Bernanke: Fed actions prevented a depression

Lectures at GW a lesson in history

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For Americans who have forgotten, or who never knew, how much worse things could get — shantytowns, gnawing hunger and a desperate 1 in 4 people out of work — Federal Reserve Chairman Ben S. Bernanke is providing a reminder.

In a series of four lectures he is delivering at George Washington University this month, the one-time Princeton professor and renowned specialist on the Great Depression is expounding on the horrors of the Depression and how the austerity policies of the central bank at the time made things worse.

Lessons learned from the 1930s debacle led to more enlightened central bank practices in the subsequent decades that nurtured prosperity. But some conservatives say Mr. Bernanke has gone to the other extreme with lenient policies in his drive to nudge a healthier recovery from a stubbornly slow-growing economy.

The first-ever such lectures by a sitting Fed chairman present a subtle pushback against such criticism, spearheaded by Rep. Ron Paul of Texas but endorsed to one degree or another by most of the other Republican presidential candidates. President Obama and most Democrats view Mr. Bernanke as a hero who likely averted a second depression.

The easily understandable lessons, and the videos of the lectures that the Fed is making available to the public on its website, suggest that Mr. Bernanke’s target audience is the generation of young people attending college who grew up in affluence and know little about the Depression, as well as many parents and older folks who seem to have forgotten its bitter lessons.

But there’s no amnesia at the Fed. Mr. Bernanke makes it clear that as long as he is chairman, he will not let the central bank repeat the devastating mistakes that made the Depression so painful for a whole generation of Americans.

“The Great Depression informed the Fed’s actions and decisions in the recent crisis,” he said in his opening remarks, noting the Fed’s multiple missteps during the 1930s in failing to stem the financial panics, bank runs and economic downspiral that created such desperate conditions.

In the years after the great stock crash of 1929, as the Fed stood by, unemployment soared to 25 percent, stocks lost 85 percent of their value, the economy shrank by one-third, prices fell by 10 percent and nearly 10,000 banks collapsed, he said, underscoring the economic devastation with dramatic graphics provided on the Fed’s website. In the truly worldwide collapse of the early 1930s, other countries, especially Germany, had it even worse.

Why the Fed failed

“The Fed failed” to carry out its missions, Mr. Bernanke said. “It did not ease monetary policy for a variety of reasons,” including wanting to stop speculation in the stock currency markets and trying to uphold the gold standard, which dictated the value of the dollar at the time, he said.

“Part of the problem was intellectual,” he added.

At the time, the Fed subscribed to the “liquidationist” philosophy of President Hoover’s administration, which held that too much credit was fueling market bubbles and the economy during the Roaring ‘20s, and the excesses had to be squeezed out through fire sales of highly leveraged assets such as real estate and stocks.

As Mr. Bernanke noted, Hoover administration Treasury Secretary Andrew W. Mellon famously advised the president to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate” to rid the economy of too much debt.

Hoover subscribed to Mellon’s theory that a financial panic was not such a bad thing.

“It will purge the rottenness out of the system,” the president said. “People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.”

Eighty years later, it “sounds pretty heartless, and it was,” Mr. Bernanke said. Millions of people were thrown out of work and tossed from their homes and farms into the streets.

Some conservatives have propounded a similar philosophy, saying the Fed should not have prevented banks and Wall Street firms from failing in 2008, and the government should not have tried to stop the downward spiral in financial markets and housing that — even with government intervention — resulted in the loss of more than one-third of the value of those assets.

Following such advice as the economy imploded in the 1930s, the Fed raised interest rates rather than easing them to try to revive growth. It cited the need in 1929 to prick a stock market bubble — which it ended with notable success and tragic consequences. As unemployment was soaring in the early 1930s, the Fed raised interest rates again to defend the dollar and its link to the gold standard against raids by speculators.

“That was the wrong thing to do,” Mr. Bernanke said, because it sent the economy plummeting further and drove up unemployment.

Meanwhile, the Fed neglected its primary mission by allowing a massive run on the banking system that destroyed thousands of banks and took the life savings and deposits of millions of Americans, further impoverishing them as they endured widespread unemployment, hunger and homelessness.

Recurring bank panics

“Financial panics in the U.S. were a very big problem” even before the Depression, Mr. Bernanke said, noting six major bank panics between 1873 and 1913, including more than 500 banks that failed in the 1893 crisis. Yet the Fed, which was founded in 1914 to prevent such panics, failed to act in the 1930s.

While Congress made mistakes during the Depression as well, including trying to balance the budget under President Franklin D. Roosevelt when the economy was still fragile in the middle of the decade, Mr. Bernanke said it took an act of Congress to ease some of the devastation wreaked by the Fed.

Roosevelt called for, and Congress enacted, laws in 1933 and 1934 dropping the gold standard and creating deposit insurance, measures that were successful at reviving the economy at least for a while and stopping the run on banks, he said.

