Failure and Prosperity

0:00Well, it seems like I'm kind of a junkie for financial TV. I watch all the financial channels every chance I get. But what's starting to annoy me is to hear this constant going on about, thank goodness the government stepped in or the world financial system would have collapsed. I mean, I'm afraid we're going to hear this kind of talk go on longer than the war on terror. I mean, if bailouts are questioned at all, the TV talking heads will challenge with, yes, but everyone was just worried in the fall of 2008 whether if they went to their ATM machine, whether any money would come out. And if there had not been any bailout or stimulus, there would have been the depression for sure.

0:49And if we wouldn't have had the wise men and women at the Treasury and the Fed, We'd all be standing in soup lines. We'd be selling apples on street corners. Sheesh, the prices might even plummet. I mean, we'd all be doomed. White House economic director Lawrence Summers said a year ago, deflation is a real risk facing the economy, urging passage of a stimulus bill and taxpayer funds to bailout banks. Summers said that stimulus and bailouts was required for our economic security. So do financial failures and falling prices mean depression and a stagnant economy that Summers and these other people so much fear?

1:42For instance, many historians describe the period after the crash of 1873 to 1896 as a deflationary dark age. John Lupkin in his book, Jay Cook's Gamble, writes that the damage from the Panic of 1873 lasted for five years. And its economic damage was second only to this past century's Great Depression. However, Jim Grant, Grant's interest rate observer writes, You can look far and wide without finding a decade so ebullient, prosperous, and in so many ways, so modern as that as the 1880s. The U.S. economy in the 1880s moved from agriculture to manufacturing, and even at that time, global trade was controversial.

2:39But while prices fell in that decade, the U.S. economy prospered. Industry expanded, the railroads expanded, physical output, net national product, real per capita income all roared ahead. For the decade from 1869 to 1879, the real national product grew 6.8 per year, And the real product per capita was described by Murray Rothbard as phenomenal at four and a half percent per year. The money supply didn't actually contract during this period, but rose 2.6 percent annually. So the period that Wikipedia describes as a severe nationwide economic depression that lasted until 1879 was really a period of prosperity.

3:36This Great Depression was a myth, and as Rothbard explains, a myth brought about by misinterpreting of the fact that prices in general fell sharply during the period. Sure, prices fell by 3.8% per annum, but what's so bad about that? While economists and historians believe that falling prices equal bad times, that's just not true. is not true. Falling prices in the United States mean dollars are worth more. If prices of goods and services are falling, more and more people in all income brackets can enjoy the fruits and the efficiencies of free market capitalism. It is a fact, the definition of prosperity is when people's standard of living improves as goods and services become more affordable.

4:30Rothbard explains that these economists have overlooked the fact that in the natural course of events, when government and the banking system do not increase the money supply very rapidly, free market capitalism will result in an increase in production and economic growth so great that it will swamp the increases in the money supply. Prices will fall and And the consequences will not be depression and stagnation, but prosperity, economic growth, spread of increased living standards to all consumers. All the panic of 1873 did was topple bloated banks and bloated railroads into bankruptcy.

5:19Philadelphia firm Jay Cook & Company was a powerful government bond dealer. Its owner, Jay Cooke, was one of the creators of the national banking system. He also controlled the Northern Pacific Railroad, which had, by the way, benefited from 47 million acres worth of land grants from the federal government in the 1860s. Cooke had sold Northern Pacific bonds by hiring pamphleteers to spin tales alleging that the The climate in the Great Northwest was similar to that in the Mediterranean and had a number of politicians and government officials on his payroll. The mighty House of Cook fell apart in 1873 with the banking firm filing for bankruptcy on September 18th of that year.

6:09But the Panic of 1873 was really a worldwide affair, just like the Panic of 2008. It started with the stock market crash in Vienna, stock market crash then in Berlin, and throughout Europe, and then three months later in New York, the New York warehouse and security company failed, followed by Jay Cooke's firm. Now Jay Cooke was a powerful financier, he was a millionaire many times over, he lived in a 53 room mansion on 200 acres just north of Philadelphia, he entertained presidents, Captains of Industry, and Jay Cooke, if not the nation's largest house, was clearly the most powerful, writes Lupkin.

