10/25/2001 Allyn Abbott Young *

It was a liquidity charged marketplace this week, with surging stock prices, sinking credit market yields, and record corporate debt issuance. For the week, the Dow surged 4% and the S&P500 gained 3%. Economically sensitive issues performed well, with the Morgan Stanley Cyclical index jumping almost 5% and the Transports adding 3%. The Morgan Stanley Consumer index increased 1%, while the Utilities declined 2%. The broader market continued its recovery, as the small cap Russell 2000 gained 3% and the S&P400 Mid-Cap index increased 4%. The tech sector enjoyed strong gains, with the NASDAQ100 and Morgan Stanley High Tech indices jumping 8%, while the Semiconductors surged 13%. So far this month, these indices have jumped 25%, 25%, and 29%, respectively. This week, The Street.com Internet and NASDAQ Telecommunications indices gained 5% and 7%, increasing month-to-date gains to 36% and 10%. The Biotechs surged 15% this week, as October gains jumped to 28%. The S&P Bank index jumped 6% and the AMEX Securities Broker/Dealer index added 4%. With bullion dropping $2.40 this week, the HUI Gold index was about unchanged.

On the back of absolutely dismal economic news, the credit market enjoyed an exceptional week. Two-year Treasury yields sank 17 basis points to 2.58%, while 5 and 10-year yields declined 9 basis points to 3.72% and 4.52%. The long-bond saw its yield dip 9 basis points to 5.27%. The benchmark Fannie Mae mortgage-back security yield dropped 9 basis points, while 10-year agency yields generally dropped about 11 basis points. The benchmark 10-year dollar swap spread narrowed one to 66. The dollar index gained just under 1%.

Apparently, a desperate Argentina is considering going completely to a U.S. dollar standard, although it is difficult to see how such a dramatic move could be considered feasible politically or otherwise. Economy Minister Domingo Cavallo is currently in difficult negotiations with cash-strapped provincial governors to accept reduced federal government tax payments, and there is worry that if he fails to reach an accord he could be forced to step down. Bloomberg this afternoon reported that Argentina has been drawing on a credit line from J.P. Morgan Chase and 12 other international banks established five years ago, borrowing $500 million this week after drawing $1.3 billion last month. There is also increasing concern that commitment to the Hong Kong dollar peg could be waning, as currencies throughout Asia continue to act sick. From The Australian Financial Review, 25 October: "Talk of Asian Monetary Union Revived - In 1997 Asian currency stability was a hotly debated issue and it may resurface in 2001 as a matter for discussion. Although the turnover of foreign exchange dropped significantly in many Asian and Australasian countries between 1997 and 2001, the present economic downturn has caused liquidity problems for some currency markets. In this environment, it is easy to see why Robert Mundell raised the topic of a new Asian monetary union at the Asia Pacific Economic Co-operation summit meeting in Shanghai, China. A possible model would be to base the union on a US dollar bloc, which would also improve Asia’s attractiveness as an investment destination."

Broad money supply (M3) expanded another $8.4 billion last week, with year-to-date growth of $729 billion (13% rate over 41 weeks). Institutional Money Fund assets increased $10.8 billion, having now jumped $102.4 billion over the past four weeks. Year-to-date, Institutional Money Funds have surged $330 billion, an annualized growth rate of 54%. Broad money supply has increased $932.6 billion over the past 52 weeks (13.4%). Extraordinary liquidity has created strong demand for relatively strong corporate credits, with Ford (despite a recent rating downgrade) this week increasing the size of its bond issuance to $9.4 billion, the fifth largest corporate bond sale on record. With investors apparently clamoring for more, GMAC increased its bond issuance to $6 billion today. And while Ford Credit paid 270 basis points above Treasuries for its 10-year borrowings, GMAC paid as much at 282 basis points. According to Bloomberg, at $30.9 billion, it was a record week of total corporate bond issues.

