Saturday, January 5, 2013

Markets Vanish - "In a Flash"

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

          The same title cheered in the new years of 2011 and 2012 ("Markets Vanish - "In a Flash"," January 4, 2011 and January 8, 2012). These warnings described how quickly, and with no foresight by participants, markets evaporated in 1914. In 2013, markets have never been more susceptible to such a bolt of recognition. This is a consequence of such imperturbable faith in the prices set by besotted bureaucrats. What follows is a quick look at the nasty, brutish, and short results from government manipulations after such policy failures.

            There are few failures that compete with World War I. Having failed, the same bumblers garnered fame by subjecting their own populations to conquest. Whether it was the patriotic call to the trenches or confiscation of securities, there is no question those who had failed worst made out best.

            The British and the French governments were short of money to pay for supplies by 1915. Note: this was still a world in which non-redeemable, government, money-printing operations would not pass muster. If a hard-up, food- and munitions-famished government attempted to print pounds or francs for goods, the boat from London to New York would have made a round-trip after the counterfeit fodder had been sequestered and burned at the Customs House on Bowling Green. The customs officials would no doubt have been acting in good faith, an attempt to suppress the embarrassment due the British or French governments in the belief that some lunatic, war criminal had attempted to pass bad notes.

Instead, force majeure was employed. The following description by Harold Nicholson goes beyond the specific point addressed here (underlined) since the nearly insurmountable problem of those governments is unfamiliar in an age of quantitative easing. Yet we are approaching the point (yep, any day now baby, just you wait) when worthless Bernankes, Draghis, and Abes will call for just such a calculus: "[W]hereas American exports to Great Britain alone had in 1914 been $594,271,863, they increased in 1917 to $2,046,812,678. This enormous expansion in the American trade export trade was due, of course, to the European demand for more war material and food. Such purchases could no longer be paid for in goods and services; only a small proportion could be liquidated in gold; the purchases for 1915 alone were some $700,000,000 in excess of gold capacity; the balance had to be financed by credit. How could such vast credits be obtained? Three separate systems were adopted. The first was the export of gold; a billion dollars of gold were transferred to the United States between 1914 and 1917. The second method was to commandeer the American securities held by British and French nationals. This method was first put into operation in January 1916, and in the end provided the British government with the collateral of $2,425,000,000 and the French government with the collateral of $51,000,000. The third method was just confidence." J.P. Morgan acted as agent to the British and French governments.

To imagine governments would take such action demanded the mind of a Houdini in 1914, even after markets had vanished in late-July. In the United States, a country without an income tax in 1912, and a continent away from the fighting, a 77% surtax on incomes was imposed after Americans embarked on its holy mission to save European from itself. President Wilson told the leaders of the Federal Council on Churches: "[Y]ou have got to save society in this world, not in the next.... We have got to save society, so far as it is saved, by the instrumentality of Christianity in this world." Wilson went on to compare Christianity to the highest form of patriotism since they were both "the devotion of the spirit to something greater and nobler than itself."
This was in December 1915. In 1916, Woodrow Wilson was reelected to a second term as president with an appealing campaign slogan: "We didn't go to war." During the presidential campaign, he wrote to his Secretary of the Navy: "I can't keep the country out of the war." Nor, did he.

Having abused trust with the American people under the banner of a holy crusade, the Wilson administration took measures inconceivable before 1914. This is the lesson to be contemplated in 2013. We have two Holy Crusaders, one at the Fed and one in the White House, both of whom (this is where it gets very dangerous) view humanity in the abstract and who preach in the dreadful certainty of the former Princeton College president (that would be Wilson).

After the U.S. declared war on European Sin (May 6, 1917), Wilson refined his impersonation of American Gothic: "Woe be the man that seeks to stand in our way in this day of high resolution when every principle we hold dearest is to be vindicated and made secure." A Rip Van Winkle who had been asleep since 1914 may have wondered if the "we" included a mouse in the parson's pocket. George Santayana expressed doubts about such blending of the material with the spiritual. Wilson and his fellow travelers were "fanatics, who redoubled their efforts after losing all sense of aim." Santayana had left his teaching position at Harvard in 1912, sailed to Europe, never to return, but bequeathed a compelling indictment of American letters, especially the poisonous, pious, and inert influence of Harvard upon American consciousness, as true today as a century ago, and just as stubbornly ignored.

One sample of World War I financial mischief was the Liberty Bond. The first of these offerings (in 1917) was a $2 billion issue, over ten times the size of any previous effort. Given the scale, was a 3-1/2% coupon inadequate compensation? Not by any means. Americans would buy them whether they wanted to or not, (and who would?) Charles G. Dawes, chairman of the Liberty Loan Drive, declared: "Anybody who declines to subscribe for that reason, knock him down."

This captures the spirit of U.S. economic policy ever since. In the Holy Quest for GDP Growth, post-millennial economic policy has unerringly chosen to "knock him down." The Greenspan Fed sustained an overextended economy with the Internet bubble. Those who played it to the end got knocked down. Greenspan fanned the housing bubble, handed the baton to Bernanke, who battered credulous mortgage-buying Americans back to the stone age.

The 3-1/2% Dawes bond yields look gargantuan given today's investment alternatives. This is not so much a question of yield as it is of quality. First and foremost, money is not what it was. Most of what is considered money today is a claim on a non-existent asset. This is a far deeper problem than when the British and French governments ran out of real money during World War I. (They both abandoned the gold standard, with consequences beyond today's discussion.) Given how easily governments bullied and confiscated private citizens' property a century ago - a far more civilized period than today - and the flagrant lawlessness of Financial Repression today, the commandeering securities can be accomplished in an instant of double-talk.