By Carlos Lozada
Sunday, November 16, 2008
It was the annual conference of the American Economic Association in January 2000, and the well-regarded Princeton professor was explaining why he had always loved macroeconomics. What made his chosen field so compelling, he said, were the "extreme and dramatic events" it covers, such as hyperinflation, depressions and financial crises.
"This dramatic aspect always appealed to me," Prof. Ben S. Bernanke told fellow economist Brian Snowdon in an interview.
If economic turmoil really fascinates him, the Federal Reserve chairman must now be having the time of his life. The global economy is in the midst of the most extreme and dramatic financial trauma since the Great Depression, when markets crashed, prices plummeted, banks collapsed and jobs vanished, leaving a legacy of breadlines, Joads and Hoovervilles.
Echoes from that era resonated in Washington this weekend as leaders from the world's top economies gathered for a summit that has evoked overblown comparisons to Bretton Woods, the 1944 conference that sought to repair a global economy emerging from depression and war. It seems somehow fitting to see Bernanke -- a top scholar on the economics of the 1930s -- at the helm of the Federal Reserve in yet another age of war and financial peril.
Bernanke, whose term as Fed chairman began in February 2006 and runs through the first year of the incoming Obama administration, has devoted years of research to explaining how policy mistakes and financial panics transformed a 1929 recession into a worldwide calamity meriting its own capital letters. If anyone can steer us clear of a similar fate today, it should be Bernanke -- right? Now history has put the self-described "Great Depression buff" to the test.
As I watch him grapple with our current crisis, I feel guilty for not having a better sense of his efforts. Nearly 14 years ago, as a distracted 23-year-old graduate student in public policy, I sat in the bowels of Robertson Hall at Princeton University, struggling through Bernanke's course in macroeconomics. He wasn't yet chairman of the economics department -- much less of the Fed -- but for one semester, the man who would succeed Alan Greenspan taught me theories of business cycles, why prices rise and fall, and whether the government can boost economic growth or prevent downturns. Go figure.
Bernanke was a good instructor, but the class wasn't easy. I recall tough assignments and a stressful midterm exam that had me wrestling with something called the Euler condition. (Don't ask, because I still don't know.) The exam was challenging, we were told, because a test should be a learning opportunity, not just a gauge of whether we could spit back class notes.
It was not my finest academic moment, nor one I imagined ever revisiting. But recently, watching my old professor testify before Congress and move markets with each speech, I decided to crack open his textbook and sift through his prolific writings on the Depression -- books, speeches, articles and interviews -- looking for new lessons that shed light on his quest to keep today's recession from becoming another Great one.
As I read Bernanke's "Essays on the Great Depression," a selection of his academic papers, what leaps out is his emphasis on the Depression as a global phenomenon. Tempting as it is to focus on President Herbert Hoover and the 1929 U.S. market crash, Bernanke explores conditions across dozens of countries -- assessing where banking crises erupted, how deeply economic activity plummeted and which central banks made the right calls.
"Arguments which focus almost entirely on the U.S. are missing a crucial aspect of the issue," Bernanke stressed to Snowdon, as recorded in Snowdon's 2002 book, "Conversations on Growth, Stability and Trade."
As the current downturn ricochets through the global economy -- with Europe and the United States entering recessions, China launching a massive New Deal-like stimulus package and developing nations teetering as capital flows dry up -- Bernanke has coordinated interest-rate cuts with other countries and extended up to $120 billion in lending to the central banks of Brazil, Mexico, Singapore and South Korea. As with the Depression, the transnational dimensions of today's crisis never seem far from his mind.
Bernanke also emphasized that decisions by central bankers were crucial during the late 1920s and early '30s -- and nowhere more so than in the United States. In a paper called "Deflation and Monetary Contraction in the Great Depression," he offered "the clearest indictment of the Federal Reserve" and concluded that the Fed's moves were "actively destabilizing" in the crisis's early stages.
"By raising interest rates" after the 1929 crash, "policymakers contributed to soaring unemployment and severe price deflation," Bernanke explained in a Foreign Policy magazine essay in 2000 -- a sharp contrast to the moves his Fed has made this year, slashing the federal funds rate to its lowest level since early this decade.