Freddie Mac released its quarterly "Housing and Refinance Survey" this week. For the third quarter, 63% of borrowers who refinanced single-family mortgages increased their loan balances by five percent or more, compared to 58% during the second quarter. "As mortgage rates continued to fall…and average home values continued to rise, many homeowners found it advantageous to increase the amount of their loans when they refinanced," stated Freddie’s principal economist. The median age of the typical refinanced mortgage was 3.3 years, with an average appreciation of 19%. Considering the average home sales price today is about $190,000, one can get an idea of the significant amount of home price inflation available for extraction. Last week a Fannie Mae executive stated the average "cash out" at about $34,000.

The National Association of Realtors reported September existing home sales dropped almost 12% from August’s all-time record pace (5.54 million units) to an annualized rate of 4.89 million. This was about 5% below last year’s rate. Average (mean) prices dropped from $193,500 to $186,700, but remain about 5% above year ago. In a trend to monitor closely, year over year sales in the key Northeast and West regions were down 8% and 10%. September new homes sales were reported today at the softest level in over a year, with average prices weakening noticeably. And according to DataQuick Information Services (reported in the LA Times), September sales in the San Francisco-area were 26% below year ago levels, although prices remain up about 5%. Year-to-date, sales are down about 17% from last year. Nationwide, inventories of existing homes jumped to 5.4 months of sales, up from August 4.8 months and the highest in some time (4.6 months at the end of September 2000). Inventories of unsold home are up 200,000 units, or about 10%, from this time last year. It is also worth noting that housing permits have not seen a month over month increase since May, with September year over year starts down 6.4% (single family down 5.8%, multifamily declining 8%). And, importantly, the Mortgage Bankers Association index of purchase applications dropped to the lowest level since the (aberrational) final week of December, almost 12% below year ago levels. The tug-of-war between the Team of Low Rates and Ultra-Easy Mortgage Credit appears finally in the process of succumbing to Team Job Loss, Waning Confidence and Faltering Economy.

From the Sacramento Bee: "Gov. Gray David warned Thursday that the state may face a shortfall of up to $14 billion next year, and called on legislative leaders to prepare for a possible emergency session to address the worsening budget crisis." Such a deficit would represent 18% of revenues. Davis was quoted as saying, "We have tremendous demands on our public health system and enormous additional security costs and they are directly attributable to the attack on America. At some point down the road, the federal government better help us with those costs." Bloomberg quoted a managing director from Standard and Poor’s: "It’s gone south from where it was just a few weeks ago. It is surprising in that it’s much bigger but one of the reasons that we kept the state on negative outlook is that we felt that they were deteriorating with the recession and because we felt there was going to be a big hole to fill." Predicting a $71 million budget shortfall, the mayor of Los Angeles today ordered a hiring freeze.

October 23 – "Home equity loans hit a record high of 2.1% of charge-offs at the end of the second quarter 2001, following a year of rising delinquencies, compared to 1.9% a year earlier, reports Moody’s Investors Service in its most recent Home Equity Index Composite. ‘Subprime mortgages, which represent 80% of the index’s dollar value,

showed the most serious deterioration, reaching 11% of delinquencies, which will eventually lead to higher charge-offs,’ said Henry Engelken, Moody’s analyst…"

From a Wall Street research report commenting on Capital One’s optimistic business projections for the foreseeable future: "In the scenario where the 90% rise in loss scenario, in which 3Q02 losses increase to 7.5%, the company would receive even more benefit from higher delinquency related fees, cut marketing $350 million, and institute and/or raise some late and over limit fees from $29 to $35 dollars on selected accounts. The company suggested that in the worse case scenario -- which we estimate would correspond to a loss rate of over 12% -- it could cut marketing as much as $500 million, raise late and over limit fees, and reprice accounts to generate $1 billion in earnings. The company has less than 4% losses at present. From these scenario analyses, one can see why they are so optimistic about 20% earnings growth." Sure, and Providian’s customers looked very "profitable" as well… It is no problem to bill for late charges and other fees, while booking accounting "profits." It’s just not so easy – and getting much more difficult by the week - to collect them. Such practices can lead to nasty charge-offs and funding difficulties down the road…

