Regime Uncertainty - Then and Now

0:00All right, our next speaker, senior fellow in political economy at the Independent Institute, edits their quarterly journal called the Independent Review. He is the 2007 winner of the Schlarbaum Prize for Lifetime Achievement and the Cause of Liberty. He's the author of a number of books, and here is one of his right there, Against La Leviathan, Depression, War and the Cold War, and of course, as I always mention when I introduce him, a book that is near and dear to my heart because Murray Rothbard has signed it as the text for U.S. Economic History, a book called Crisis on Leviathan, which we have on sale out front. He's going to be talking about regime uncertainty then and now. Please Please help me welcome Robert Higgs.

1:02Meaning no offense to my colleagues, I'm going to put this little book up here. I was going to refer to it, but I didn't know I'd have a stand for it. So there it is. This is a book published originally in 2006 by Oxford University Press in a font that's a little hard to read, I think, and it was republished in 2009 by the Independent Institute and reset with a larger font and a much cheaper price. So this is the one I recommend if you have an interest in it. It's called Depression War and Cold War. And the reason I'm referring The work I've done on regime uncertainty, which is a term I devised as it were, at least as I define it, was first dealt with in a published article in 1997, an article I put in the independent review, which is easy for me, I'm the editor.

2:14So, even though I'm normally my own worst critic, I let that one slip through. And the article is called Regime Uncertainty, Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War. And that, with a little revision, becomes the first chapter in this book. But it goes on because that was one of a number of papers I was writing in those days and they all can be seen as sequels to my book Crisis and Leviathan which was published in 1987. From that book I developed a very keen interest in the war economy and in particular how the war economy of World War II related to the preceding depression and the following Prosperity in the United States.

3:12And being an economic historian, I knew what the economic historians and economists almost unanimously had been saying about that relationship for decades, which was, as the saying goes, the war got the economy out of the depression. Well, I was a good enough historian, even though I'm an amateur, to know that there There are some ways in which that just wasn't so, and appreciating that I began to do research into that area that led me to write a number of articles, and the first five chapters of this book pull the most important ones together. I think they do hang together pretty well to try to explain why the depression lasted as long as it did. I call that the great duration.

4:04Why the war economy was not what people think it was, that is a time of prosperity, and yet why the economy did enjoy real prosperity as soon as the war ended and resources were reconverted to civilian use overwhelmingly in 1945 and six mainly. So the whole period from 1935 or so to 1948 is one that I've been at pains to understand for a long time because I think it's been generally misunderstood almost by the entire economics profession. And so I feel like, you know, that Johnny, whose mother saw him marching by with the the Troop and declared why they're all out of step, but Johnny. I'm the Johnny here.

5:02Although I have to say I think I've brought a few people over eventually and I'm hoping to bring some more over before I'm finished. I've argued since the mid-90s that one of the reasons, and I'm not arguing it's the only reason, one of the reasons why the depression and Persisted So Long in the 1930s was because the private property rights of investors became uncertain and as a result of their fears about what might happen to their property rights in the future, both their ability to control their capital and their ability to accrue income generated by that capital, they became very reluctant to make new investments, especially When you're going to lay out current resources to acquire an asset which will pay back your investment only over a period of 10 or 15 or 20 years, you're making a bet, as it were, on conditions over a very long time in the future.

6:10And the longer the time you're betting on, the more important it becomes that you not not be afraid of what the government might do to attenuate your private property rights along the way so that the investment would never pay itself back fully and you would simply have lost money by making it. So it's a very common result in investment theory and options theory and a lot of ordinary sub-fields of economics that investors tend to become paralyzed or they become very careful and Reluctant to Make Investments, the more uncertain prospects are. Now that's a long, that's kind of an axiom of finance theory going back for centuries up, I suppose, but what I did in the concept of regime uncertainty was to think about this relevant uncertainty here rather differently.

7:07Economists had talked about changing regimes of various sorts, but my concept of the regime Regime here has to do with the security of private property rights. That's what it's all about. And that is not simply a matter of what the law says. And one of the things I've been at pains to try to make people understand over the years is that when I speak of regime uncertainty, I'm not speaking of something that is equivalent to policy uncertainty. That's part of it, sometimes an important part. It's not the only part, however. And so what I'd like to do is recite for you how I described in my first article what I mean by regime uncertainty. To narrow the concept of business confidence, which is again an old idea, I I adopted the idea that business people may be more or less uncertain about the regime, by which I mean distress that investors' private property rights in their capital and the income it yields may be attenuated by future government actions.

