01/11/2002 Harry E. Miller *

It almost appears as if a bit of reality is returning to the stock market, as difficult as that may be to believe after the past few months. For the week, the Dow dropped 3% and the S&P500 declined 2%. In a notable change of fortunes, economically sensitive issues under performed. The Transports and Morgan Stanley Cyclical indices sank 4%. Defensive stocks fared better, with the Utilities and Morgan Stanley Consumer indices dipping about 1%. The broader market gave up a bit of recent gains, with the small cap Russell 2000 and S&P400 Mid-Cap indices dropping 2%. The technology sector came under some selling pressure, as the NASDAQ100 declined 2% and the Morgan Stanley High Tech index and Semiconductors slipped 3%. The NASDAQ Telecommunications index sank 5% and The Street.com Internet index dropped 3%. The Biotechs generally declined about 2%. Financial stocks were weak, with the AMEX Securities Broker/Dealer index and S&P Bank index both dropping 3%. With bullion jumping $8.50, the HUI gold index surged 7%. The dollar was relatively unchanged.

It was a fascinating week in the Credit market, with something getting the marketplace in a lather. On the back of Greenspan’s ultra-dovish comments, June Eurodollar yields dropped 14.5 basis points today to 1.775%. Two-year yields collapsed 42 basis points this week points to 2.73%, with 5-year yields dropping 35 basis points to 4.08%, and 10-year yields declining 27 basis points to 4.86%. Mortgage-backs performed well, with benchmark yields sinking 39 basis points. Implied agency yields dropped 32 basis points, with the spread to Treasuries for Fannie Mae’s 5 3/8% 2011 note narrowing 2 to 70. The benchmark 10-year dollar swap spread narrowed 6 to 66. Corporate spreads were mixed, with financial spreads narrowing marginally while industrial spreads generally widened. (Ford announced it would take a $4 billion charge to “cut costs.” Were they not already “lean” after years of “cost cutting"? Ford now plans a $3 billion convertible bond sale to shore up its balance sheet.) It was certainly not economic data that was driving the intense buying.

Could it be that the bond market is beginning to sniff out impending Consumer debt problems? Or is it more likely a case of increased recognition of the harsh reality that acute financial problems are festering beneath the surface of the U.S. and global Credit systems? The week certainly ended with a rather ominous tone. It is difficult to make sense of it all, but it does seem worth noting the confluence that has one of the few countries operating a currency system pegged to the dollar in complete disarray (the Argentine peso plunging as much as 44% today), our largest creditor (Japan) mired in intractable financial crisis, and the country (UK) whose financial structures most mirror our own in the midst of its own Credit Bubble (and could be forced to move to temper overheating). Globally, we see extreme monetary accommodation and the rising specter of “beggar thy neighbor” policies. Throw in the grimy and thickening Enron plot and there’s little wonder why gold is catching a bid…

Interestingly, Fed chairman Greenspan’s “significant risks” speech today put the spotlight directly on the “stabilizing force” having been played by the household sector. He addressed specifically the key issue of mortgage finance and the “associated liquification of increases in home values,” stating that “cash-outs rose from an estimated annual rate of about $20 billion in early 2000 to a rate of roughly $75 billion in the third quarter…” in addition to “realized capital gains.” “The recent rise in home mortgage rates, however, is likely to damp housing activity and equity extraction.” We have noticed other Fed officials’ recent comments suggesting that perhaps there is increased recognition of the looming consumer debt problem. Going forward, we expect the vulnerable consumer Credit Bubble to garner considerable attention from the corridors of the Federal Reserve to the trading desks on Wall Street.

Broad money supply (M3) contracted $13 billion last week, with institutional money market funds declining $6.5 billion. Japan’s seasonally adjusted measure of “broad liquidity” expanded in December at an annualized rate of 7.5%, with three-month expansion at an annualized 6.1%.

From Raymond C. Scheppach, Executive Director of the National Governors Association: “State budgets are in a crises situation. To a large extent, the budget gaps governors face will drive their agenda. Times of fiscal crises often lead to major changes in state government. We could see consolidation, streamlining of processes, and more efficient use of technology. I expect economic development, health care, a continued focus on homeland security, and education initiatives to be some of governors’ top priorities.”