“They were essentially offsetting problems that the Fed created or exacerbated by not fulfilling its responsibilities,” he said.

In condemning the Fed’s actions during the 1930s, Mr. Bernanke strikes at the heart of his critics who say he has been too lenient with loose money policies that threaten to set off a revival of inflation. Mr. Bernanke has held interest rates at record low levels since 2008 and is promising to continue to do so through 2014 in an unprecedented effort to nurture a faster recovery.

Gold standard rejected

The Fed chairman also details, for the first time, his reasons for rejecting calls for a return to the gold standard voiced by Mr. Paul and his many ardent supporters.

Although Mr. Bernanke said he sympathizes with gold-standard supporters’ “desire to maintain the value of the dollar” and keep inflation low, he added that a return to the gold standard wouldn’t work and would hurt the economy more.

“It would be very expensive” because the government would have to buy more and more gold and store it in vaults at the Federal Reserve and Fort Knox, where it would sit idly as backing for the currency, he said. “The simple fact is, there’s not enough gold to meet global needs” in a $50 trillion global economy.

“More fundamentally, the world has changed,” he said, with the global economy much larger, more complex and interconnected than it was in the 1930s, and people and politicians much more concerned about the Fed potentially throwing millions of people out of work.

“If you look at history, the gold standard didn’t work that well, and it worked particularly poorly after World War I,” he said. “There’s good evidence the gold standard was one of the reasons the Depression was so deep and long. Those countries that allowed flexibility in their exchange rates recovered more quickly than those that stayed on gold to the bitter end.”

Mr. Bernanke addresses another school of conservative critics led by Peter Schiff, president of Euro Pacific Capital Inc., who say the Fed’s unprecedented programs since 2009 to purchase Treasury bonds and mortgage bonds in an effort to lower long-term interest rates in reality are a thinly veiled effort to print money to finance the government’s bloated deficits.

They say this is a big mistake that will lead at some point to a run on the dollar and Treasury bonds, end the dollar’s long reign as the world’s reserve currency, and create a debilitating run of inflation.

Rebutting Bernanke

Like the liquidationists during the 1930s, Mr. Schiff advocates a hands-off policy that lets markets resolve bad debts through massive liquidations of housing and defaulted mortgage bonds.

Mr. Schiff has scheduled what he is calling a “nonpoliticized” lecture to rebut Mr. Bernanke’s arguments Thursday while the Fed chairman is delivering his last lecture addressing the 2008 financial crisis.

Rather than keeping bank lending rates near zero, Peter Schiff said, interest rates should be anywhere from 2 percentage points to 4 percentage points higher to compensate investors for higher inflation, said Andrew Schiff, his brother and spokesman.

Keeping rates so low “creates all kinds of economic problems and encourages all kinds of destructive economic behavior,” Andrew Schiff said, including overleveraging by investors seeking to take advantage of low rates to maximize their positions in bonds, stocks and other markets. Such overleveraging often leads to investment bubbles.

While Mr. Bernanke intends for the low rates to encourage more lending by banks to consumers and businesses, that is not happening, Andrew Schiff said. Instead, banks are borrowing at near-zero from the Fed and then investing in Treasury bonds to earn a 2 percent return risk-free.

“This is not a good way to help the economy” and only lets the government go further into debt, he said.

Peter Schiff agrees that the central bank helped cause the Depression, but for different reasons than expounded by Mr. Bernanke. He blames too-loose money policies during the 1920s for creating stock and real estate bubbles, a mistake he says the Fed repeated during the 2000s, fostering the real estate bubble — a charge Mr. Bernanke denies.

Regardless of who wins the debate, one clear outcome of Mr. Bernanke’s clash with conservatives is that he has little chance of being reappointed if a Republican wins the presidential election this year.

Jeffrey Kleintop, chief market strategist at LPL Financial, said Mr. Bernanke is at odds with most Republican candidates, who “indicate that they would favor a less-cautious Fed and an earlier start to getting interest rates back up to more normal levels.”

One former candidate, Texas Gov. Rick Perry, called Mr. Bernanke’s policies “treasonous” and suggested that he would fire him if elected, although that would not be possible because the Fed chairman cannot be removed until his term expires in 2014 unless he commits an impeachable offense. But Mr. Bernanke already has indicated that he would announce his retirement rather than seek another term.

Mr. Bernanke continues to get accolades from Wall Street investors and analysts for his strenuous efforts to resuscitate the economy and markets.

Ward McCarthy, managing director at Jefferies & Co., applauded the Fed chairman’s lectures and other appearances as an “admirable effort” to demonstrate the Fed’s transparency and “get the message out” in a powerful way that moved markets.

“The Bernanke Fed will not repeat the mistakes of the 1930s,” he said. “Chairman Bernanke will not preside over the next Great Depression and wants the world to know why he continues to see a need for providing stimulus to the economy and support for the banking system.”

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