’t the most important central banker in the world. Jean-Claude Trichet is. 

That's... crazy. Europe is certainly important, but the dollar is still the world's reserve currency, and Bernanke manages it. Plus, the Fed is responsible for overseeing the US financial system, which is central to the global financial system in a way no European countries are, separately or taken together. Additionally, the ECB isn't (technically, legally) supposed to have all that much to do with the European financial system; regulatory authority still resides with national governments. Trichet faces constraints that Bernanke doesn't face, which limits his influence, but even if that weren't true he'd be less important.

To illustrate: During the crisis, the Fed routinely provided liquidity support for foreign firms, most of which were in Europe. Has the ECB done anything similar for US firms? During the crisis the Fed opened up swap lines with every major central bank in the world. Did the ECB do anything similar? Not outside of the eurozone, as far as I can tell.

(Side note: Yglesias notes that the EU is a larger economy than the US. Which is true. But Trichet only controls monetary policy in the eurozone, not the entire EU, and eurozone GDP is roughly 75% of US GDP.)

Strange Bedfellows

McMegan passes along this tasty tidbit:

Jay Cost of Real Clear Politics tweets that the Senate just voted for cloture on Ben Bernanke's confirmation, 77-23. Immediately thereafter came the tweet from Jim DeMint: "By confirming Bernanke, the Senate rubber-stamped a failed economic policy."

That's right, Senator DeMint (R-SC); the Senate just rubber-stamped George W. Bush's failed economic policy. Would you be happier if Barack "Sgt. Socialist" Obama replaced Bernanke -- a conservative Republican (like you) who was nominated by a conservative Republican (like you) and confirmed by a Republican Senate (including you) -- with a Keynesian? Would you rather have Paul Krugman as Fed chairman, as Simon Johnson proposed? Doesn't it give you pause that you and Bernie Sanders voted the same way on this confirmation? At least Sanders was voting out of conviction rather than misdirected partisanship.

Bernanke is one of the foremost scholars on financial crises and how to get out of them, and he's performed as well as could be expected under the circumstances since Sept., 2008. Regardless of what led to the situation we're now in, he's the right guy for the job right now, and I'm very happy he was reconfirmed.

Bernanke Update

Fed Chairman Ben Bernanke just cleared a major hurdle a few minutes ago when the Senate voted 77-23 to end debate (cloture vote) on his reappointment. This means that there should be a final up or down vote coming sometime this afternoon/evening. I'll throw up the final vote tally when it becomes available.

UPDATE (4:24pm): Ben Bernanke has been confirmed by the US Senate 70-30.

Interesting fact: Bernanke received more “no” votes than any nominee for Fed chairman since Paul Volcker was confirmed to a second term by a vote of 84 to 16 in 1983.

Shock and Awe

Reading the news feeds, one can't help but wonder if governments know what the heck they're doing.  New three-point plans, rate cuts, and proposals are exploding onto the scene like the finale in a fireworks display, often to no avail at stemming the depressing tail-spin of global equity markets.  Now, we have a whole lot of smart people working on a whole lot of stop gap solutions, and a very capable Bernanke using his knowledge of the Great Depression to try to make sure monetary policy doesn't make things worse.

Still, it seems through all the noise, the policy makers are missing the core problem - you can cut interest rates and provide increased government funds for short-term lending all you want, but banks still are simply not lending to one another.  Robert Pozen of MSF Investments has an opinion piece in the Wall Street Journal today calling for governments to guarantee short-term interbank lending.  This, in turn, will provide the time and space for the Economic Stabilization Act to generate more liquidity through the absorption of toxic debt.

It's clear from the increased international cooperation that governments understand and are willing to act (to varying extents) in concert to avoid the worst of the worst scenarios of deep and protracted global depression.  But, willingness to act is not enough.  Let's hope that global leaders are willing to cut through the noise and the panic to enact the correct combination of stop-gap and systemic measures to limit the damages and strengthen global credit and equity markets for the long term.