Tuesday the Treasury Department reported that consumer Credit increased by $19.8 billion during November. This was easily a new record and four times consensus estimates of $4.7 billion. Consumer Credit jumped a combined $31 billion during October and November, an almost 12% annualized rate. During November, Credit card/revolving consumer debt increased by $5.4 billion, the largest increase since April. Non-revolving (largely auto loans) Credit increased by $14.4 billion, the largest increase since January 1989. This is but one of many indications of systemic monetary disorder exacerbated by the Fed’s frantic rate cuts.

With earnings reports beginning to trickle in, evidence of aggressive lending is already conspicuous. Credit card behemoth MBNA’s managed loans increased by $4.9 billion to $97.5 billion during the quarter, a 21% annualized growth rate. The company’s total assets jumped $2.4 billion, a 22% rate, with year over year asset growth at 18%. The company added 2.4 million new accounts during the quarter and 9.5 million for the year. Loans held for securitization surged to $9.9 billion, up almost $3 billion during the three months. AmeriCredit, king of subprime auto lending, saw managed receivables jump $1.05 billion to $12.38 billion, an annualized rate of about 37%. Year over year, averaged managed receivables jumped 51%. Total company assets expanded at a 42% annualized rate to end the year at almost $4.3 billion. Delinquencies (including repossessions) jumped from 11.8% to 13.4% during the quarter, very disconcerting numbers especially considering continued extreme receivable growth. Trouble brewing… Mortgage insurer MGIC reported credit losses for the quarter of $51.7 million, double year ago levels. Its delinquency rate of 3.46% compares to last year’s 2.58%.

And Wednesday we had some candid dialogue from Robert McTeer, President of Federal Reserve Bank of Dallas: “Those of you who studied money and banking at a time that they were emphasizing the monetary aggregates might say, “yea, we know about short-term interest rates but what about the money supply growth and all that stuff?” Well, it’s been uneven over the year, but it’s been very rapid. Both by short-term interest rate standards and money growth standards, Fed policy got very easy (inaudible) - peddle to the metal.” Peddle to the metal indeed…

You’ll have to excuse my excitement (and the pages of quotes to follow), but I came across some wonderful research and analysis this week. Dusting off some old issues of The Quarterly Journal of Economics, I came across a 1924 article by Harry E. Miller, “Earlier Theories of Crises and Cycles in the United States:”

“American economists, when they seek to trace the development of economic doctrines, do not commonly turn to the early literature of their science at home. Yet on the matter of commercial crises and business cycles it is quite possible that a few of our neglected writers before the Civil War, whose writings are too often regarded as virtually sterile, had a better understanding than any of their English contemporaries. And certainly, in the analysis of aggravating factors in the American banking system, their achievements were substantial.”

After reading this fine article, Harry E. Miller’s excellent book Banking Theories in the United States Before 1860 (1927), and some of the original writings referenced in his research, I could not agree more that some of our early writers exhibited a keen understanding of important fundamental issues of Credit, money, and banking, as well as their roles in fueling booms and busts. This work is today strikingly pertinent.

I will first highlight extracts from the writings of several of these early “monetary theorists.” I am especially fond of this analysis for several reasons. For one, it is fortunately lacking the overarching ideology that too often weighs on objective monetary analysis. These writers, of course, predate the likes of Keynes, Mises, and Friedman, and are thus exempt from the “Keynsian,” “Austrian,” and “Monetarist” balkanization that for the past few decades has been detrimental for the development of cohesive, practical, and sound monetary doctrine. Additionally, these analyses are valuable for being “homegrown,” absent the British and European financial nuances that often add an additional layer of complexity. There is, as well, the critical issue of the role central bankers (and reserve requirements and such) play in the process of money and Credit expansion, which today too often distracts from the heart of the issue - inflationary lending processes. These writings predate the Federal Reserve System by at least a half a century, and are thus particularly insightful for their focus on the mechanisms and consequences of excessive private lending/Credit creation. Moreover, I see it as a significant advantage that these early analyses were of a primitive financial system. They by their nature, then, provide an edifying fundamental framework for analyzing money, Credit and lending/financial intermediation. Contemporary financial systems, with their myriad of sophisticated institutional structures, relationships, instruments, and vehicles, are so incredibly complex that we invariably lose sight of key basic principles governing the process of creating additional purchasing power through the expansion of financial claims. In this regard, I believe extracts from these early writers are perhaps superior in illuminating critical core issues than anything we monetary analysts are propagating today.

