Where's a Good Economist When You Need Him?
I personally believe that a few lesser-known economists did actually get it right, with little variance among them. Among these the one whose name is most familiar to me is Edward C. Harwood of the American Institute for Economic Research. (See his book Cause and Control of the Business Cycle and the monologue-booklet Keynes vs. Harwood by Professor Jagdish Mehra, available at AIER.)
The fact that so few have taken Harwood's ideas seriously is unfortunate, because as I look through his research today I find it irreproachable. The closest he came to valid criticism was the comment that his statistical series did not prove cause and effect any more than any other coincidental movements would. The response to this is twofold:
- Okay, but in order to disprove the theory, you have to prove that this specific cause did not or could not perpetrate the effect, or that something else did (and for you methodology students, his theory is falsifiable, unlike the non-existence of green swans); and
- Harwood's pesky little theory has the annoying habit of correctly predicting all of the recessions since 1929 up to Harwood's demise in 1980, and even thereafter up to today's latest fiasco. (It did give a couple of false positives; but that's statistically acceptable, given that government actions or economic events can forestall busts temporarily.)
The economic phenomena present in today's credit crunch are strikingly similar to those of 1929; and Harwood's theory seems to fit once more. His Institute has been warning of a recession for several months now, and it looks like they're going to "get their wish," even though the marketplace has resisted up to now with less efficacious wishful thinking.
If I understand Harwood's theory correctly, the basic tenets are that two misalignments caused 1929 (and in fact equivalent ones have caused every boom/recession cycle since then):
1. After the First World War, the government purposely inflated the money supply so as to finance the war effort. Instead of allowing that supply to deflate back to gold-standard measures, they chose to allow it to continue. Excess purchasing media therefore circulated throughout the next decade, creating the boom cycle that ended with the 1929 bust.
2. Related to the above-mentioned inflationary actions of the government were the slipping banking standards of the times. Banks had begun to expand credit at an unhealthy rate, as follows:
Harwood believed in what he called "sound commercial banking," whereby banks would operate on a 20 percent or higher fractional reserve system under a federally-defined gold standard, and their functions would be divided into two distinct operations: Commercial operations, and savings & loan operations.
Commercial banks should only function as creators of credit to the extent that they had checking accounts, capital, and commercial paper (real bills) representing goods coming to market within three to four months.
Savings & loans, on the other hand, should only give as much credit (i.e. acquire investment-type assets) as they had deposits and capital (savings-type liabilities). These two quantities should remain in constant balance.
But as it happened in the 1920s, banks' accounts became unbalanced. They had begun to create credit on the basis of things other than those stated above, i.e. upon real estate, stocks and bonds, and other unsound collateral, taking on too much risk. (Sound familiar?)
This excess credit manifested itself as excessive money supply, the proverbial "too much money chasing too few goods." Harwood went to the trouble of calculating the extent of this money-supply overextension, calling the results his Harwood Index of Inflating. He used this Index to predict the coming bust, as witnessed in the 1928 and mid-1929 articles he wrote for the New York Times's weekly journal called The Annalist and other papers of the day. The crisis hit in October 1929.
He went on to use that index and his research to predict just about every single recession and inflationary episode in 20th Century monetary history, up until his death in 1980.
What a pity no one has bothered to dig up this valuable research and vet it through application of modern economic expertise--although one wonders just how much expertise there is, given the mess we're in. (As I've noted before, lots of people knew this mess was coming, most notably the BIS, or Bank for International Settlements, a collection of central bankers; but it has taken them eight years to draw up some ideas of how to impose new banking rules to lessen the dangers--six years too many.)
What a loss that we don't still have Harwood around today, bellowing warnings from the rooftop of his Institute and allowing us all to take protective measures to preserve our purchasing power in the scary months ahead.
(For more on Edward C. Harwood, see my posts starting back in the beginning of this blog in March 2005.)