Page 4 of 6 THE SHAPE OF US POPULISM, Part 5 Rubin's poisoned chalice
By Henry C K Liu
universally opposed by the arms industry as ineffective and only resulting in
smuggling.
The Nye investigation did reveal that Du Pont’s plant near Nashville had
grossed a profit of 40,000% on its capital, soliciting a response from Pierre
DuPont that since his company was selling explosive technology rather than a
commodity (gunpowder) to the government, looking at return on capital was
misleading. Microsoft uses essentially the same rationalization on
spectacular profits derived from intellectual property a century later, as does
the drug industry.
With predatory acquisition and financial manipulation, GM overnight became the
biggest automaker in the world and the most spectacular moneymaker of the
1920s. GM was in the business of making money and the fact that it did so
through auto manufacturing was only incidental. Ford’s paternalistic management
style was no match for the organizational approach of GM. Anyone who invested
$25,000 in GM in 1921 was a millionaire by 1929. Durant became one of the
richest men in the country. By 1928, 24.5 million cars had been produced,
employing 4 million workers, about 10% of the workforce, while Federal and
state governments spent over $1 billion a year to build roads for them, with
the effect of greatly increasing land value in the new "suburban" bedroom
towns.
Other industries also experienced unprecedented growth, the most spectacular
being the rapid increase in electricity production, which increased from 7.5
billion horsepower to 44 billion, a 600% increase from 1912 to 1930. Aviation
was another technological triumph. The Wright brothers made their first flight
in December 1903 and Charles Lindbergh flew the Spirit of St Louis in a
historic first cross-Atlantic flight from NY to Paris in 1927. The age of coal
and steam was being replaced by the age of oil and electricity, a change that
historians labeled the Second Industrial Revolution. A wave of unimpeded
optimism swept the whole nation.
Income unfairly distributed
Unfortunately, a serious weakness in the economic system was the inability of
the free market to distribute income fairly to sustain the consumption needed
for absorbing the increased production. With each passing decade since the
Civil War, corporatism had achieved increased dominance in the US economy and a
greater share of its new wealth. In 1929, out of 460,000 corporations, 1,350
had annual income in excess of $1 million, earning 80% of all corporate
profits. Half of the corporate wealth and 25% of the national wealth were
concentrated in 200 firms. Gigantism was in full bloom under a general rule of
grow or die. Many did die so that a few might become giants who kept most of
the wealth for their shareholders.
Though wages did rise enough to check the growth of unionism, wages rose at
half the rate of productivity all though the 1920s. Wages in the decade rose
33%, management salaries rose 42%, corporate profits rose 76% and stockholder
dividends rose 108%. Pension funds were not significant investors until after
the New Deal strengthened worker pensions, thus dividend income in the 1920s
went mostly to the rich. Wage earners were receiving a smaller share of
national income. Half of the farming families had annual income below $1,000,
less than $3 a day, less than what low-wage workers in Asia receive today under
globalization.
Too much money was going to the rich elite, who invested their savings in more
productive capacity, and too little money was going to wage earners whose
spending was needed to balance supply with demand. Overcapacity then was
handled with a sharp rise in consumer debt and by encouraging speculative gains
on all levels. But debt addiction required more debt until the debt bubble rose
beyond the ability of income to carry. When the speculation bubble burst, the
excessive outstanding debt faced default through the decline of the market
value of collateral. The broad interconnection of debt obligations caused a
systemic collapse and the Great Depression began. Fundamentally, the debt
crisis of 2007 had similar causes.
GM shares fell sharply as the stock market began to stall in April 1929. Durant
could have stood on the sideline to wait for the recovery. Instead, he was
forced by high leverage to try to protect his investors and employees by
attempting in vain to support GM share prices, buying in the open market with
full use of margins with limited backing from the Rockefeller interests.
By October, GM's share price had fallen by two-thirds of its previous April
price of $42 to $14, a fraction of its peak price of $210 in 1926. On November
16, Durant barely managed to meet a new margin call for another $150,000 when
the Rockefellers cut off further support. Two days later, when the GM share
price fell by another 50 cents, Durant failed to meet a new margin call and
lost control of his 3 million shares of GM stock to JP Morgan and the Du Ponts.
Unlike top executives of failed firms in 2008, who left in disgrace and still
managed to leave with tens of millions of dollars of company money in severance
pay, in 1929, one of the world's 10 richest men went bankrupt at age 68 and
spent the rest of his days with a small stipend from GM, managing a bowling
alley in Flint, Michigan for another 18 years until he died at age 86 in 1947.