The first and longest of these extracts is from Condy Raguet’s (1784-1842), A Treatise on Currency and Banking, 1840, pp. 134-138. (Underlines is mine, italics the author’s)

“Having shown that banks of circulation, as such, neither create nor lend capital, and that what they do lend is their credit, by means of which the capital of individuals is circulated with more facility and less security than it would be without their instrumentality, I come now to examine this question, upon which most of the popular delusion hangs: Does not the increased activity given to business, occasioned by banks lending their credit very freely, tend to the promotion of public prosperity, and to the production of wealth, faster than would otherwise take place? The answer will...not be found in accordance with the cherished opinions of the day.

By the operation of such bank issues the credit of the banks is placed at the disposal equally of all who borrow from them. Consequently, the inexperienced, the unskillful, the incautious, and the speculative, are placed upon a level, in their purchases, with the experienced, the skilful, and the prudent. The result of this equality is, that some men are able to buy who before were not able owning to a deficiency of credit. More competitors are brought into the market, and prices rise from the spirit of speculation, which never fails to be engendered by the facility of procuring the means to speculate with. In addition to this local rise which takes place from the competition of new dealers in the immediate neighborhood of the banks, a general rise takes place from the expansion of the currency, owing to the abundance of the paper which has been thrown amongst the community by the original borrowers from the banks. This rise goes on with every new emission of paper, and appearing to the public, which is not acquainted with the internal operations of banks, like an increase in value, the spirit of speculation is excited amongst all classes of the community, and purchases are made for no other reason than that the buyers suppose they can sell the next day at a profit. Industrious persons abandon productive employments to pursue speculation, which, however profitable it may be to the successful operator, does not at all add to the wealth of the community, seeing that what is gained by one man is lost by another. Extravagance and luxury are increased in proportion to the increasing abundance of paper credits, because, as prices rise, all who have property or commodities on hand think they are getting richer every day. Merchants embark in more extensive enterprises; manufactures extend their establishments; farmers build houses that are not wanted, and ornament their farms; railroads, canals, and every other species of internal improvement, are prematurely projected. All these operations give employment to the laboring classes, and for a time exhibit the semblance of accumulating wealth. Every new sale of property or commodities on credit creates new promissory notes or obligations, and these create a new demand for more discounts, whilst more currency is required to circulate the same commodities at their augmented price. (This is great!!)

But there is a final limit to this delusion. The depreciation of the currency has become so great, from these extraordinary issues, that timid people become alarmed, and make a run upon the banks, whilst coin is also demanded for exportation. The banks are called upon to pay their notes, and they in turn call upon their debtors, who are by this means first awakened from their dreams. Money becomes scarce, and prices of property and commodities fall. The operation which the banks require is merely that those with whom they exchanged notes upon such unequal terms, shall exchange back again. But with this demand the merchant cannot comply, because he has in their place a store full of goods, which he has been induced to import or purchase, on account of the high prices created by the issues of the banks, but which he cannot now sell without a loss that will render him insolvent. Or he has parted with his bank notes in exchange for goods which he has sold to country merchants, who cannot pay him owing to the fact that the planters or farmers whom they trusted have over-planted or over-farmed, or over-speculated in lands, or over-expended. The manufacturer pleads the same inability, because the same high prices and appearance of universal prosperity induced him to erect buildings and machinery, not required under a diminished demand for goods, which he cannot now dispose of at any price; while the farmer or planter confesses, that the temporary rise in the prices of land, agricultural produce…which he thought was a permanent rise in value, had induced him to invest in unproductive improvements on his estate and in the purchase…of new lands, the notes which he had received from the banks; or, that his belief in his apparently growing wealth had led him into extravagance and luxurious expenditures.

The speculators in railroads and canals, who subscribed to those improvements, not because they had capital to invest, but because they fancied that the delusion under which they labored was a reality, and that consequently they would be able to sell their stock at an advanced price, cannot pay their notes, because they can find no purchasers with actual capital who are willing to take their bad bargains off their hands. At this winding up of the catastrophe, it is discovered that during the whole of this operation, consumption had been increasing faster than production – that the community is poorer in the end than when it began – that instead of food and clothing it has railroads and canals adequate for the transportation of double the quantity of produce and merchandise that there is to be transported – and that the whole of the appearance of prosperity which was exhibited while the currency was gradually increasing in quantity, was like that appearance of wealth and affluence which the spendthrift exhibits whilst running through his estate, and like it, destined to be followed by a period of distress and inactivity.

