JULY 2018

JULY 2018
One Hundred Years Later, Same Message. 1916 - 2017


Wednesday, October 23, 2013


I have said it before, and I say it again - letting an economist graduate without a minor in psychology, is like allowing a doctor to become board certified without knowing how to identify their own colon. The original psychologically impaired financial genius was David Ricardo (above). In 1785 the 14 year old David joined his father Abraham's successful brokerage firm in London. David showed an affinity for the business, including the profitable sideline of lending money to his clients. He steadily built a small fortune of his own, until, in 1794, the 21 year old eloped with the 25 year old Priscilla Anne Wilkinson, which precipitated a complete business and familial split with David's father.

The problem was her family were Quaker Christians, while his were Jewish Orthodox. And forced to choose between the woman he loved and the faith of his father, David chose Priscilla. That the marriage was based on passion is hinted at by the 11 children David and Priscilla produced over the next 11 years of their 35 year marriage. But after the marriage David's father disinherited his third born child and forbade all family contact with him. David never spoke with either of his parents again. The finality of the break hints at two men with a rigid absolutist self assurance in their own vision. It was obvious David was destined for a career as an economist.
David's second career began in December of 1799 when the 27 year old millionaire read Adam Smith's bone dry book, “The Wealth of Nations”. In this verbose work, the Scotsman argued the greedy selfish practitioners of capitalism were actually useful to society because en mass they were being directed by an “invisible hand” toward doing the public good. But what David Ricardo read was slightly different. To his eye the lesson was that individually the greedy capitalists, such as the successful David Ricardo, were good. Smith's invisible hand became a mystical incantation invoked in the abstract as justification, but legislated against in the actuality. What had motivated Ricardo to finally read “Wealth of Nations'” a quarter of a century after it was first published, was known as the gold crises.
A generation's on again, off again wars with France stretched Britain’s finances to the breaking point. And after two particularly disastrous years, in 1795 and 1796, Britain had a 22 million pound deficit. With the economy and the banking system frozen near collapse, the government became desperate enough to introduce the Restrictive Act in 1797, which for the first time established paper money as legal tender, and put a limit on gold (then referred to as 'cash') withdrawals from the private-public conglomerate Bank of England. It was not much of a limit – 75% of personal gold could still be withdrawn. But the Restrictive Act was still considered so radical the ruling class had built in a time limit. The act would automatically expire in five years.
To David Ricardo the act was an outrageous violation of the “free market” and every business principle he knew. And, of course, he had suddenly lost direct access to a quarter of his 'cash', and was prevented from from demanding repayment of loans in “cash”. David was so angry he even struggled through the tangled web of Adam Smith's book, looking for a rationalization for his anger. And he found it.
David's problem was the Restrictive Act worked. Prices for food and goods stabilized, and despite predictions, gold poured back into the Bank of England. The act was so successful that in 1802 it was extended for another five years, even though England was now technically at peace. The lender class was burning with indignation. To men such as David Ricardo, it did not matter that the paper currency was working for consumers and industrialists. It did not matter that gold deposits were increasing at the Bank of England. The Act was not working for him, and thus it was not working. And he and his “monoterist” allies came up with a long list of ideological explanations as to why, despite the evidence, paper money was a failure.
In 1806 the new French Emperor Napoleon Bonaparte led his grand army into Austria, capturing an entire Austrian army and Vienna, and then smashing a combined Austrian and Russian army at Austerlitz. This victory gave France control of Europe, which was then closed to all British trade. This renewal of the war increased spending to 15 million pounds a year, and despite more “outragous taxes” capping out at 10%, forced the government accounts three million pounds in the red.
The economic disruption created a political opening, into which, in 1810, David Ricardo dispatched his first book on economics: “The High Price of Bullion, a Proof of the Depreciation of Bank Notes.” In it he argued that the Royal Mint's program of releasing quantities of new one and five pound notes – what modern economists would call cheap money - had made all pound notes worth less, or devalued the currency as a whole. As proof David pointed out that the price of an ounce of gold was higher at the European gold market in Hanover, Germany, than in London, which meant the English pound notes were worth less.
