Recently Michael Hirsh interviewed monetary historian Anna Schwartz for Newsweek. She doesn’t sound happy at all about the state of monetary policy in the face of the financial crisis. Excerpts:
Anna Schwartz is 93 and has been working at the same place since 1941. She’s that rarity in economics, or indeed any field: a living legend from another era who hasn’t lost a step mentally and who grasps everything that’s going on around her in the present. Or at least she seems to—but more on that later. Schwartz is one of the most renowned monetary scholars in the world. She’s the woman who authored, with Milton Friedman, The Monetary History of the United States—the book that launched the free-market counterattack against Keynesianism in the early ’60s. And now, as she surveys the wreckage of the last two years, Schwartz has one thought: if only Milton were here. “Ever since his death I have lamented the fact that he has not been around to express his views on what’s going on,” she told me the other day at her mid-Manhattan office at the National Bureau of Economic Research.
Despite constant criticism of the Obama administration and the Federal Reserve over their handling of the financial crisis, opponents of their policies don’t have a leader—especially on the right. Their problem is “the big lack of a voice like Friedman’s, someone who’s got instinctive understanding of the way markets operate, a very profound knowledge of history,” Schwartz told me. Had Friedman been around to speak out (he died in 2006), “I don’t believe we would have had a Fed balance sheet currently that has doubled, or tripled, in such a short period of time without any kind of Fed acknowledgment that it was creating a problem for itself [with] inflation already baked into the economy.”
Slamming the Fed, of course, is old hat for Schwartz and her alter ego, Friedman. They concluded in Monetary History that had the Federal Reserve not existed, the Great Depression might never have happened. Their argument: the Fed bungled things by tightening money from 1929 to 1932, something the New York bankers who used to be in charge of resolving crises would never have done. But Schwartz says that Friedman—who along with John Maynard Keynes, his polar opposite in thought, was the 20th century’s most influential economist—would be just as disturbed by what Barack Obama is doing today. “Obama nowadays is the typical believer that government can do everything. So he’s going to change the way electricity is produced in this country. He’s going to change the way energy is going to be produced in this country. And it’s all going to be a government effort. And Friedman would say, ‘Look, if these really are such desirable things, why isn’t it that the private sector has taken advantage of an opportunity to make money and to improve things?’ ”
Schwartz is more than a prominent voice for free markets; she is a breathing intellectual link to the Depression and its lessons. All of modern economics—and every major debate currently raging over the financial crisis—dates back to the 1930s. All the policy options we now discuss without even thinking about them—deficit spending, monetary policy, the role of the Fed, government intervention in general—spring out of what economists learned from that period. It was thanks to the Depression that Keynes created macroeconomics. It was in response to the Depression, and his finding that the Fed dramatically deepened it by tightening money supply, that Friedman developed his theory of monetarism, rebutting Keynes. (Monetarism holds that the money supply is the primary driver of prosperity and recession, and that Keynesian fiscal spending doesn’t work. Government should therefore stay out of the way, other than to adjust the money supply.) And it was because of the Depression that Bernanke, another renowned scholar who studied its causes, expanded the Fed’s lending by more than $2 trillion, angering Anna Schwartz.
Schwartz’s criticism is unpleasant to hear for Bernanke, who has long admired both her and Friedman. He has said that reading Monetary History “hooked” him on monetary economics when he was an MIT student. Against her arguments now, Bernanke has one main counterargument, and it’s a pretty good one: if he hadn’t done what he did, we would be in another depression. The banking and financial system would have melted down; ironically enough, the near meltdown that occurred after the collapse of Lehman Brothers last September, which Bernanke was criticized for, is the best proof of that. Bernanke knows more about this than perhaps anyone in the world; the academic work for which he was most noted showed that a serious recession became the Great Depression when, in the critical three and a half years between the 1929 stock-market crash and FDR’s New Deal, the Hoover administration allowed a third of the nation’s banks to go under. As a result, Bernanke and Friedman/Schwartz are now considered the leading theorists of the Depression. Indeed, in a touching and generous gesture—considering the importance of his own work showing that bank failures were mainly responsible—Bernanke turned to the aging Friedman at a 90th-birthday celebration in 2002 and told him and Schwartz, who was there, “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we [the Fed] did it. We’re very sorry. But thanks to you, we won’t do it again.”
He’s made sure of that, by flooding the system with liquidity. The effect of Bernanke’s actions has been to increase the money supply, which is what you might think Milton Friedman would have wanted. But Schwartz still believes that, as she told The Wall Street Journal last fall, Bernanke is fighting the last war. Yes, he’s studiously taken the opposite course from what the Fed did in the early 1930s. But she maintains that the current crisis is less a liquidity problem and more a crisis of confidence because of the market’s doubts about the toxic assets on banks’ balance sheets. “What disturbed me particularly about Bernanke’s performance was the insistence on bailouts,” said Schwartz in a flood of passion. […] I think that’s a real failure. I think the Fed or the government has no business bailing out a firm that is not solvent.”
It may be time for modern economics, created around the Great Depression, to reinvent itself. New ideas are needed. It’s a debate that Ben Bernanke would no doubt love to have with Milton Friedman, were the great man still around.
Here is the WSJ article by Brian M. Carney mentioned in Newsweek, published in October. Some highlights:
Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She’s not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, “A Monetary History of the United States” (1963). It’s the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.