But even admitting all this to be true, it may be argued, that at any rate banks of circulation, by liberal issues of their notes, make what is called money plenty. That they make it plenty with those who first get their paper is undoubtedly true, as is evinced by the speculative operations which have been above described; but as soon as time has been afforded for that general rise in the prices of property and commodities which is inseparable from increased issues of paper after it has become diffused throughout the circulation, the plenty disappears.”

I wish we could “clean the slate” and use Mr. Raguet’s now more than 160-years old analysis as the foundation on which to construct contemporary money, Credit and economic theory. It’s both brilliant and remarkably comprehensive, but best of all it’s just good common-sense economics. He understood and wrote clearly as to how the inflation of bank Credits distorts prices, expectations, the nature of demand, and, hence, the underlying structure of the economy. Raguet’s analysis was as well astutely qualitative and quantitative. He, as have writers of economic and monetary issues throughout the centuries, recognized the momentous role speculative borrowings play in precarious self-reinforcing Credit expansions. Right here we find a most important lesson, one that is repeatedly and painfully learned and then somehow “unlearned” with the indoctrination of what is believed “advanced” understanding. Back then, speculative flows were generally channeled to commodities, merchandise and land. The age-old tradition holds true today, although the prominent monetary channel is speculative leveraging in the securities markets (and real estate). It is also interesting to note how often the word “scheme” is found in historical analyses of money, Credit and speculation, a custom that is destined to live on at least through this cycle.

Albert Gallatin was also a prominent writer, and I will extract from the introduction to his book, Considerations on the Currency & Banking System, 1831, pp. 5-6. It certainly demonstrates the seriousness that statesmen of that period held for the over-issue of paper money and monetary stability:

“THE framers of the Constitution of the United States were deeply impressed with the still fresh recollection of the baneful effects of a paper money currency, on the property and on the moral feeling of the community. It was accordingly provided by our National Charter, that no state should coin money, emit bills of credit, make any thing but gold and silver coin a tender in payments of debts, or pass any law impairing the obligation of contracts; and the power to coin money and to regulate the value thereof, and of foreign coin, was, by the same instrument, vested exclusively in Congress. As this body has no authority to make any thing whatever a tender in payment of private debts, it necessarily follows, that nothing but gold and silver coin can be made a legal tender for that purpose, and that Congress cannot authorize the payment, in any species of paper currency, of any other debts but those due to the United States, or such debts of the United States as may, by special contract, be made payable in paper…

The provisions of the Constitution were universally considered as affording a complete security against the danger of paper money. The introduction of the banking system, met with a strenuous opposition on various grounds; but it was not apprehended that bank notes, convertible at will into specie, and which no person could be legally compelled to take in payment, would degenerate into pure paper money, no longer paid at sight in specie…and it was the catastrophe of the year 1814 which first disclosed not only the insecurity of the American banking system, as then existing, but also, that when a paper currency, driving away, and superseding the use of gold and silver, has insinuated itself through every channel of circulation, and become the only medium of exchange, every individual finds himself, in fact, compelled to receive such currency, even when depreciated more than twenty per cent…”

And from Eleazar Lord, Principles of Currency and Banking, 1829, pp. 43-47:

“The object of all conventional regulations of the currency, should be to secure an adherence to the principles which naturally govern it. For though the operation of these principles can no more be superseded or hindered permanently, than that of any of the laws of nature can be, yet they may be temporarily violated and resisted; and by a constant effort to evade or oppose them, the most ruinous consequences may be produced; especially where a joint currency of metal and paper is in use, and where paper is issued, not by a controlling power like that which regulates the coin, but from a multitude of subordinate sources.

The most essential quality of a currency, the point of all others to be chiefly aimed at, is invariable steadiness of value. Invariable uniformity of value in the currency, has a relation to the interests of the people, similar to that of uniformity of weights and measures. Variation in the standard of value, produce much the same effects as variations in measures of capacity…

Though paper has not, like coin, the qualities necessary in a standard, it has in circulation the effect of a criterion of value; and it is the suddenness and ease with which the quantity of paper can be increased or diminished, which constitute the principal objection to the employment of it in circulation. This quality of bank paper is the true source of nearly all the variations and fluctuation in the currency of this country since the introduction and multiplication of banks. It is presumed to be sufficiently notorious, that for twenty or thirty years, there has been a constant recurrence alternatively of abundance and scarcity of circulation; that great abundance is uniformly succeeded by great scarcity; and that the embarrassing and disastrous effects of these fluctuations, are commonly ascribed to one another, or to some peculiar state of things in foreign countries, or to some other cause known or unknown, instead of being traced to the true cause, the excessive emission of paper.