The directors of the Bank of England, which ran the mint, responded that it was the growing economy that was pushing the volume of paper currency up, not the reverse. Besides, they asserted, the alleged price variation between London and Hanover was actually a fluctuation in the local value of gold, not the value of the paper money. An ounce of gold was still worth no more than an ounce of gold in either market. But since the Bank of England now had more gold than the Hanover banks, you would expect an ounce of gold would cost more in Hanover. Despite the logic of the Bank's arguments, the bankers and money lenders in Parliament, such as David Ricardo, sitting on the “Bullion Committee” still called for a return to “hard” currency, not so they could profit from it (although they would), but because it was good policy. Still the members of parliament overwhelmingly voted down the committee's suggestions. And the economy kept improving.
By 1815 this hard money movement finally had enough politically clout to convince the Bank of England to reduce the supply of paper money. As predicted by the industrialists, that caused the economy to hiccup. Prices began to fall in 1819, when the Restrictive Act was repealed. In the next two years 89 regional and county banks failed across Britain. The unemployment rate climbed. And that allowed Ricardo and his allies to push for cutting the amount of paper money in circulation. As modern Nobel winning economist Paul Krugman puts it, “Fiscal policy that focuses on deficits rather than on job creation...serves the interests of creditors...(who) want governments to make honoring their debts the highest priority..” And that, in a nutshell, was the economic thought of David Ricardo.
In 1820 the Bank of England began reducing the supply of five pound notes in circulation, from 4 million pounds worth, to, by 1822, less than a million pounds worth. The contraction hit the fan in January of 1825. It started with a series of runs on small regional banks, eventually spreading to larger banks even in London, with customers desperately trying to withdraw their funds. That terrible year another 70 banks failed. That not everyone agreed with David Ricardo's policy is shown when you read the contemporary economist and politician Thomas Attwood, from Birmingham. He witnessed the Panic of 1825 and charged the banker friendly return of the gold standard had created “More misery, more poverty, more discord...than Attila caused in the Roman Empire.”
The loss of money in circulation cut demand, and the loss of demand threw hundreds of thousands out of work. Industrialists complained full employment had been sacrificed to Ricardo's “sound money” program. The directors of the Bank of England, which had become the central bank for England's economy, much as the Federal Reserve is for today's American economy, merely clicked their tongues in moral disapproval of those whose lives had been destroyed. But the panic refused to stop at the suckers window.
The same ideological dogma would lead to a panic again in 2007, when Lehman Brothers banking and brokerage house was allowed to fail, because it was seen as having violated the “moral hazard” rule. But that failure led to a panic which destroyed confidence in the entire banking system. Back in 1825, by December even the directors of the Bank of England were forced to step in, if to save no one else, to save their friends and people their knew. The Bank of England became the “lender of last resort”, printing new paper notes to pay debts that exceeded the failing banks' gold reserves. And with those guarantees, the panic subsided.
Logic would seem to demand that David Ricardo be noted in economic texts as a selfish short sighted fool, who thought that which favored him, favored all, and whose theories produced far more economic misery than success. But that is not the case. Another Nobel Prize winning economist, John Maynard Keynes, admitted to being perplexed as to why Ricardian economics “conquered England as completely as the Holy Inquisition conquered Spain." And Ricardian theory is setting today's conservative agenda. Why? Keynes suggests several reasons: “That it reached conclusions quite different from what the (average)...person would expect, added...to its intellectual prestige. That...translated into practice (it was), was austere...lent it virtue....That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress...commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.”
In other words, what Ricardo thought made money for the bankers. He preached that government was the enemy of business. His Iron Law said increasing wages was actually bad for the workers. And when David Ricardo died in 1823, two years before the panic that proved him wrong, he left an estate valued at over 600,000 pounds (about $100 million today.) And to bankers that is the final judgement as to the accuracy of his views.
 And that is just nuts.
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