Tuesday, 7 July 2009

Let the dead man speak

Keynesians routinely malign policymakers from the 1930s, charging them with failing to run sufficiently large fiscal deficits to maintain aggregage demand. According to this modern myth, mass unemployment during the interwar years could have been avoided, if only the officials running the Treasury and the Bank of England had been brave enough to spend their way out of recession.

Of course, it is easy to pour abuse on long dead officials. However, the excellent jka online blog produced a wonderful post recently, which goes a long way to counterbalancing this malicious Keynesian myth.

The site published a memo, written in 1931 by Sir Warren Fisher, who was then the permanent Secretary to the Tresuary. The memo outlines the case for responsible fiscal policies during a deep and damaging financial crisis.

Here is rare chance for a long dead Treasury official to put forward the case for low fiscal deficits and sound money. The memo is as valid today as it was back in the 1930s.

"The seriousness of the financial difficulties which are engaging public attention is perhaps not fully realised. It may therefore be useful to set out the elementary facts. The root cause of the "run" on the part of the foreign depositor is the fact of our living beyond our means as evidenced by our ordering from abroad more goods than we could pay for and therefore our owing to other countries more in dollars and francs than they owe to us in sterling.

Closely associated with this fact in the foreign mind is the question of our national Budget. After the war a certain number of countries continued to have difficulties in balancing their budgets and instead of pulling in their belts, resorted to the expedient of meeting deficits by printing innumerable bank or currency notes. Whenever this was done, the national currency lost much or all of its value i.e. purchasing power, and with the corresponding rise in prices, hardship, even hunger, was widespread.

Consequently, when any of these countries subsequently desired financial assistance from other countries before the citizens of the latter could be induced to lend, they insisted on the borrowing country balancing its budget. And no one was more emphatic than ourselves in preaching this doctrine.

A national Budget has thus come to be regarded as a touchstone of a country's financial stability second only in importance to its international balance of trade; and if, as the case at present with us, we are "down" on our balance of trade with other countries, foreigners to whom we owe money automatically turn a microscope on to our Budget. And if the Budget is not really balanced, but is merely dressed up to look as though it were; or again if the national expenditure is of a scope and type such as to involve (by means of taxation) taking people's saved, up capital and spending it as if it were recurrent income, the distrust abroad of our soundness would be intensified.

Any expectation that we might continue on a "rake's progress" would complete the destruction of international confidence and thus result in the final collapse of our greatest asset, i.e. our credit.

The remedy is to reverse the process which has been responsible for the trouble, and this means that instead of living at a level which has entailed ordering abroad more goods than we can pay for, we must relate our orders to our capacity to pay. And unless we can produce and sell abroad more goods (including "services") than we have been doing, we shall be forced to cut down our orders abroad, and our and our standard of living must be reduced accordingly.

If not the epitaph of us English of to-day will be written by historians to come in Shakespeare' words (Richard II , Act 2, Scene l )
England, bound in with the triumphant sea,
Whose rocky shore beats back the envious siege of watery Neptune,
Is now bound in with shame, with inky blots and rotten parchment bonds.
That England, that was won’t to conquer others, hath made a shameful conquest of itself".


Nick Drew said...


Anonymous said...

That Shakespeare put down words in the right order to cover everything. What a man! Think I'll reread The Merchant of Venice and Macbeth before making any more trades.

Mick said...

That's so apposite I'd suspect it as a hoax. But looking at the beautiful use of language I think not.

Have you checked the provenance Alice?

JKA on Economics said...

Hi Mick
Had we met before then I would have been offended. Checking primary sources is an obligation.
The memo is from
National Archives - Cabinet Papers 1915 - 1978
Finance and the Economy
Economic Policy in the 1920's
World Trade Downturn
Cabinet Memorandum. The Financial and Economic Position of the United Kingdom. Note by the Secretary. 14 September 1931
It is our first encounter, it is my obligation to inform.

Anonymous said...

Unlike 99 percent of the politicians and public officials working in the US and UK, I actually successfully pulled an asian country out of the 97 crash. So here is my insight: sound money. People need to believe money has worth and it is worth saving (and your savings won't disappear). Targetted investment ONLY in new equipment and the latest technology. Encouraging free exchange of ideas. And a culture that says getting off your butt and doing things is the only way to get ahead. Do those things, and you can turn it around. We are not doing any of those things right now.

Man in a Shed said...

I found this interesting about the alternative of not doing fiscal stimulus etc etc. Why You've Never Heard of the Great Depression of 1920.

Another lesson from history unlearned.

When all this started I used to comment on boards etc that Franklin Roosevelt New Deal didn't work ( having studied American History at school ). But at the time no one seemed to listen.

PS Did Britain weather the great depression much better than the US - until we had to transfer all our wealth for the next 50 years to the US to save the world from Hitler ? ( About the same amount of money Gordon Brown has just borrowed to keep himself in office. Maybe we should have a rule that money can only be borrowed to remove a dictator. Though at the risk of saying something about Hitler - unlike Brown he was at least elected ! )

Mike Dimmick said...

Keynes himself said not just that fiscal deficits caused a stimulus in the economy, but that it was an automatic thing to occur when tax revenues drop in a recession. If you're budget-neutral after recovery but before boom, you get a little more revenue than spending during the boom, which stops it inflating. It's a negative-feedback system.

Politicians have believed that they can run stimulus at any time and barely reduce deficits at all. I have no problem with the level of spending that occurred from about 1999 onward, but it should have been financed by taxation. We were in the boom part of the cycle and should have been extracting some of that to pay off past debts, and even build up a reserve for future recessions. Ken Clarke had actually put together a minor surplus budget, which Labour followed for the first year.

Instead Mr Bush and Mr Brown continued to run ever increasing deficits, which inflated the bubble ever further. It now leaves us having to throw ludicrous amounts of money to have an effective stimulus, with massive debts, and much of that money being used unproductively as bank bailouts.