When the issues of paper have been pushed to such excess as to lower the market rate of interest, occasion large sums of money to be unemployed, and render it extremely easy to obtain the control of funds, an advance in the prices of commodities immediately takes place, and speculative transactions are induced. The continued rise of prices, and increase of speculation, cause a proportionate demand for more notes; and the greater the quantity of notes issued the more prices rise. At whatever point an excess of issues begins, the whole country is soon inundated with a depreciated currency. Universal confidence is felt, and the progress of redundancy and speculation is called prosperity. At length the people discover with consternation, that the precious metals have been withdrawn and sent abroad; that the paper in circulation has lost its exchangeable value, or is fast disappearing; that prices are rapidly falling; and that the payment of their debts, should that be possible, must sweep off their property, destroy their hopes, and occasion wide spread distress and ruin.

Whether, in such a case, the evils which attend the struggle of the currency to right itself, are greater or less when the convertible character of the paper is maintained, than when it is lost, depends very much on the length of time required for the process. But nothing can be more certain than that this train of disastrous results, originates in an excessive issue of paper. The flexible quality of paper currency, its capacity of sudden and indefinite expansion while confidence is maintained, and the contraction when distrust or necessity requires, is the root of the difficulty. It is against this that the public requires security; and this, in connection with the system under which the issues of paper are made, needs to be controlled and regulated.”

Miscellaneous quotes (from Miller 1924,1927): “In every country where credit enters extensively into the transaction of people, there must be liabilities to what are called panics.” Condy Raguet, Examiner, 1834

“All active, enterprising, commercial countries are necessarily subject to commercial crises. A series of prosperous years almost necessarily produces overtrading. Those revolutions will be more frequent and greater in proportion to the spirit of enterprise and to the extension or abuse of credit.” Gallatin, Suggestions on the Banks and Currency, 1841

“If our circulation was gold and silver it would be impossible to create those ruinous fluctuations in prices that cover the land with misery and desolation…The moment a spirit of speculation can be excited, the banks increase the flame by pouring oil upon it; the instant a reaction takes place they add to the distress a thousand fold.” Theophilus Fisk, Banking Bubble Burst, 1837

“The tendency of speculation is undoubtedly to widen the range of fluctuation, not only in the prices of the articles operated upon, but also of many others.” Colwell, Ways and Means of Payment, 1895

“Speculation is the only business that can be followed with money loaned of banks, and hence we always find that speculation is most rife, where banks are the most abundant.” Raymond, Elements of Political Economy, 1823

“(The) effect of too much bank capital upon the industry of the country is injurious, by encouraging the investment of money in temporary loans for purposes of speculation, instead of inducing permanent and productive investment.” Hooper, Currency or Money, 1855

“Projects for land banking…were by no means lacking long after commercial banks had been well established in this country. Similar schemes are, to be sure, advanced to this day by those who, though comfortable ignorance, mistake the archaic for the novel.” Miller, 1927, p. 129 (GSE “land bank” scheme?)

“Others feared that borrowing by the federal government and by the several states whose securities were made eligible (by law) would be facilitated by the creation of an artificial market for their stocks. Public extravagance would thus be fostered. The New York law, it was prophesied, would tend to ‘raise up a clamorous horde of advocates for a perpetual State loan and national debt, to supply the demand for public stocks.” Miller, 1927, p. 149 (A “prophesy” of the agency market?)

I am very impressed with the language used in the early analyses, with banks regarded for “their role as creators of an important form of media of payment, to the analysis that dealt with them as special agencies in the distribution of loanable funds.” “The significance of the role played by credit in the mutations of business prosperity was recognized by nearly all.” (Miller, 1924, p. 307). Extracting directly from Harry E. Miller’s 1924 article: “It is to the introduction of the credit system that these troubles must be laid. Credit was believed to play a three-fold part in producing crises. First, it enabled men to ‘overtrade’ in periods when mutual confidence was high. Secondly it formed a net-work of interrelations through which the insolvency of a few merchants involved a great many others in difficulty. ‘It is the practice of giving credit that implicates trading men so much with each other, so that one very often involves many others in his misfortunes or errors,’ Willard Phillips explained in 1819. Everyone depends more or less upon the ability and punctuality of his debtors for the means of meeting his own engagements…distress and insolvency thus tend to spread cumulatively… Finally, some emphasized the fact that the use of credit instruments in normal times furnishes a substitute for money, and that in troublous times insistence upon cash payment in lieu of credit formerly extended adds to the financial stringency…” (pp. 297-298)

“(From) Edward Everett… ‘If I mistake not,’ he wrote, ‘the distress of the year 1857 was produced by an enemy more formidable than hostile armies; by a pestilence more deadly than fever or plague; by a visitation more destructive than the frosts of Spring or the blights of Summer. I believe that it was caused by a mountain load of Debt.’ The payment of interest upon the huge amount of indebtedness – personal, business, and public – had proved too great a strain. The remedy was simply – keep out of debt.