Since 1941, Ms. Schwartz has reported for work at the National Bureau of Economic Research in New York, where we met Thursday morning for an interview. She is currently using a wheelchair after a recent fall and laments her “many infirmities,” but those are all physical; her mind is as sharp as ever. She speaks with passion and just a hint of resignation about the current financial situation. And looking at how the authorities have handled it so far, she doesn’t like what she sees.
Federal Reserve Chairman Ben Bernanke has called the 888-page “Monetary History” “the leading and most persuasive explanation of the worst economic disaster in American history.” Ms. Schwartz thinks that our central bankers and our Treasury Department are getting it wrong again.
even though the Fed has flooded the credit markets with cash, spreads haven’t budged because banks don’t know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is “the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue.”
In the 1930s, as Ms. Schwartz and Mr. Friedman argued in “A Monetary History,” the country and the Federal Reserve were faced with a liquidity crisis in the banking sector. As banks failed, depositors became alarmed that they’d lose their money if their bank, too, failed. So bank runs began, and these became self-reinforcing: “If the borrowers hadn’t withdrawn cash, they [the banks] would have been in good shape. But the Fed just sat by and did nothing, so bank after bank failed. And that only motivated depositors to withdraw funds from banks that were not in distress,” deepening the crisis and causing still more failures.
But “that’s not what’s going on in the market now,” Ms. Schwartz says. Today, the banks have a problem on the asset side of their ledgers — “all these exotic securities that the market does not know how to value.”
…”firms that made wrong decisions should fail,” she says bluntly. “You shouldn’t rescue them. And once that’s established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich.” The trouble is, “that’s not the way the world has been going in recent years.”
How did we get into this mess in the first place? As in the 1920s, the current “disturbance” started with a “mania.” But manias always have a cause. “If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.
“The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses.”
The house-price boom began with the very low interest rates in the early years of this decade under former Fed Chairman Alan Greenspan.
“Now, Alan Greenspan has issued an epilogue to his memoir, ‘Time of Turbulence,’ and it’s about what’s going on in the credit market,” Ms. Schwartz says. “And he says, ‘Well, it’s true that monetary policy was expansive. But there was nothing that a central bank could do in those circumstances. The market would have been very much displeased, if the Fed had tightened and crushed the boom. They would have felt that it wasn’t just the boom in the assets that was being terminated.'” In other words, Mr. Greenspan “absolves himself. There was no way you could really terminate the boom because you’d be doing collateral damage to areas of the economy that you don’t really want to damage.”
Ms Schwartz adds, gently, “I don’t think that that’s an adequate kind of response to those who argue that absent accommodative monetary policy, you would not have had this asset-price boom.” Policies based on such thinking only lead to a more damaging bust when the mania ends, as they all do. “In general, it’s easier for a central bank to be accommodative, to be loose, to be promoting conditions that make everybody feel that things are going well.”
Fed Chairman Ben Bernanke, of all people, should understand this, Ms. Schwartz says. In 2002, Mr. Bernanke, then a Federal Reserve Board governor, said in a speech in honor of Mr. Friedman’s 90th birthday, “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
“This was [his] claim to be worthy of running the Fed,” she says. He was “familiar with history. He knew what had been done.” But perhaps this is actually Mr. Bernanke’s biggest problem. Today’s crisis isn’t a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. “I don’t see that they’ve achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job.”
Found via Greg Mankiw.
Here is an interview by Ambrose Evans-Pritchard in The Telegraph, also with Professor Schwartz. Some excerpts:
Her fame comes from a joint opus with Nobel laureate Milton Friedman: A Monetary History of the United States. It revolutionised thinking on the causes of the Great Depression when published in 1965. The book blamed the Fed for causing the slump. The bank failed to use its full bag of tricks to stop the implosion of the money stock, and turned a bust into calamity by raising rates.
“The book was a bombshell,” says British monetarist Tim Congdon. “Until then almost everybody thought the free-market system itself had failed in the 1930s. What Friedman-Schwartz say was that incompetent government bureaucrats at the Fed had caused the Depression.“
“It had an enormous impact in revitalising free-market conservatism, and it broke the Keynesian stranglehold over policy,” he says. Keynes himself was a formidable monetarist. He became a “Keynesian” big spender only once all else seemed to fail.
Schwartz warns against facile comparisons between today’s world and the Gold Standard era. “This is nothing like the Depression. I don’t really believe the economy as a whole is going to fall apart. Northern Rock has been the only episode of a bank failure so far,” she says.
She is scornful of Greenspan’s campaign to clear his name by blaming the bubble on an Asian saving glut, which purportedly created stimulus beyond the control of the Fed by driving down global bond rates. “This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can’t be blamed on global events,” she says.
That mistake is behind us now. The lesson of the 1930s is that swift action is needed once the credit system starts to implode: when banks hoard money, refusing to pass on funds. The Fed must tear up the rule-book. Yet it has been hesitant for three months, relying on lubricants – not shock therapy.
“Liquidity doesn’t do anything in this situation. It cannot deal with the underlying fear that lots of firms are going bankrupt,” she says. Her view is fast spreading. Goldman Sachs issued a full-recession alert on Wednesday, predicting rates of 2.5 per cent by the third quarter. “Ben Bernanke should be making stronger statements and then backing them up with decisive easing,” says Jan Hatzius, the bank’s US economist.
I will not be posting until next week, since I’m going to SFO. I am more than happy to hear suggestions of things to do.