Stephen King: Roosevelt's lesson... a decisive act to break the psychology of depression
[Stephen King is managing director of economics at HSBC.]
...The nuclear option is to bypass the banking system altogether. In effect, this is what President Roosevelt did in 1933 and 1934. If banks are unwilling to lend to each other and, thus, unable to lend to non-banks, governments can elect to turn themselves into banks. After all, during a banking crisis, people are typically happier to hold cash and government bonds than anything else. The desire to avoid financial losses absolutely dominates, and the best avoidance scheme is to rely on the taxpayer: government bonds are attractive in these circumstances because governments in the developed world, at least, will always coerce their taxpayers to repay creditors. During banking crises, governments can, therefore, raise funds relatively cheaply.
They can do even more. They can also choose to monetise government debt, by selling bonds to the central bank rather than to the public. By doing so, governments can flood an economy with money. At a stroke, the perceived monetary shortage which leads to hoarding, bank runs and a financial climate of fear can be removed. Moreover, with excess money, other assets suddenly look more interesting, at least in nominal terms.
If, though, the banking system is in a mess, how does a government get money into the economy? The answer is simple: either tax cuts or, even better, big increases in government spending. In the first two years of the Roosevelt administration, government spending increased by 80 per cent. If ever there was a decisive act designed to break the psychology of depression, that was it.
If, though, this is the ultimate "do", what about the "don'ts"?
First, central banks should not defend their independence at all costs. This, after all, is what the Federal Reserve did during the Hoover administration at the beginning of the 1930s. The approach was a hopeless failure. During banking crises, central banks lose their power. To restore it, they need, and should ask for, fiscal help.
Second, each central bank should, ideally, speak with one voice. Better, in my view, to show strong leadership than to advertise publicly a collection of disparate views which can only sow the seeds of doubt throughout the financial system. After years of success in highlighting the nuances of the economic debate, we're now seeing the downside to the Bank of England's committee system.
Third, under no circumstances should countries resort to capital market protectionism. The Irish government's offer to underwrite deposits in Irish banks (and, hence, to protect the Irish banks' interests) is an unfortunate precedent (it would be far better if all countries were to offer deposit guarantees simultaneously, but that hasn't happened). It's reminiscent of the Smoot-Hawley tariff in 1930, designed to protect the interests of American exporters but, ultimately, a contributor to the subsequent collapse in world trade. Others were forced to launch their own "beggar-thy-neighbour" policies, contributing to a global economic collapse and, tragically, fanning the flames of fascism. We don't want to go down that route again.
Read entire article at Independent (UK)
...The nuclear option is to bypass the banking system altogether. In effect, this is what President Roosevelt did in 1933 and 1934. If banks are unwilling to lend to each other and, thus, unable to lend to non-banks, governments can elect to turn themselves into banks. After all, during a banking crisis, people are typically happier to hold cash and government bonds than anything else. The desire to avoid financial losses absolutely dominates, and the best avoidance scheme is to rely on the taxpayer: government bonds are attractive in these circumstances because governments in the developed world, at least, will always coerce their taxpayers to repay creditors. During banking crises, governments can, therefore, raise funds relatively cheaply.
They can do even more. They can also choose to monetise government debt, by selling bonds to the central bank rather than to the public. By doing so, governments can flood an economy with money. At a stroke, the perceived monetary shortage which leads to hoarding, bank runs and a financial climate of fear can be removed. Moreover, with excess money, other assets suddenly look more interesting, at least in nominal terms.
If, though, the banking system is in a mess, how does a government get money into the economy? The answer is simple: either tax cuts or, even better, big increases in government spending. In the first two years of the Roosevelt administration, government spending increased by 80 per cent. If ever there was a decisive act designed to break the psychology of depression, that was it.
If, though, this is the ultimate "do", what about the "don'ts"?
First, central banks should not defend their independence at all costs. This, after all, is what the Federal Reserve did during the Hoover administration at the beginning of the 1930s. The approach was a hopeless failure. During banking crises, central banks lose their power. To restore it, they need, and should ask for, fiscal help.
Second, each central bank should, ideally, speak with one voice. Better, in my view, to show strong leadership than to advertise publicly a collection of disparate views which can only sow the seeds of doubt throughout the financial system. After years of success in highlighting the nuances of the economic debate, we're now seeing the downside to the Bank of England's committee system.
Third, under no circumstances should countries resort to capital market protectionism. The Irish government's offer to underwrite deposits in Irish banks (and, hence, to protect the Irish banks' interests) is an unfortunate precedent (it would be far better if all countries were to offer deposit guarantees simultaneously, but that hasn't happened). It's reminiscent of the Smoot-Hawley tariff in 1930, designed to protect the interests of American exporters but, ultimately, a contributor to the subsequent collapse in world trade. Others were forced to launch their own "beggar-thy-neighbour" policies, contributing to a global economic collapse and, tragically, fanning the flames of fascism. We don't want to go down that route again.