Changes in the state of confidence in the business world were usually associated with the credit system in explaining crises… Phillips describes banks as ‘barometers to show the state of the commercial atmosphere,’ for ‘business will have its floods and ebbs, and the spirit of enterprise and production must necessarily be checked.’ He had explained earlier that when ‘from some change, people suddenly become more cautious and distrustful of each other,’ the break-down of the credit system results in a scarcity of money because of the unusual demand for cash payments. Professor Thomas R. Dew…and Albert Gallatin, among others, wrote similarly of the destruction of confidence by sudden shocks so that ‘credit no longer serves as cash.’” (p. 298)

“(William) Gouge observed in 1833 that, ‘Anything that excites the spirit of enterprise, has a tendency to increase the amount of Bank issues…As the wild spirit of speculation has in most cases its origin, and in all its ailment, in Banking transactions, these various causes operate in a circle.’ In 1842 he went into greater detail, following Raguet. A speculative demand for goods, however incited, raises prices, and at the same time, ‘leads to the creation of a large amount of new business paper. This is discounted by the bankers, and then prices undergo an additional rise, through the additions made to the currency. This leads to a new speculative demand, which causes the creation of more business paper, and that in its turn a fresh issue of banks notes; and thus things go on until prices are raised so high that an adverse balance of trade calls a halt.” (pp. 311-312)

“(Thomas) Dew seems to have had some understanding of the tendency of a particular industry to become unduly stimulated, attracting capital and labor from other lines until reaction begins a depression which spreads to all trades…Amasa Walker, after describing the period of rising prices and business activity, followed by that of falling prices and stagnation, declared that the activity of the boom period is primarily in speculation, not production… There is, in truth, ‘more change of occupation than increase of industry.’” …(George) Tucker agreed with Raguet, explaining that ‘by the suspension or diversion of industry from its usual employments, production is diminished, and, by creating notions of wealth which are fleeting and fallacious, consumption is increased.’” (pp. 314-316)

“Still another aspect of the situation at New York attracted attention – the deceptive qualities of the call loan. Call loans secured by stocks as collateral seem to have become popular with the banks of New York and Boston at an early date; but their mischievous influence received rather little comment before the panic of 1857 had imparted its many lessons… Raguet, in enumerating various abuses whereby banks seek to increase their earnings…the practice ‘adopted by many of the banks of New England, and perhaps of other places, of lending to brokers on interest, repayable on demand…’ (p. 327)

“Ezra C. Seaman, the historian, writing in December of 1857, included excessive resort to call loans in a...recounting of the varied causes which he considered responsible for the crisis that year. The keen observer (Edmund) Dwight went into further detail. Resort to ‘the treacherous resource of ‘call loans,’ delusive alike to the banks and the public,’ he termed ‘the great panic-making power.’ ‘Call loans with stock collaterals are put in the place of specie. The theory looks plausible as proposed by each separate bank. ‘If the balances are against us we can call in our loans – get checks on other banks – and thus obtain the needful coin at any moment.’ But in practice it is not so. The causes which alarm one bank alarm the whole. Upon any shock to confidence, they all call in at once. The stock collaterals are forced upon the market at the same moment that its ability to take them is almost destroyed by the total cessation on new loans.’ The prices of stocks collapse, while merchants are in turn adversely affected by the struggle of brokers for money to avoid sacrificing their holdings, and by the cessation of banks loans. The country banks share in the panic and the whole country becomes involved. By the operation of these call loans, million come suddenly due, and, while they ruin fortunes, they are comparatively impotent to strengthen the banks…” (pp. 327-328)

“The call-loan evil was referred to in the next few months by many others including the special committee appointed by the New York Clearing House Association immediately after the (1857) crisis, and a similar committee of the Boston Board of Trade…These criticisms of the specific conditions producing the crisis of that year, read in the light of what Raguet and others knew about the more general nature of the cycle, leave the reader feeling as if he had just turned from the comments of some economist of 1908 upon the crisis of the preceding year.” (pp. 328-329)

Little would Harry E. Miller likely have believed at the time he wrote his article, that by the end of the decade broker call loans would again play an instrumental role in fueling an historic stock market and economic Bubble turned devastating collapse. I wish I could mollify my view that an historic speculative Bubble has once again enveloped the U.S. securities markets and economy. Although the contemporary version encompasses the Credit and equity markets, as opposed to being isolated in the stock market, with the greatest source of speculative financing emanating from the “repo”-loan market, as compared to broker call loans.