8:27Such attenuations can arise from many sources, ranging from simple tax rate increases, to to the imposition of new kinds of taxes, to outright confiscation of private property. Many intermediate threats can arise from various sorts of regulation, for instance, regulation of securities markets, labor markets and product markets. And in any event, and this is important, the security of private property rights rests not so much on the letter of the law as on From the Character of the Government that Enforces or Threatens Presumptive Rights As extreme as the legal and regulatory changes of the 1930s were, the real source of regime uncertainty lay less in those changes than in the character of the people in charge of the U.S. government at that time.

9:32The real reason for regime uncertainty in recent years lies not so much in all the outrageous actions the government has taken, including those Bill just described actions taken by the Fed, the TARP program, the GM Chrysler bailouts, the AIG takeover, and so forth. Those are bad enough on their face. But I think in addition to that we have to understand that the Obama administration is a scary thing for most investors. Not if you're one of their crony capitalists on Wall Street, not if you're a partner at Goldman, that doesn't scare you at all, that allows you to sleep soundly at night. But if you're not in that privileged circle of crony capitalists, you have very good reason to be afraid of the kind of people in charge of administering, enforcing, or violating the law from positions of power in the current administration.

10:35So even though good friends of mine have urged me over the years to give up the name regime uncertainty and substitute something more immediately comprehensible such as policy uncertainty, I've refused to do that because that is not what I mean. is bigger than that, more robust than that, and in a sense scarier than that as well. Now this kind of uncertainty began to emerge around 1935. Before that, in the so-called first New Deal, the Roosevelt administration had done a lot and a lot of radical things, but it had continually worked with business interests in a lot of ways.

11:21Starting around 1935 and in some ways slightly before that, President Roosevelt decided to deal with the threats he faced in the coming election from very radical challengers. People like Huey Long, Upton Sinclair, Father Coughlin, just a host of crackpots that were gaining large followings in this country. The economic troubles always bring the crackpots out of the woodwork and allow them to get followings. And that certainly happened in the 1930s. Every kind of crackpot imaginable had a plan for getting the economy out of the depression. And Roosevelt feared these people. He had good reason to fear them. Someone like Huey Long, our pride and joy here in the state of Louisiana, every man When a king, every woman a queen, but nobody wears a crown. I love that. But other people loved it too at the time. That's why some people felt the need to shoot Huey dead. So at all events, Roosevelt was quite afraid of Huey while he lived, and even after Huey was out of the way, he was afraid of other such crackpots. And so he felt that he could,

12:35as it were, cut them off at the pass by radicalizing himself, by shifting from this first New Deal to the so-called social New Deal, whose landmark statutes were the Social Security Act and the Wagner Act, the National Labor Relations Act, which as it were unleashed the labor unions of the United States and made them very frightening to investors, frightening and Forceful Members of the New Deal Coalition from that time on until after World War II. So Roosevelt's radicalization of himself in order to be re-elected in 1936, it worked like a charm. He was re-elected by a huge landslide and I think he took so much pleasure in how well this radicalization of himself had worked that he stuck with it.

13:29At the same time, however, as Raymond Moly describes beautifully in his book after seven years, Roosevelt became increasingly maniacal and paranoid. He more and more wanted to have all the power over everything he could get, and he more and more became afraid that everything The only thing that went wrong was the product of machinations of his enemies, particularly the big business interests that continued to oppose him, conservative newspapers and people of that sort. So it became harder and harder for moderates like Ray Moly, I mean if you can think of him as a moderate, he really was compared to the people that gained Roosevelt's major And if you pay your attention from 1935 on, people like Ben Cohen and Cochran and William O. Douglas and Jim Landis and Felix Frankfurter and Brandeis, they were the leaders of this crowd.

