A Flawed History of Doom
One of my borrower customers told me a long time ago, “builders build, when lenders lend.” That could have been the title of Richard Vague’s new book. Instead, his book is entitled “A Brief History of Doom: Two Hundred Years of Financial Crisis.”
If you’re looking for academic theory to explain boom and bust episodes, a reader won’t find much in Mr. Vague’s very readable chronology of the last couple hundred years of irrational exuberance and inevitable crashes.
The author has run a couple of banks and is currently managing partner of Gabriel Investments, an early stage venture capital fund, and chair of The Governor's Woods Foundation, a non-profit philanthropic organization.
His simple conclusion is “Runaway private debt and the resulting overcapacity does a better job than any other variable in explaining and predicting financial crises.” The author’s only mention of business cycle theory is to give a hat tip to Hyman Minsky’s devolution of loan quality during the boom phase from “hedge” to “speculative” to “Ponzi.”
Whether its real estate or railroads, both, or something else, lenders and borrowers, over and over believe there is no end to future demand and thus lend and borrow to excess. “Hence delusion, especially self-delusion, is also a prerequisite for a financial crisis, even if it is delusion couched in carefully extrapolated graphs and serious, high-toned presentations,” writes Vague.
So, how much is too much? Vague says if private debt to GDP grows at 15 to 20 percent or more over a five year period and the overall ratio hits 150 percent, a financial crisis is on it’s way. The author makes no criticisms of fractionalized banking or central bank interest rate manipulation. His view is lenders become too promiscuous and the engendered boom turns to bust. There is no discussion of interest rates below the natural rate or malinvestment.
Vague’s history is richly footnoted, however, the Austrian school, which has provided the most clarity on explaining booms and busts is not mentioned once. For instance, Vague writes of the 1819 crisis and the Great Depression, but foundational texts about those two episodes, Murray Rothbard’s The Panic of 1819 and America’s Great Depression are not cited.
Vague’s telling of FDR’s gold confiscation in 1933 provides his point of view. “Roosevelt stopped loan contraction with his monumental April 1933 decision to discontinue private ownership of gold,” gushes Vague. He goes on to claim, “ Instead of people withdrawing deposits from banks or using currency to buy and hoard gold, they were required to deposit all their gold.” “The executive order immediately brought hundreds of millions of dollars of deposits back into the banking system as Americans compliantly deposited their gold…”
Reading Vague, one might think Americans happily took their gold to their bank. The bank would then credit their account $20.67 for each ounce, and the banking would loan the deposits out and the depression must have ended. Except it didn’t happen like that.
The great Isabel Paterson wrote of FDR’s gold seizure,
Never shall we forget the line of women we saw turning in their savings, under threat of ten years in jail and ten thousand dollars fine, while the multimillionaire Senator Couzens stood up bravely on the floor of the Senate and promised to "hunt them down" if they tried to hold out a few dollars.
Rothbard, in “A History of Money and Banking in the United States: The Colonial Era to World War II,” described FDR’s confiscation as a “revolutionary deed.” Roosevelt “confiscate(d) almost all the gold of American citizens and place(d) it under the ownership of the Federal reserve” and then devalued the dollar to $35 per ounce after forcing the citizenry to accept $20.67 per ounce.
Rothbard cites a letter economist and inflationist, Irving Fisher, wrote to his wife after the confiscation. “Now I am sure--as far as we ever can be sure of anything--that we are going to snap out of this depression fast. I am now one of the happiest men in the world.”
Fisher was counting on the inflated dollar to goose the stock market where he had invested all of his wife’s and sister-in-law’s fortunes. However, the stock market continued to sink. The depression would last until the end of the decade.
Later Vague writes this whooper: “In the end, the increased economic activity surrounding World War II boosted the country all the way out of the Depression. This was not an unprecedented salve. The recovery from earlier U.S. depressions had been much aided by such things as the onset of war and its expenditures.”
Robert Higgs debunked the war-fixes-depression theory long ago. Art Carden, in a piece highlighting Higgs’ work on the subject, wrote on mises.org ,
As Higgs points out, because of the array of interventions in the wartime economy, war materiel was valued incorrectly and therefore the GDP data overstate economic conditions. Moreover, conscription and arms production gave a misleading employment picture. Instead, Higgs argues, the war was a period of capital consumption rather than capital accumulation. Tanks, bombs, and helicopters have limited uses outside of military applications. The labor that was used to produce them was not available to produce consumer goods and services; in fact, people went without consumer goods. The warships at the bottom of the world's oceans represented lost opportunities for real consumption and prosperity. Conflict is sometimes necessary, but we should recognize what wartime expenditures represent: destruction of life and resources. If a depression constitutes a widespread contraction in living standards, then the Great Depression cannot have ended during the war.
In his conclusion, the author writes (in the winter of 2018) a financial crisis is not imminent because debt-to-GDP growth is not high enough, and don’t worry about China because “China has remarkable and demonstrated expertise in finding ways to remediate its lending institutions when they have excessive bad debt.”
Those theories are about to be tested; good and hard.