The tragic irony of today’s predicament - with the Fed having evolved into the great nurturer and accommodator of leveraged speculation - is captured within one of Harry E. Miller’s footnotes: “Antipathy toward speculation is, of course, reflected in the Federal Reserve Act, with its discrimination against the collateral call loan and its purpose to lessen the financial dominance of New York. To some extent this was intensified by the undoubted financial evils associated with the call-loan market as it developed under the peculiar circumstances of the National Banking System. The local banks of France appeal to prejudice against speculation in their attempt to cope with the encroachment of the great credit companies. Patronage of the local institutions is urged in order to avoid centralization of capital in Paris from use in encouraging speculation rather than commerce and industry. The early writers had commodity speculation in mind, however; the present-day aversion is rather to stock speculation.” (1927, p.95)

I will conclude with the old adage, “The more things change, the more they remain the same.” It is also appropriate to paraphrase an apt comment I read awhile back (I regret I am unable to give proper attribution) that I am forced to paraphrase. “It is simply not true that people do not learn from history. But perhaps the problem is that they learn too much from recent history.” As such, the good news is that we literally have centuries of cogent analyses of money, Credit, speculation, and economics to draw from. Unfortunately, and for a variety a reasons, I think it is fair to view the past 35 years as a troubling aberration – including a distracting analytical diversion into “sophistication” and too often undue “complexity”. Surely, there is no precedent for this period’s confident adoption of a regime of inconvertible and unregulated money and Credit. Somewhere along the way we lost sight of the invaluable “basics” of monetary analysis.

For our final Harry E. Miller quote: “Throughout the whole of our period, the school that denied that banks can do more than lend on the one hand what they borrow on the other was very large… banks in their deposit and loan operations ‘only play the part of brokers in this matter, bringing borrowers and lenders together’.” (1927, p.80) Today, similar erroneous analysis remains entrenched with respect to “non-bank” lenders. There’s much analytical work to be done.

I almost discarded the following quote from Mr. McTeer and my too cynical by half comments regarding the unfolding Argentine crisis. I will attach them here at the end, but they certainly can be disregarded.

“I didn’t mean to put (in my speech) Argentina right after Europe, but you know there’s parallels. Argentina is a disaster right now. It’s a slow train wreck that we’re still watching. Ten years ago they had hyperinflation. I went down there in ’96 and went to a flea market and bought some currency – a handful of Argentine currency for $10. It was worthless. Around ’91 they pegged their Argentine peso to the dollar at a one-to-one basis to set up a currency board arrangement so the central bank couldn’t create pesos unless it had dollar reserves – a dollar for each peso created. That was killing inflation cold turkey. It worked; they went from hyperinflation to zero. In the ‘90s their inflation performance was a little better than ours, because they were pegged off the dollar. But the dollar kept getting stronger and stronger. Here they are tied to this dollar. And like Europe but worse, their internal institutions weren’t quite as good and flexible – their internal policies weren’t quite good enough to manage within that straightjacket that they were in. Particularly, they continued to run very large fiscal deficits, not just at the federal level but at a more local level. And their labor unions remain very strong and labor flexibility is pretty much lacking there as well as in Europe.