In the run-up to the Depression, Bernanke argued, better leadership could have made a difference. In a November 2002 speech honoring the economist Milton Friedman, Bernanke, already serving on the Fed's Board of Governors, recounted the tale of Benjamin Strong. As head of the Federal Reserve Bank of New York in the 1920s, Strong opposed the Fed's attempt to curb Wall Street speculation by tightening monetary policy when "there was not the slightest hint of inflation," Bernanke said. But Strong died of tuberculosis in 1928, and his views lost sway.
"We don't know what would have happened had Strong lived; but what we do know is that the central bank of the world's economically most important nation in 1929 was essentially leaderless and lacking in expertise," Bernanke lamented. "This situation led to decisions, or nondecisions, which might well not have occurred under better leadership. . . . And associated with these decisions, we observe a massive collapse of money, prices, and output."
One reason that collapse lasted so long, Bernanke explained in a 1983 paper, was that credit markets "dammed up," falling prices increased the burdens on debtors and financial panics disrupted banks' ability to lend. "Some borrowers (especially households, farmers, and small firms) found credit to be expensive and difficult to obtain," Bernanke wrote. "The effects of this credit squeeze . . . helped convert the severe but not unprecedented downturn of 1929-30 into a protracted recession."
Bernanke praises government efforts to prop up those financial markets in the 1930s, but that does not necessarily translate into support for wider interventions. The notion that massive public works projects ended the Depression is one of the "major errors" people make about the era, he told Snowdon. And although Bernanke once urged Japan to show "Rooseveltian resolve" in getting out of its own economic crisis in the 1990s, his assessment of FDR's New Deal seems lukewarm. "It might be argued that the federally directed financial rehabilitation -- which took strong measures against the problems of both creditors and debtors -- was the only major New Deal program that successfully promoted economic recovery," he wrote in 1983 -- an intriguing perspective, given his recent backing for a new fiscal stimulus package.
Finally, Bernanke fervently believes in the lessons of history. "Those who doubt that there is much connection between the economy of the 1930s and the supercharged, information-age economy of the twenty-first century are invited to look at the current economic headlines -- about high unemployment, failing banks, volatile financial markets, currency crises, and even deflation. The issues raised by the Depression, and its lessons, are still relevant today."
He wrote those words in 2000, long before today's crisis. But even in the midst of the current market meltdown, when Bernanke stood alongside Treasury Secretary Henry M. Paulson Jr. and Federal Deposit Insurance Corp. Chairman Sheila C. Bair on Oct. 14, as the administration announced the injection of hundreds of billions of dollars into the banking system, the Fed chairman again invoked history. "Americans can be confident," he said, "that every resource is being brought to bear: historical understanding, technical expertise, economic analysis and political leadership."
Note the order: History comes first.
So have our leaders truly absorbed the lessons of the Depression? In his speech on Friedman, Bernanke praised "A Monetary History of the United States," the landmark 1963 book by Friedman and Anna J. Schwartz that blamed the Depression on bad monetary policy. His concluding words indicated an awareness of the Fed's past errors but also an abiding confidence in his ability to get it right next time. "I would like to say to Milton and Anna: Regarding the Great Depression: You're right, we did it. We're very sorry. But thanks to you, we won't do it again."
But an understanding of history may only get you so far, other economists argue, especially when we haven't really been transported back to 1929. In an Oct. 18 interview with the Wall Street Journal, Schwartz herself said that Bernanke's historical smarts were his "claim to be worthy of running the Fed" but concluded that "my verdict on this present Fed leadership is that they have not really done their job." And Harvard economist Greg Mankiw, former chairman of President Bush's Council of Economic Advisers, recently suggested that the Treasury and the Fed today face a tougher challenge than that of the 1930s. "Then, the problem was largely a problem of confidence and a shortage of liquidity," he wrote Oct. 26 in the New York Times. "Today, the problem may be more a shortage of solvency, which is harder to solve."
For all our sakes, I hope my old professor has distilled the right lessons from the Great Depression and can discern which do and which don't apply today. If he passes this test, history will grade him generously. If not, I suspect it will be hard for the country to find solace in a new learning opportunity.
Carlos Lozada is The Washington Post's national security editor.