Economic Analysis: Schiff vs. Bernanke

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If you haven’t had the pleasure of watching Peter Schiff’s response to Ben Bernanke’s college lectures, then you ought to take a moment and watch. In Schiff’s presentation we are reminded that there are facts and there is analysis; and sometimes people believe things that are counter-factual, but more often it’s a case of bad analysis. In the lectures of Bernanke the facts of history have been misconstrued by way of faulty analysis, and Schiff catches him out.

Bernanke claims that central banks are necessary because they promote stability. In his third lecture Bernanke defended the massive bailouts of Bear Stearns and AIG as “difficult and in many ways distasteful....” This was unavoidable, he said, because “we needed to … prevent the system from collapsing.” Bernanke further stated that the propriety of what was done “is increasingly gaining acceptance [because it] stabilized the financial system in 2008 and early 2009….” Thus, the Fed Chairman argued that massive government-sponsored intervention in the financial system is sometimes essential.

According to Bernanke the United States historically suffered from periodic financial panics prior to the creation of the Federal Reserve. Since banks were private businesses, they could fail. If customers realized a bank might fail, they could panic and try to withdraw their money. Under these conditions even a solvent bank would collapse; and, without any doubt, many good businesses were hurt by panics. “This is not a hypothetical issue,” said Bernanke. “Financial panics in the United States were a very big problem.” Bernanke then named six major financial panics that occurred: in 1873, 1884, 1890, 1893, and 1907. More than 500 banks failed in the panic of 1893. In the 1907 crisis the threatened banks were larger, and the U.S. Congress began to contemplate the creation of a central bank.

Bernanke covers other points of interest in his lecture series, but his analysis of past banking panics was telling. Having a better understanding of financial history, Schiff responded with the following criticism: “The record of stability was better before we had the Fed than with it. In fact the biggest busts and booms happened with the Federal Reserve….” By this statement Schiff was referring to the Great Depression, of which Mr. Bernanke claims to be student. According to Schiff there can be no comparison between the bank panics and collapses of 1873-1907 and the Great Depression of 1929 – 1939. If we check the figures for bank failures during the Great Depression we find that Schiff is exactly right. If roughly 500 banks failed in 1893, then 744 banks failed during the first 10 months of 1930. But here is the difference: In 1893 the bank failures ended because the government didn’t intervene, while in 1929 the government intervened and the crisis continued until 9,000 banks had failed.

Schiff reminds us that government intervention is what turns small busts into big busts. Even more egregious than a system where banks can fail is a system where they cannot fail. Quite naturally, “too big to fail” avoids the problem of panics; but you achieve this by introducing moral hazard, by depriving the person who deposits money of the responsibility of choosing the right bank. As Schiff explained, “Bank customers no longer care about the solvency of the banks.” And if a bank is too big to fail, perhaps such an institution will take risks on the assurance that government will make up its losses.

Whatever stability the Fed produces is negated by the massive risk it poses to the economic system overall. For without central banking you cannot collapse an entire financial system. Furthermore, a collapse becomes even more possible once you have abandoned the gold standard. According to Schiff this is because fiat currency “allows the government to be fiscally irresponsible.” If interest rates are determined by planners and not by a currency system based on gold, the interest rate may run too low and thereby fuel bad investment which creates a false boom. Adding to the confusion, today’s politicians see the boom as good and the bust as bad. In truth, the boom is what damages the economy while the bust is what heals the economy; so even in terms of our politicians’ economic “fixes,” ignorance leads them to make serious errors.

According to Schiff, everything Bernanke had to say was “pure fantasy.” The people responsible for engineering the country’s economic recovery don’t know what they’re doing. “The economy is struggling under the weight of all this government and central banking,” said Schiff. “The real crisis, the real day of reckoning is not in our past. It’s in our future.”

The facts of history are important. But proper analysis is also important. If we have the facts and fail to discover their proper meaning, we will base our policies on historical misunderstandings. In his book Intellectuals and Society, the great economist and social analyst Thomas Sowell wrote: “Nothing established the idea that government intervention in the economy is essential like the Great Depression of the 1930s.” And what was the result of this intervention according to Sowell? “[M]any things that the Federal Reserve, Congress and the two Presidents did were counterproductive. Given these multiple failures of government policy, it is by no means clear that it was the market economy which failed.”

Those who do not learn from history are doomed indeed. Our leaders are incompetent because they pretend to lead us when they should leave well enough alone. The free economy works wonders. Government works disasters. As Gustave Le Bon once wrote, “The historian who shall know the ruin that our weakness will cause, and the downfall of the civilizations we have so ill defended, will not mourn us, and will decide that we have merited our fate.”

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About JR Nyquist