From Market News International (Steven K. Beckner)- "Dallas Federal Reserve Bank research director and National Association for Business Economics (NABE) President Harvey Rosenblum said Tuesday an October survey of NABE members shows ‘the weakest economic performance and outlook’ in 22 years’… NABE, announcing the results of a survey of 126 of its business members, said ‘underlying demand at NABE panel firms turned negative in the third quarter, for the first time since the 1990-1991 recession.’ It said demand fell for every industry sector except consulting and other services… The group reported the following highlights of its survey: * Export demand declined in the third quarter, as well. * Current capital spending fell below that of the last recession. Only 17 percent of NABE firms reported increased capital spending, the lowest percentage in the history of the survey. * More NABE firms reported falling profit margins than rising margins for the fifth quarter in a row. * Employment declined, with 14 percent more firms decreasing employment than increasing. * Economic outlook: In a dramatic shift in the outlook, 90 percent of NABE industry panelists revised their forecasts for the second half of 2001 downward."

"Oct. 25 (Bloomberg) -- Concerns Enron Corp. will run short on cash haven’t prevented commodities traders from doing business with the largest energy broker, customers say. The company handles about 25 percent of U.S. power and natural-gas trading, said John Kilduff, vice president of energy risk management for Fimat USA. It’s also a leader in complex derivatives that allow others to hedge against the risk of fluctuating commodities prices. Enron’s credit rating is on watch for possible downgrade at Moody’s Investors Service, and Standard & Poor’s lowered Enron’s long-term credit outlook to negative after $1.01 billion in third-quarter losses from some soured investments. The company needs good credit to raise cash every day to keep trading partners from demanding collateral and to settle transactions. So far, there are no signs that Houston-based Enron is handling less business, Kilduff said. ‘If they were unable to perform, it would be a major problem,’ he said. ‘It could get like Long-Term Capital if things really broke down because the numbers are that big…’ Some investors are concerned that Enron’s complex book of hedges, swaps, options and other derivative contracts involves so many partners, participants and companies that a failure would pose a risk to the economy, and force a bailout like Long-Term Capital Management’s." Enron bonds came under pressure again today, as it was reported that liquidity issues forced the company to tap into its $3 billion credit line.

So we now have, at a minimum, three major operators in the "risk" market – Enron, Providian, and Conseco – very much at the precipice. These three combine for almost $150 billion of assets and significant off-balance sheet exposure. And with festering problems in CDOs and credit derivatives, systemic risk builds throughout the entire "structured finance" arena. It is important to recognize, however, that credit problems are worsening virtually across the board in the U.S., the unfortunate consequences of an inflated Bubble economy. Moreover, it appears that the major capital market borrowers are experiencing some of the most rapid deterioration.

(www.marketnews.com) – "Moody’s Lowers GM Ratings - Approximately $100 Bln Debt Securities Affected - Moody’s Investors Service lowered the long-term rating (from A2 to A3) and short-term ratings (from Prime-1 to Prime-2) of General Motors Corporation (GM), and confirmed the A2 long-term and Prime-1 short-term ratings of General Motors Acceptance Corporation. The rating outlook for both companies is negative… The downgrade of GM’s rating reflects the erosion in the company’s longer-term competitive position in North America. This erosion stems from the increasingly competitive environment in the high-margin U.S. SUV, light truck and minivan markets, which accounts for the majority of GM’s earnings and cash flow. Moreover, the returns generated by GM’s domestic car operations and its international business have been chronically poor."