14:38They were sometimes known as the Harvard Boys because of Frankfurter's key role in guiding them and goading them and placing them in key positions inside the federal government. They became the main advisors in the so-called second New Deal, and its second New Deal just scared investors to death. And as a result, long-term investment never came close to recovering. In fact, for the entire decade, or more than a decade, the 11 years from 1930 through 1940 inclusive, if you add up all the investment in the United States, it comes to a negative number. That is, depreciation of capital stock in that 11-year period exceeded the amount spent for new investment.

15:25So here we had a decade that was a lost decade in any way you look at it. There was no real economic growth. We ended the decade with still a great high level of unemployment. And we hadn't in any way increased the economy's capacity to produce because the capital stock had not been increased. This is the only decade in our history that has that remarkable aspect to it. Now, not everybody likes my idea of regime uncertainty, and in fact, most mainstream economists dismiss it out of hand. Krugman, of whom previous speakers have spoken, calls it a fairy tale. He speaks of the confidence fairy. However, Krugman is the paradigmatic vulgar Keynesian, which means he basically explains everything as based on animal spirits. And I guarantee you, my regime uncertainty has a much more solid basis than Lord Keynes' animal spirits, which had none whatsoever.

16:31In fact, I've used various forms of evidence all along to test, as it were, the idea of regime uncertainty. I've used historical facts in abundance describing what the government was doing, what other people were doing, and the economic logic of it. You don't have to be a rocket scientist to see if the government is threatening some draconian new form of regulation. That's going to discourage investors at the margin. You don't need economic genius to figure that out. So I've looked at a lot of historical facts. I've looked at a lot of testimony specifically on this issue by people in business and by investors. And let me read you just one of these to illustrate.

17:17This was something that was written in 1937 in a letter from Lamont Dupont, who was one of the bigger investors of the day. He said, Uncertainty rules the tax situation, the labor situation, the monetary situation, and practically every legal condition under which industry must operate. Are taxes to go higher, lower, or stay where they are? We don't know. Is labor to be union or non-union? Are we to have inflation or deflation? More government spending or less? Are new restrictions to be placed on capital? New limits on profits? It is impossible to even guess at the answers. This wasn't a public relations statement. This was something he wrote a personal letter. But this is perfectly illustrative of how many business people were feeling at the At the time, all the way from 1935 to 1940, at the time I started my work on this subject, I had not read a book called Pride, Prejudice and Politics, subtitled Roosevelt versus Recovery 1933 to 38. The author is Gary Dean Best, a historian who was not an Austrian and not

18:45even an economic historian for that matter, but I highly recommend this book if you want I want to understand how business people were feeling about what was going on in the United States between 1933 and 1938 because Best went to the archives and he pulled out a gigantic mass of testimony and it's a very revealing book. I wish I'd read it before I started my work but I eventually did catch up. So that's one form of evidence, what businessmen themselves were saying. I also looked at a number of polls. Scientific polling began in the mid-30s and some of these polls specialized in polling business people, particularly the fortune poll. So they asked a lot of interesting questions bearing on regime uncertainty and I looked at those and what I found was that the businessmen were pretty much convinced even late in 1941 that after the war, the government of the United States would exercise Somewhere between more severe control of the economy and draconian control, they might convert it into outright fascism or communism or socialism with central planning or something extreme like that.

20:04After all, it was happening in other places in the world at the same time and many people feared, for good reason, that Roosevelt would have liked to be a dictator like Mussolini or Hitler or Stalin. One. So these polls tell us about the extent to which these kinds of beliefs were in the minds of investors. I also looked at the structure of investment. If business people are afraid that not only invest less, but they'll change the kind of investment they make. They'll move away from longer term investments and towards shorter term. And the data show exactly that for the 1930s. And finally, I looked at, as it were, evidence that shows businessmen putting their money where their mouth is.

20:55A lot of historians being left liberals or even farther left than that tend to see these kind of business statements as just self-serving propaganda. Yeah, that's just the plutocrats generating PR against Roosevelt. But you can't bring that objection against how people end up pricing bonds in the corporate bond market. People don't buy and sell corporate bonds to make publicity statements. They have money at stake and they have to think about what real risks are. So I looked at what happened to the spreads between interest rates for high-grade corporate bonds over the period from 1929 to 1950, actually, and I found an astonishing result, which was that the yield spreads were very small between long-term payoffs and short-term payoffs on on Corporate Bonds, up through the beginning of 1934.

