The Big Myth

Debunking a Lie

Don Watkins of the Ayn Rand Institute wrote an article, The Myth of Banking Deregulation, to debunk a lie. The lie is that bank regulation is good. That it helped stabilize the economy in the 1930’s. And that deregulation at the end of the century destabilized the economy and caused the crisis of 2008.
As of early 2015, Dodd-Frank had imposed altogether 27,670 new restrictions, more than all other laws passed under Obama combined (that is really saying something, considering the regulatory frenzy let loose by his administration. Note: the law may have “only” 2,300 pages, but more than 10 different regulatory agencies have been producing administrative laws for six years in a row to put it into practice – and they are not finished yet. Don’t you feel safer already?

Dodd Frank and All Other Laws 2009 - 2015

If deregulation is the problem, then re-regulation is the solution. So, in the wake of the crisis, Congress enacted a 2,300-page monstrosity of regulation known as Dodd-Frank. - Click to enlarge

The headline is that this law reduced regulation, and allowed banks to be in the securities business. However, the truth is that it mixed in a dollop of increased regulation.

Dodd Frank Final Rule Total Costs

The economic cost of Dodd-Frank (one guess as to who is going to end up paying for this…). Note: this is not cumulative – the cumulative tally so far is a cost of $36 billion (about $310 per household!); it has so far taken 74.8 million paperwork man hours to create this monster. You will be happy to learn that the law not only makes us perfectly safe, but introduces racial and gender quotas as well. The number of final rules exceeds those generated by Sarbanes-Oxley by a factor of 30 – so far. - Click to enlarge

Imagined Stability

I commend him for tackling regulation and the moral hazard of deposit insurance, and calling for real deregulation. However, I must criticize his article. He says:

“By far the most important factor in postwar stability was not New Deal financial regulations, however, but the strength of the overall economy from the late 1940s into the 1960s, a period when interest rates were relatively stable, recessions were mild, and growth and employment were high.”

Here is a graph of the interest rate on the benchmark 10-year Treasury bond from 1946 through 1969.

10 Year Treasury Bond - Interest Rate, 1946 - 1969

10 year treasury note yield, 1946 to 1969 – stability looks different - Click to enlarge

This is about double what it had been just 15 years earlier. And at the end of the 1960’s, the interest rate had hit 7.7%, or about 3.5 times where it started.

Watkins gives us a hint that he means that the interest rate destabilized after President Nixon severed the last link to gold in 1971. He says, “…[the] U.S. government cut its remaining ties to gold in 1971. The volatile inflation and interest rates that followed…”

So let’s look at the interest rate for the full period of rising rates, up to the peak hit in 1981.

We can see that it does indeed get worse after Nixon’s ill-conceived act. However, it is just a continuation of the same trend that had been underway since 1946. It’s a combination of rising interest rates with rising interest rate volatility. Both phenomena inflict damage on the economy.

10 Year Treasury Bond - Interest Rate, 1946 - 1981

10 year treasury note yield, 1946 – 1981 (it seems fair to assume that the market already anticipated the coming gold exchange standard default in the 50s and 60s – deficit spending and money and credit supply expansion had rendered it untenable) - Click to enlarge

The “Good Monetary Policy” Myth

Watkins claims, “Part of the credit for this [interest rate] stability goes to monetary policy.” He thus contributes — I assume unintentionally — to the myth of monetary central planning.

Myth: central planners were successful for decades, delivering a strong and stable economy. They can do it again. So if our present planners are not getting it right, then we just have to hire the right people.

If our civilization is to have a future, then this myth must come down! In recent decades, most people believed that Fed Chairmen Greenspan and Bernanke administered a strong and stable economy. They called it “the great moderation”. Of course, this view ended with a crash in 2008, along with the markets.

Watkins reinforces the myth in his subsequent discussion of regulation and the savings and loan crisis. He says that New Deal regulation, “collapsed under the pressure of bad monetary policy from the Federal Reserve…” The very phrase “bad monetary policy” implies that there is such a thing as good monetary policy.

There is no such thing as good monetary policy. There is no such thing as effective monetary policy, or monetary policy that does no harm. There are only the times when most people see no overt symptoms, when they don’t realize the damage being done.

And there are times of pain, when reality takes hold again. Since monetary policy can have lags of decades, most people do not know how to ascribe the blame properly.

The Quality of Economic Growth

One economic indicator that may make the postwar economy appear strong is Gross Domestic Product. GDP quadrupled from 1946 to 1969. Unfortunately, GDP is not a measure of the quality of economic activity.

A fever is not a measure of the quality your health, but merely the quantity of calories your sick body is burning. Similarly, GDP is not a measure of the quality of the economy, only the quantity of dollars turned over.

GDP should be understood to be a measure combining destruction plus production. Government waste is added to private activity. And of course, not all private activity is productive.

GDP does not distinguish between the squandering of precious capital during false booms and the genuine productive enterprise. It also includes many other wasteful activities, such as regulatory compliance. A rapidly-rising GDP does not necessarily mean the economy is healthy or stable. In fact, it was not in the postwar period.

One subtle but deadly problem was described by economist Robert Triffin in 1959. Rational domestic fiscal policy was in conflict with international demand for the US dollar, used as their monetary reserve asset.

The US was obliged — and happy to oblige — to run greater and greater budget deficits. Triffin knew that a crisis was inevitable. It came under the Nixon administration.

The Self-Immolating Gold Standard Myth

I want to pick on a phrase that feeds — again I assume inadvertently — into the anti free market, anti gold standard myth. Watkins uses the passive voice to say that the classical gold standard “had fallen apart during World War I…”.

Most people today, if you press them, will tell you that that a free market contains the seeds of its own destruction. “Falling apart” is precisely what they fear will happen when a free market is unregulated, uncontrolled, and not centrally planned. That’s why they want regulators and central planners.

It needs to be said again and again. No. The classical gold standard did not fall apart!

It was killed by government. In 1913, the Federal Reserve was created. That altered the gold standard the way drinking a bottle of wine alters consciousness. If a drunken worker drives a bulldozer through a house, no one says that “the building had fallen apart.”

In addition to the Fed in the U.S., the governments of Britain and Germany and other belligerent powers suspended the gold convertibility of their currencies in 1914. Many people blithely say that the gold standard fell apart. I say, again, it did not.

After the war, the victorious countries claimed they were returning to the gold standard, but instead they created a pseudo gold standard. As everyone knows now, it didn’t work. At least one economist, Heinrich Rittershausen, knew in advance. He warned that this dysfunctional monetary system would cause great unemployment.