It is troubling that General Motors (and Ford) did not emerge from the protracted boom with a stronger financial position. We are, today, early in the downswing and it is not beyond the realm of possibilities that the U.S. auto market is at the brink of a major slump. Currently, zero financing options and other significant incentive programs stoke sales, but even industry executives admit this is a dangerous course. Bloomberg quoted the CEO of DaimlerChrysler AG’s Chrysler unit as stating that these programs are "eating up our future." "We are afraid that what we are experiencing now is eating up our future in a couple weeks." From an analyst at Merrill Lynch: "The kind of decline in sales that is likely to occur once these sales programs end will push many companies below their break-even point." October sales are expected to be about 8% above last year’s level.

Oct. 23 (Bloomberg) – "Xerox Corp., the biggest copier company, said its third-quarter loss widened and sales are slowing. Standard & Poor’s Corp. reduced the company’s credit rating to junk because sales and profit will likely be lower than expected this year and next. The loss increased to $211 million, or 29 cents a share, from $191 million, or 30 cents, in the year-earlier period. Sales fell 13 percent to $3.9 billion from $4.5 billion, the company said in a statement. It’s Xerox’s fifth consecutive quarterly loss."

Oct. 25 (Bloomberg) – "AT&T Corp.’s senior debt and commercial paper ratings were cut by Moody’s Investors Service, which warned it may lower the No. 1 U.S. long distance telephone company’s ratings again. The rating on senior debt was cut to ‘A3,’ the seventh-highest of 10 investment grades, from ‘A2,’ the sixth-highest. On commercial paper, AT&T was cut to ‘P-2,’ the second-highest of three grades, from ‘P-1,’ the top short-term level. The reduction may limit AT&T borrowing in the commercial paper market… AT&T is the third-largest issuer of debt in the U.S. and has about $53 billion of debt securities outstanding, according to Moody’s. The company’s total debt had risen as high as $65 billion after Chief Executive C. Michael Armstrong spent more than $100 billion to make AT&T the largest U.S. cable TV company. The company then retreated from its strategy, deciding in October last year to sell off its wireless and broadband businesses and create a tracking stock for the consumer business."

Oct. 23 (Bloomberg): "Harris County-Houston Sports Authority, the builder of the new ($200 million) stadium for the Houston Rockets, may sell shorter-term debt than originally planned this year to keep down its borrowing costs after the Sept. 11 terrorist attacks drove up its bond yields… The Authority’s struggle to sell the debt underscore how the Sept. 11 attacks have pinched the finances of businesses that rely on tourism… " Also from Bloomberg: "Soccer’s World Cup needs to renegotiate insurance, one of the tennis Grand Slams lacks a title sponsor and Formula One teams fear going out of business. After a decade of riches fueled by television and advertising, the professional sports boom may be over. Even before the Sept. 11 terrorist attacks, broadcasters were looking to pay less for sports programming and companies were reining in sponsorship spending… ‘Sport is having to reevaluate fast since Sept. 11,’ said John Pritchard, managing director of London-based sports risk management company Long Reach International…" There have been enormous excesses throughout the sports and entertainment industries that will be problematic going forward. The financial positions of the scores of professional sports venues that have been built during this boom will likely now come into question, with ramifications for many municipalities and, in many cases, the credit insurance industry that stand behind the significant amount of debt issued.

I have never met or communicated with Perry G. Mehrling (professor of economics at the Barnard College of Columbia University), but I will again ("Mehrling on Minsky," October 27, 2000) highlight his work. And for anyone interested in garnering Hyman Minsky insights, I strongly recommend any of several exceptional articles written by Dr. Mehrling. He comprehends and articulates the intricacies of the great Minsky analysis like few others. I have, not casually, come to the opinion that Dr. Mehrling is brilliant. In the tradition of the great Charles Kindleberger, he combines a wonderful knowledge and appreciation for financial and economic history, a powerful understanding of the complexities of finance, an admirable social conscience, and a gift for writing that I can only dream of. There is a quality and generosity about his work (to the reader as well as to previous economists whose work he illuminates) that I find refreshing and quite endearing.