6:56Decades later, people who knew him would compare him to Jay Pierpoint Morgan, and Cooke was regarded as one of the Union's saviors. He was the financier of the Civil War, and he had conceived and managed the sale of over 1.6 billion dollars of federal bonds. That's when a billion was really a billion, to hundreds of investors, and this was all without the whiff of a scandal. But Cook bribed two vice presidents, he bought members of Congress, and while he was feared by all politicians, He was venerated by the public because he's a great philanthropist, and according to John T. Flynn, he was considered by all the country's leading banker.

7:47So imagine here, there was a bank that had unprecedented monopoly power to underwrite all government bonds, whose owner was close friends with the secretary of treasurer. He controlled the railroad that had been allowed to grab more acres than any other, and he had managed to have himself granted several national banking charters, historians believe that the Grant administration was culpable for not responding to the crisis soon enough and not bailing him out, but this big, powerful, dare we say, systemically important bank was was allowed to fail in 1873, and what happened? Prosperity. And that prosperity continued for another two decades. From 1879 to 1896, phenomenal growth in American industry, production, phenomenal growth of American industry and production continued. Real net national product The stock rose by a rate of 3.7% and per capita net national product increased a percent and a half a year.

9:00Prices were falling during this period by over 1% and although money supply increased slightly, it wasn't fast enough to outpace the gains in productivity in the supply of products. Prices fell less during the 1873 to 1879 period because the money supply rose, despite a return to the gold standard. Now, of course, there was agitation for inflation. There were over 60 inflation bills introduced in Congress. Congress actually debated inflationary policy and passed the Inflation Bill of 1874 that called for the release of 18 million in greenbacks. But President Ulysses S. Grant unexpectedly vetoed the bill, citing that inflation would destroy the credit of the nation.

9:56The next year, Grant signed the Resumption of Specie Act, which provided that paper money in circulation be exchanged for gold and silver, effective January 1st, 1879. Now, there was a financial crisis in 1884. It was triggered by an overflow of gold abroad as foreigners began to lose confidence in the willingness of the United States to remain on the gold standard. As Jim Grant writes, the crisis was the real McCoy, the wildest kind of panic raged and securities were thrown overboard regardless of price. But remember, there was no Federal Reserve, no lender of last resort, no central bank to flood the market with liquidity and cheap credit.

10:46So left to the market, the overnight money rate rose to 4% per day. That's a higher rate than your local payday lender will offer you right now. But how long did the crisis last? Three weeks. From 1879 to 1889, prices kept falling, but wages actually rose by 23 percent. And so, with there being no inflation, real wages soared. And according to Murray Rothbard, no decade before or since has produced such sustainable rise in real wages. Rothbard goes on to point out the three conditions that must be present to produce such a rise in real wages.

11:34An absence of inflation, an increase in savings, an increase in capital formation. Bond yields fell during this period, from 6.5% on railroad bonds in 1878 to 4.5% in 1889 and given that prices were falling, savers and lenders were richly rewarded. Productivity was robust 3.8% per year, gross domestic product almost doubled in the 1880s from the decade before. This was the largest decade-on-decade jump any time since. Labor productivity increased 26.5%, which reflects the increase in capital investment.

12:21There was an explosion of business start-ups in the 1880s and a 500% increase in the purchase of structures and equipment. Capital formation roughly doubled, farm productivity and production all increased, and farm wages also increased. So the most powerful bank in the country failed, and what was followed was a couple decades of prosperity. There was no too big to fail policy, no worried about systemic risk. J. Cook and Company blew up. Life not only went on, the economy actually flourished. But what happens now? Back in the fall of 2008, AIG, an insurance company, was viewed as too systemically important to be allowed to fail.

13:15Susie Orman told Larry King, Thank God they bailed out AIG. Felix Salmon wrote in Portfolio Magazine, Whether or not AIG deserved the money was pretty much beside the point. The key thing was that if it didn't get the money, the entire global financial system would be put at risk of collapse. In which light the cost of the AIG bailout looks positively modest compared to the benefit. Nobel Laureate Paul Krugman claims that the rescue pulled us back a few inches from the edge of the abyss. And just why was AIG rescued? Pennsylvania Republican Representative Paul Kanjorski told reporters, Reporters. One of the reasons we had to rescue AIG was the fact that it was going to bring down Europe. Well, that's sure working out. Well, now it turns out that Goldman Sachs was one of the 16 banks paid off when AIG was bailed out. 200 million in taxpayer money was pumped into AIG's insurance holding company, and it was essentially a huge backdoor bailout of International Investment Banks, led by Goldman Sachs.