22:01But in the next two years, they became enormous, huge, so huge that a 20-year payoff was commanding Effective interest rate to five or six percent above. That is, you know, several times the payoff on a one-year payout on a corporate bond. So the bond market clearly showed me this gigantic jump in what I interpret as risk premiums on the future, reflecting regime uncertainty. When I first had my computer spit out a graph on this, I couldn't believe it. I said to myself, nobody's going to believe this.

22:48They'll think I made it up. But, you know, if you don't believe me, you can go rerun it yourself. The data are there for you to check. And it stayed up there until sometime between the first quarter of 1941 and the first quarter of 1942. Think about that. The economy is now going into the greatest war in the history, and yet, businessmen now are less apprehensive about the future than they had been for the previous six years. And it's because Roosevelt had to placate the business class to get them to build the war economy. And so he did it by basically handing the war economy over to them, with Stimson and and Knox being put in charge of the war department, the Navy department, and Patterson and Forrestal running those departments on a day-to-day basis.

23:41And 10,000 or more, I'm not making this up, there are more than $10,000 a year men or no dollar a year without compensation, they recall, business people running the war agencies that the US used to run a war command economy from 1942 through 1945. So once these businessmen were running the economy and allocating resources, no, they weren't afraid of the government anymore. They were controlling it along with the military itself. And so they got over their regime uncertainty, but they couldn't do anything about it while All the war went on because all the resources were being steered to military uses. It was only when the war ended and resources now could be released for civilian uses that they were able to show that their fear was gone.

24:37At that point we saw the most amazing recovery or growth of the private economy ever took place in the U.S. economy in one year. 1846 was the greatest year of American economic history for the growth of private product, never anything like it. So that's how we got back to prosperity and there's a lot more to it, so buy a case of my books and give them to all your family members for Christmas. Now, I'm out of time, but I just want to say that in the past three years we've seen a re-emergence of regime uncertainty because of the snowstorm of government measures and all the apprehensions that they have created about what's going to be next.

25:31Because some of these statutes, for example, Obamacare and the Financial Reform Act, basically They just create gigantic crates full of invitations to regulators to fill in the details. Hundreds of regulations have to be made to tell people specifically what these laws are going to mean when they're enforced and administered. Well, if you're in business, you have no way of knowing what health care costs are going to be two or three years from now, none. You don't have any good way of knowing what kind of controls are going to be exercised over financial markets. And I mean everything from pawn shops on. These statutes are written very broadly.

26:18And so many people get snared at them who don't even think they're part of the financial markets. And taxes are going to expire. Are they going to be extended? Are they going to be increased? Who knows? And it's just one thing after another that have put investors in a frightened mood lately. And so investment has been very slow to recover. It's still net private fixed investment is still down about 75% or more from its peak before the recession. So this recovery has been very slight, certainly not enough to be the engine of a bonafide real recovery that would allow us to reduce the unemployment rate substantially.

27:09So I looked at all the same kinds of evidence I looked at before. Recently, I looked at just the facts and the logic, the testimony of businessmen and investors, which has been voluminous. Poll data, I've looked at the structure of investment, and I've looked at the corporate bond yields and the yield curves have done just what they did before, just not to the same degree. After the turmoil from late 2008 to mid 2009, we ended up with a yield curve that was much steeper for all kinds of corporate bonds than before. and furthermore we finally got what the mainstream economists always blamed me for not having which is a quantitative index of regime uncertainty just publicized in the last two or three weeks by three researchers two people at Stanford and one at Chicago so they have very good credentials as mainstream economists and they produce this index I don't have time to describe how it works but But their names are Baker, Blumen, Davis, and if you're interested I can give you some places to look for their index.

28:26It's quite interesting. I don't think it's the last word by any means, but what it shows is indeed what I've been arguing from other forms of evidence. That the level of policy uncertainty has risen to much higher levels since the Lehman Brothers bankruptcy, and it stayed there, it fluctuates, but it stayed at extraordinarily high levels since then. So, why is the recovery so pathetic? One of the reasons, and I think an important reason, is regime uncertainty. Thank you very much.