Importantly, he has an eye for recognizing the brilliance of (often non-mainstream) past economists, while at the same time possesses the deep and sound understanding of finance and economics that lead him directly to the critical economic issues of our day. It is a powerful combination. From the Introduction of his 1997 book The Money Interest and the Public Interest – American Monetary Thought, 1920-1970: "Historically, the experience of price instability in the world of low finance (e.g., falling commodity prices) brings forth proposals formulated in quantity theoretic language that the monetary authority should stabilize prices by controlling the quantity of money. Likewise, experience of price instability in the world of high finance (e.g., falling security prices) brings forth proposals formulated in credit theoretic terms that the authority should stabilize prices by controlling the quantity of credit…Underlying that practical debate, and only occasionally emerging into the light, is the more fundamental debate about what money is and how the monetary system works. At each historical conjuncture, the practical debate is resolved and some policy or other is adopted. But the more fundamental debate never ends because each tradition of monetary thought enjoys its own natural constituency, where it continues to survive regardless of the resolution of the practical debate." 5

"The development of American monetary thought since World War I cannot be fully understood without the appreciation for its origin in the prewar Progressive tradition. Most important, the Progressive tradition framed the central question for American thinkers: What is the proper function of the monetary system in a democratic society, and, more specifically, how can the money interest be aligned with the public interest?

"Throughout the history of economics, running in parallel with the quantity theoretic tradition, there has always been a second tradition that starts from credit and the world of wholesale trade and develops an alternative credit theory of money. One of the great insights of the credit tradition is that money is the highest form of credit. Credit is a promise to pay at some time in the future, and the quality of a particular credit depends both on what is promised and on the credibility of that promise."

Dr. Mehrling’s "strategy" was to look at the years 1920 to 1970 - a period of "enormous intellectual disequilibrium on the subject of money" – "through the eyes of three individuals from three successive generations of academic economic thought about money." The format works wonderfully, with Mehrling brilliantly meshing the contributions of his three subjects with his profound grasp of the subject matter. "The three intellectual biographies are linked not only by the common theme of understanding money but also by the Progressive tradition that informs the question all three ask about money, namely, How can the money interest be aligned with the public interest?…The history of American monetary thought that emerges is, therefore, also in part a history of the evolution of the monetary system from a system of commercial banking to one in which public credit, household credit, and a large array of non-bank financial intermediaries play an essential role."

Mehrling’s subjects were Americans Allyn Young, Alvin Hansen, and Edward Shaw. These are not household names, and I appreciative that the work of these outstanding men has been given heed. "All three men grew up in small-town, even rural, settings imbued with the Protestant value of individual responsibility for the common good…all three chose to build on their economics training by becoming devoted teachers, in the belief that education could be a powerful tool for social improvement…All three were interested in aligning the money interest with the public interest, and to do so they had to understand how money works... Each of the three contributed to our modern conception of democracy as a form of society that is compatible with the continued existence of the powerful forces of big business, big finance, and big government…As institutional economists, all three believed that the future is made by human action and directed by human intent. ...they must be recognized not only as economists and social scientists but also as good citizens and guardians of the public interest."

This week I will focus on the timeless (and pertinent!) work of Allyn Abbott Young, analysis and an individual I find fascinating. Born in Ohio in 1876, he moved with his family at an early age to South Dakota. Young attended the University of Wisconsin, where he studied economics under Richard T. Ely. "In his exploration of the terrain of economics, Young found a map missing one of the most obvious and everpresent features of the modern economy, namely, its monetary character…Young was that rare type of scholar whose bond with his field of study comes close to love, and who finds his life’s meaning in devotion to its service." 17

"Like Fisher…Young was interested in understanding the effects of money on prices. However, unlike Fisher, it was not so much the price level as it was distortions of the structure of relative prices that most concerned him… The repercussion of monetary interventions ‘upon banking, upon foreign trade, and upon business enterprise and industrial progress in general, are exceedingly complex matters…" Young’s preferred approach began with his own more disaggregated conception of money flows meeting commodity flows and establishing relative prices in individual markets. He argued that the effect of a proportionate increase in all money flows (not the quantity of money), holding constant commodity flows, must be to raise prices on average, but not all prices necessarily rise in the same proportion, and some individual prices may even fall…for Young the effect on average prices was not so significant as the effect on relative prices because in his mind it was distortion of relative prices that ultimately lay behind the phenomenon of business cycles."