14:41Well, I gotta tell you, I sure believe Goldman Sachs is in jeopardy. Then Treasury Secretary Hank Paulson told CNBC's Steve Leesman, I believe that if any major financial institution, Goldman Sachs or any other major financial institution had gone down there, gone down then, with everything else going on in the market, would have been all she wrote for the American economy. Current Secretary of Treasury Tim Geithner, he's testified under oath he knew nothing about the bailout, the bank's worthless derivatives contracts, although he happened to be president of the New York Fed at the time. Neil Barofsky, he's testified that Geithner actually personally made the immediate early It was early November 2008 to pay the banks full face value for their toxic derivatives and collateralized debt securities.

15:37During a hearing on Capitol Hill, Representative Steve Lynch shouted at Geithner for several minutes, the commitment to Goldman Sachs has trumped your responsibility to the American people. But Geithner probably feels like he's being responsible to the American people. I mean, after all, Goldman Chairman Lloyd Blankfein says, I'm charged with managing and preserving the franchise for the good of the shareholders. And while I don't want to sound highfalutin, it's also good for America. I think a strong Goldman Sachs is good for the country. Peter Greer writes that, Cook & Company was the bare stearns of its time, a pillar of national finance. If it could fail, anyone could and the U.S. stock market collapsed that awful autumn.

16:29But the House of Cook would never have been allowed to fail today. Today's cook is AIG or Goldman Sachs, not Bear Stearns or Lehman Brothers. The politically connected cook would be thrown a life preserver today to bail out not only his bank but his ill-fated railroad. More efficient firms would not be moving in to take over what is left of his firms or buying what could be put into productive use. As Auburn University economics instructor has written on Mises.org, the underlying goal of the financial bailout is not to keep the economy healthy, but to keep a few Wall Street firms, mortgage banks and insurance firms in business.

17:17Bankruptcies do little harm. The economy would learn to return to prosperity quickly if the government would just let markets work, let inefficient firms go broke. But General Motors, Chrysler, Fannie Mae, Freddie Mac, Citigroup, and of course Goldman Sachs are still with us, propped up directly by taxpayer money or indirectly through zero interest rates. Just this week, Fed Chairman and 2009 Man of the Year, Ben Bernanke reiterated that the central bank officials expect the Fed's key short-term interest rates to remain at nearly zero for an extended period of time, which generally means several months.

18:07And while Bernanke believes, quote, that most indicators suggest that inflation likely will be subdued for some time, unquote, John Williams over at shadowstats.com, who measures price inflation the way they did in the old days, says price inflation is actually running nearly 10%. If we could only return to the 1880s, deflation. Because price deflation, instead of being evil, as Guido Holzman points out, actually fulfills the very important social function of cleansing the economy and the body politic from all sorts of parasites that have thrived on the previous inflation.

18:58Explains Holzman, there is absolutely no reason to be concerned about the economic effects of deflation, and less than one equates the welfare of the nation with the welfare of its false elites. But to say governments and the friends of government are concerned about deflation is an understatement. Professor Peter Spencer from York University says that central banks have learned a lot since 1694 when the Bank of England was founded, since there's no gold standard to get in the way. He says, cutting rates, they can cut rates very fast, and of course, they will too turn to the helicopters, referring to Milton Friedman's or Ben Bernanke's idea of just dropping bundles of banknotes from helicopters to stop deflation.

19:51This printing of money will keep the deflation wolf from our door, according to Professor Spencer. But creating more money doesn't create more goods and services. There is no wolf at society's door. From the standpoint of the commonly shared interest of all members of society, the quantity of money is actually irrelevant. And if the over-indebted and the over-lent go bankrupt, that's fine. The fact is these liquidations have no effect on the real wealth of the nation. And as Guido Holzman points out, they do not prevent the successful continuation of production. The fact is, deflation is a great liberating force, because it destroys the economic basis of the social engineers, spin doctors and brainwashers.

20:48Well, we sometimes find ourselves wondering just how different the world might have been And if Bernanke had studied the Gilded Age, rather than the Great Depression, writes Jim Grant, it's safe to say that the teetotaling George W. Bush was no match for the inebriated Ulysses S. Grant. And instead of there being no Fed for Wall Street elites to fall back on, Now Ben Bernanke continues the policy created at this very place in 1913 of directing the world towards an inflationary poverty and despair that only benefits the politically connected select few.

21:35It is Rothbard and Holzman that know the way to prosperity. We must bring back failure and deflation and end the Fed.