Those who insist that 2008 is not like 1929 have a point. The other difference
is that in 1929, the loss was not borne by pension funds, which were largely
created by the New Deal, unlike 2008 when pension funds have lost untold
billions on supposedly no-risk AAA-rated investments.
Cutting production to maintain prices
Instead of cutting prices to maintain production, the financial establishment
in the 1930s opted for maintaining prices through price fixing by cutting
production volume, which caused fixed cost per unit to increase and
unemployment to rise and aggregate wage income to fall further in a downward
spiral. Another cause of the 1930s depression was the economy's excessive
dependence on the sale of luxury and capital goods, rather than on basic
necessities. In bad times, such discretionary luxury sales dropped
precipitously and caused the economy to stall. These conditions are similar to
those in 2008.
Material economic factors were not the only causes for the Great Depression.
The speculative frenzy had pushed the economy into overdrive and the bursting
of the speculative bubble left investors with more than just losses. It wiped
out all optimism as well as savings. Confidence in the market and the economic
system vanished in a matter of days and capitalism was left without its key
source of energy. Loss of confidence is the major cause of a liquidity trap, a
situation in which preference for cash overrides all other market decisions.
Friedman's counterfactual conclusion
Milton Friedman in his study of the 1929 crash and the subsequent depression (Monetary
History of the United States, 1963) concluded that if only the Fed had
provided adequate liquidity the stock market crash would have recovered to
avoid the depression. Friedman concentrated his focus on the curative effect of
monetary policy on recessions and did not have much to say about the preventive
role of monetary policy on debt bubbles except that inflation is a monetary
phenomenon. Friedman did not have much to say about debt and bubbles.
Friedman accepted the technical definition of inflation as measured, if not
caused, by rising wages. He held out hope that a monetary policy focused
exclusively on price stability could moderate if not eliminate the business
cycle, or at least moderate the severity of the bursting of a debt-pushed
economic bubble without hampering the boom. His monetarist dogma gave support
to the flawed central bank doctrine of measuring inflation by the rate of
increase of wages and consumer prices while detaching inflation from asset
price increases, which central banks welcomed as desirable "wealth effect".
This permitted the debt bubble and masked the problem of earned income
deficiency for servicing the outstanding debt.
Friedman's counterfactual claim of a liquidity magic-wand solution for the
Great Depression was merely academic speculation, since in 1929 the Fed could
not legally print money without increasing its gold holdings, set at $30 per
ounce by the Gold Standard Act of 1900. The act specified that the dollar
should consist of twenty-five and eight-tenths grains of gold nine-tenths fine,
as established by Section 3511 of the Revised Statutes of the United States,
shall be the standard unit of value, and all forms of money issued or coined by
the United States shall be maintained at a parity of value with this standard,
and it shall be the duty of the Secretary of the Treasury to maintain such
parity. Friedman was advocating the abandonment of the Gold Standard, a
position long held by populists.
The October 19, 1987 Black Monday market crash, when the Dow Jones Industrial
Average fell 22.9% in one day from the effects of portfolio insurance and
program trading, saw the largest one-day decline since 1914, and was more
severe than Black Monday, October 28, 1929, when the DJIA dropped 11.7%.
On Black Monday 1987, Alan Greenspan, newly appointed as chairman of the Fed
that year by president Reagan, bought Friedman's liquidity fallacy wholesale.
He issued a one-sentence statement at 8:41 a.m. on Tuesday, October 20, 49
minutes before the markets opened at 9:30 am:
The Federal Reserve,
consistent with its responsibilities as the nation's central bank, affirmed
today its readiness to serve as a source of liquidity to support the economic
and financial system.
Greenspan, free from the gold standard
that constrained the Fed in 1929, proceeded to use the Fed's now unlimited
power to create fiat money to offset the losses in the 1987 crash to keep the
market from seizure, with E Gerald Corrigan, president of the New York Federal
Reserve Bank, which normally transacted more than $1 trillion in the money
market each day, strong-arming all the major banks not to withhold payments for
fear of counterparty default.
This posture of the Fed saved the market but started a dangerous trend of moral
hazard in subsequent economic slowdowns. The Fed has since provided endless
liquidity to finance consecutive debt bubbles and their subsequent collapses:
1987 (23% drop, recovered in nine months), 1998 (36% drop, recovered in three
months) and 2002 (37% drop, recovered in two months), each time leading to a
bigger debt bubble.
After 18 years of debasing the dollar with excess liquidity, the Greenspan
approach ultimately landed the debt-infested global economy in its current
disastrous state of collapsing asset prices denominated in rapidly depreciating
money, causing a financial meltdown that additional liquidity of increasingly
worthless money can no longer hold up. Worse yet, spiraling prices in food and
energy, exempted by the Fed from its core inflation index, while
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