"Unlike the quantity theorist, Young expressed little interest in stabilizing the money supply or the price level per se. Rather he hoped that by slowing credit expansions the central bank could moderate the distorting effect of expansion on the structure of prices and so moderate the kind of maladjustment that ultimately caused crises. For Young, complete stabilization was probably impossible and even in a sense undesirable because, much like (Wesley C.) Mitchell, Young understood the business cycle, even in its monetary aspect, as an integral part of the organic process of economic development."43

"For Young, the flow of money and credit in the markets for individual commodities was not just a symbol of the system’s unity but also even more the very mechanism through which that unity was achieved. Similarly, the rhythm of credit expansion and contraction during business cycles was not just a symptom of the economy’s underlying organic development but also and even more the integral agency of that development. For Young, the modern economy was monetary in an essential way, and he drew the conclusion that the theory of money would provide the essential key to understanding the workings of that economy." 45

"…Young believed strongly in the importance of a monetary standard, and he judged that in the conditions then prevailing the standard would have to be gold…The first point – that the monetary standard provides a fixed point for the entire structure of money prices – is characteristic of Young’s thought. Taking to heart Adam Smith’s view of the importance of the ‘extent of the market,’ Young viewed economic development as a cumulative process in which a widening market opens up opportunities for improved production methods, the adoption of which then cheapens goods and makes possible a further widening of the market. In Young’s mind, the adoption of a monetary standard, and with it an integrated price system, was a crucial step in the creation of a wide market because it enabled individual businesses to reach out to distant areas, thus stimulating both their individual development and economic progress more generally…Young argued that a monetary standard is essential for the long-term coherence of the economic system because it makes economic calculation possible and so supports the complex structure of contracts that links different business together." 55

"Young’s second point is that a monetary standard plays a crucial role as the definite substance in which other forms of money are ultimately payable. ‘The significant thing is that all other kinds of money are exchangeable, directly or indirectly, for gold coin.’ For Young, money was above all a promise to pay the monetary standard, and any particular form of money gained its currency from the credibility of its promise…Young opposed proposals for a managed fiat currency on the grounds that without any definite commitment to repay the temptation to overissue would be irresistible. And even if resisted by the current government, speculators could easily cause ruinous depreciation by their expectations about the actions of future governments. A credible commitment to repay avoids both such problems." 56

"The third point is that a monetary standard is important as the ultimate reserve used to settle clearing balances because the payment of such balances performs a critical regulatory function for the economic system as a whole. Young saw the institution of banking as essentially a system for clearing credits and debts…All along the clearing hierarchy, it is the responsibility of banks to settle at the clearing that forces them to take account of their own position in the larger economic system and to behave in such a way as to create and maintain coherence in that larger system… From this banking point of view, the massive gold flows of the postwar period seemed to Young more a symptom of disorder than a mechanism for correcting it. The loss of gold for a country was, in this respect, analogous to the loss of reserves for a bank, an indication that something about the country’s economic behavior is out of line with its actual position in the larger world system, a warning that action is needed…" 56