But I was there the first time in ’96. I think things were getting much better – they were in the middle of a boom. But their unemployment rate was still 17% and it’s gone up from that lately. They’ve been in recession for about four years now. They had two ways they could go. They could have strengthened that link to the dollar by going ahead and dollarizing – getting rid of their own currency and using the U.S. dollar as their currency. That would have helped them lower some interest rates. To the extent that interest rates were higher because of exchange risk, that would have eliminated that and interest rates would have been lower. On the other hand, it would have been a (inaudible) strong currency and having to suffer the consequences of having their currency strong when they are already not very competitive internationally. My conventional wisdom was that they had no choice but to stay with their peg or make it stronger with dollarization. Because of their history, they are sort of like an alcoholic who hasn’t had a drink in ten years. It’s all going to fall apart if they start drinking now. What they’ve done is they’ve just broken out the bottle.” Robert D. McTeer, President of Federal Reserve Bank of Dallas, January 8, 2002

What’s that expression about people living in glass houses and throwing stones? Argentina, like many nations (and certainly the U.S. to this day), borrowed in excess when the marketplace was overly accommodative. The outcome was a most regrettable and untenable Credit Bubble. When the speculative environment and related economic boom reversed, as they always do, Argentina’s dollar-linked Credit system ground to a halt. The economy followed. Much of the foreign-sourced finance then wanted out, but the dollars had long since been spent. The Argentines lost access to new finance, while at the same time faced with the unusual and problematic circumstance of suffering from an overvalued currency. They, unlike the U.S., did not enjoy the status of the world’s reserve currency, nor did they have the capacity to collapse domestic interest rates, incite stimulating speculation and Credit creation, whereby fostering an enormous “reliquefication” of their financial system. Their system specifically prohibited such processes that allow governmental and central bank (and financial systems) attempts to inflate out of trouble.

So I can’t resist expanding on Mr. McTeer’s “alcoholic” analogy: Having hit absolute “rock bottom,” Argentina understood clearly that it had an acute addiction problem and was willing to take the “hard medicine” to go “cold turkey” in the early ‘90s. It terminated alcohol consumption – over-expansion of its domestic money supply - with the introduction of a vaunted dollar-peg currency board program (“I am a monetary alcoholic…I will not use bank deposits…”), as prescribed by the U.S. and I.M.F “substance abuse physicians”. After a difficult “detox” period, the alcohol-free outpatient was rejuvenated and ecstatic to be off the bottle. Yet despite the reality that Argentina was becoming increasingly fond of those old-favorite little blue Credit pills, no one seemed to mind the little extra spring in Argentina’s step (“But don’t you dare take a sip of that devil’s potion!”). Indeed, the confident doctors as much as suggested that those little blue Credit pills were just rewards for “staying on the wagon.” From the get-go, the medical profession was more than happy to watch their pharmacist friends (a.k.a. little blue Credit pill “drug pushers”) excitedly run down to Argentina to walk the streets, make friends in the neighborhood, and hand out lots of free samples, while all the while preparing to deal in size. They’ve dealt in this neighborhood before, and with the introduction of this new “treatment program”…

Over time, not surprisingly, the craving for little blue Credit pills became intense, with Argentina quite willing to pay a high price to ensure an uninterrupted supply. The “profiteers” arrived in droves, having procured mountains of little blue Credit pills from lower-priced markets in the U.S., Europe and Japan to distribute to the increasingly insistent but outwardly composed addict. Everyone celebrated. The doctors were absolutely giddy with their obviously successful diagnosis and treatment. Then there were those “pushers,” more than content to deal under the auspices of the medical authorities. And, importantly, the patient was no longer a blustering, stumbling drunk, but was instead demonstrating a newfound energy, intensity – a refreshing vigor. The “pushers” and the “profiteers”, however, were becoming increasingly concerned. Not only had Argentina accumulated an enormous tab, it was becoming a more unstable customer.

As has become the accustomed “dealer” routine, they were on the lookout for “deadbeats” and ready to “cut bait.” The “pushers” terminated Argentina’s supply of little blue Credit pills and moved quickly to much “greener pastures” up north. To the helpless addict, the results were catastrophic. Knowing all too well the excruciating and unmanageable reactions in store, the acutely desperate addict is willing to do anything to ease the pain – all that matters is to get through each day – each hour. Meantime, the “doctors,” careful not to show any public alarm, remorse, or let slip any utterance that might implicate their malpractice, quickly distance themselves from the terribly ill. They’re sticking with their story: the original diagnosis and treatment were correct. It was the pathologic, once again, that succumbed to his affliction. To cover themselves, (from a safe distance) they are quick to publicly chastise the “alcoholic” for so senselessly having “broken out the bottle.” Yet those that recognize the illness and the popular delusions are terrified by the quantities of these blue Credit “horse pills” being devoured elsewhere. The “moral of the story” is that it is appropriate to fault Argentina, but there is plenty of blame to be shared by the lending and speculating communities, economic doctrine, the economic “puppet masters” and the global financial system generally. And, unfortunately, there are lots of other “addicts.”