"A continuing puzzle, responsible for much internal Fed discussion during the 1920s, was the question whether the business cycle was fundamentally a productive cycle (and hence to be passively accommodated), or a speculative cycle (and hence to be actively counteracted). Influenced perhaps by the prewar experience of occasional financial crises, the dominant view seems to have been that for most of the cycle passive accommodation is appropriate, but that careful monitoring and quick action is required to stem incipient speculative tendencies before they have a chance to take hold. In the minds of Fed economists, speculation was perhaps like tuberculosis, a disease with which it is possible to live provided that flare-ups are treated promptly. The practical problem of distinguishing productive from speculative credit was all the more difficult because the cyclical patterns were overlaid on a secular trend that was transforming the nature of banking assets." 70

"For controlling business fluctuations, Young’s view that the structure of demand was a monetary phenomenon led him to conclude that the monetary system was the most likely location of an ‘instrument of control’…From this staring point, Young was naturally drawn to the work of Ralph Hawtrey…What particularly set Hawtrey apart from other monetary theorists was his treatment of currency as subordinate to credit, a treatment he justified on grounds of realism… For Hawtrey, active central control of credit was especially important because of the natural instability of credit. In his view, credit, left to its own devices, tends to fluctuate widely, carrying the rest of the economy with it. An initial expansion of credit-financed spending leads to rising prices. Rising prices lead to increased demand for credit to finance larger holdings of appreciating inventories. Accommodation of these credit demands by banks then leads to additional spending, additional price increases, and additional credit demand in an unstable upward spiral." 72

"Unlike Hawtrey, Young did not view the business cycle as monetary in origin. He argued that a business expansion proceeds on the basis of certain expectations about the future, expectations that eventually turnout for many firms to be mistaken. As mistakes build up in the economy, the structure of production increasingly mismatches the structure of demand until the strain causes a downturn in business. ‘On the strength of the estimated size and character of the market, a vast system of production is built up, held together largely by contracts – agreements to deliver, to buy or to sell, and to pay…A crisis comes when the system of contracts breaks down, proving that mistakes have been made in estimating the quantity and character of the goods consumers will purchase at prices profitable to producers and dealers.’" 75

"Even before 1913, cyclical credit fluctuations involved a strong alternation between New York and the country banks…Money was thus both cause and effect at different times in the cycle and in different places in the system. ‘ Money flows back to the interior, we might say, because loans and deposits have expanded there. Loans and discounts expand in New York because money has flowed there." (Institutional money funds?) 77

"An institutionalist by training, Young viewed the world as an evolving organism and saw economic reform as a way of guiding its evolution, not as a way of changing the nature of the organism. A progressive reformer, Young was nevertheless a conservative in the sense that he saw reform as essentially incremental, always building on existing patterns. Young believed with Marshall that ‘natura non facit saltum’ – nature does not makes jumps – and even when analyzing the dramatic events of the world war, it was continuity, not change, that most impressed him."80

Allyn Young wrote on a variety of subjects, and an excellent collection of his work has been compiled (edited) by Perry G. Mehrling and Roger J. Sandilands, Money and Growth – Selected papers of Allyn Abbott Young, 1999. The following are extracts from several of these articles:

From Monetary System of the U.S., The Book of Popular Science, 1924: "From 1897 down to the eve of the Great War, the general trend of prices in all gold-using countries was upward. Cheap money movements are always children of periods of falling prices. Rising prices, by stimulating business activities, by favoring the borrower – the active user of capital – as against the creditor, do not breed general political and social disaffection, even though they may occasion as much economic injustice and in the long run may do as much harm as occurs in periods of falling prices. The gold standard, by this test, is far from ideal. Its strongest claim is not that it gives stability in prices, but that it is, one might say, automatic in its operations. If we must have general fluctuations in prices, alternating movements up and down, it is better that these should be governed by the changes in the output of a relatively stable commodity, like gold, than that they should be the outcome of political manipulation or of arbitrary adjustment of any sort whatever. It may be said for the gold standard, not that it is perfect, but that it is measurably ‘fool-proof.’"

From Money and Prices – How Unstable Prices Work Havoc to Industry and Injustice to Individuals, The Book of Popular Science, 1924: "Crises, that is, were thought to be psychological in origin. Enthusiasm and over-optimism were contagious; expansion was carried too far; and the crisis itself might in turn be intensified by the similarly contagious qualities of pessimism. There are men even today who believe that psychology is the root of the matter, that business would be good if business men and buyers could only hypnotize themselves into believing it to be good, that the only thing responsible for a crisis is a general ‘loss of confidence’…the economics which seem to be responsible are found in the operations of credit and banking. There could be no business cycle if there were no business contracts or no debts. A crisis occurs when men are unable to fulfill their contracts or to pay their debts…"

"In the first place, the economic changes of the period of expansion are qualitative as well as quantitative. It is not merely the sum total of wealth produced which changes. It comes to be distributed in a new way… Now, of course, such swift and dramatic changes in the distribution of wealth as accompany a period of sharply rising prices are in themselves unwholesome. And furthermore, these changes tend to undermine the solidity of the whole business structure. For the industries of a country are highly specialized. Rapid changes in the distribution of wealth result in unforeseen changes in the demand for the products of industry…"

From Mobilizing Bank Credit – The Drastic Reform of the Banking System of the United States – Possibilities of the Federal Reserve, The Book of Popular Science, 1924: "Reference has been made above to the open market operations of the federal reserve banks. These are likely to prove of increasing importance in the future. It is urgently hoped that the federal reserve system may be able not only to lessen the acuteness of periods of financial crisis by insuring that in time of financial drought the springs of credit shall not be dried up, but also that it will be able to correct some of the defects in our economic system that are primarily responsible for our recurrent panics. If a man is to fall over a precipice, he is fortunate if his fall can be broken or cushioned in some way. But he would have been yet more fortunate if someone had held him back before he came to the edge of the precipice. A wisely ordered banking system would tend to check and dampen the periods of overoptimism and of too rapid business expansion, as well as to relieve the severity of the ensuing periods of depression. Just as it is sound national banking policy to lend freely to necessitous borrowers in times of depression, so it is an equally sound policy to retard the flow of credit in periods when rapidly advancing prices are tending to overstimulate business."

From the "Editors’ Preface’: "Young found it hard to overestimate the importance of the establishment of the Federal Reserve System…For Young, the establishment of the Fed was about much more than mere technical improvements in the operation of the monetary system…The Federal Reserve System took over the instruments designed in the very heart of the money power, and ensured that hereafter they would be utilized for the public interest. A triumph of economics over politics, and of the general interest over merely sectional interest, the Fed would be a force for stability not so much on account of its wise intervention, since it would inevitably err, and not so much on account of its strong control over the system, since its control was anything but strong. Rather, the real importance of the Fed, according to Young, was that no longer would monetary issues be treated as a ‘football of politics.’ Stability would come first and foremost from the fact that, given the institution of the Fed, speculators had less reason than ever before to doubt the government’s willingness and ability to do what needed to be done. It was to be expected, therefore, that what speculation remained would overwhelmingly be of the ‘prudent’ sort that operates to stabilize markets, not to destabilize them. Having been for so long a source of monetary instability for the world economy, the United States became after the establishment of the Fed the great bastion of stability…"

For a wonderful man who devoted a lifetime of service to his love of economics, he would be today left terribly heartbroken. But he clearly understood the issues…

"The problems of economic science, unlike those of the natural sciences, have the bad habit of getting into politics... The fundamental difficulty with political solutions of the problems of economic science is that they are likely to be arrived at not by scientific analysis but as a result of a test of the strength of different opposed economic interests…It is unfortunate that the particular monetary problem which has most often been the football of politics is perhaps the most difficult and elusive of all economic problems, namely, the problem of the value or general purchasing power of money."

Brilliant! Thanks to Allyn Abbott Young. Thank you Peter G. Mehrling!

Amazon links:

The Money Interest and the Public Interest

Money and Growth- Selected Papers of Allyn Abbott Young