This is one of the most enjoyable historical book I read with "The Day the Bubble Burst: A Social History of the Wall Street Crash of 1929". You will surely appreciate the inimitable style of the legendary economist: John Kenneth Galbraith.

I want so much to share this book with you that I have posted a large collection of extracts (see below). You will learn for example how Keynes, as great economist as he could, was also a real bad trader who was right at the wrong time by going almost bankrupt if not saved by a friend :)

More seriously you will learn how the Federal Reserve Bank didn't play his promised role of lender of last resort because "the American Bankers Association led the fight against that plan 'to the last ditch', holding it to be 'unsound, unscientific, unjust and dangerous'". Instead it was "a government insurance fund" who "was now back of the depositors" (yes in case you don't know the Federal Reserve is in fact a private organization) - in another book Galbraith still considers the Federal Reserve as a failure and even "our most prestigious form of fraud, our most elegant escape from reality".

In the ancient and medieval world the coins of different jurisdictions converted at the major trading cities. If there were any disposition to accept coin on faith, it was inevitably the bad coins that were proffered, the good ones that were retained. Out of this precaution came, in 1558, the enduring observation of Sir Thomas Gresham, previously made by Oresme and Copernicus and reflected in the hoarding of the good Roman coin, that bad money always drives out good. It is perhaps the only economic law that has never been challenged, and for the reason that there has never been a serious exception. Human nature may be an infinitely variant thing. But it has constants. One is that, given a choice, people keep what is best for themselves, i.e., for those whom they love the most.

As early as 540 B.C., Polycrates of Samos is said to have cheated the Spartans with coins of simulated gold.

With the passage of time and depending on the financial needs of rulers, their capacity for resisting temptation, which was generally modest, and the private development of the peculative arts, coinage had a highly reliable tendency to get worse. The Greeks, notably the Athenians, seem to have resisted debasement out of a rather clear understanding that htis was a short-run and self-defeating expedient and that honesty was, at a minimum, good commercial policy. After the division of the Roman Empire and the reassertion of Greek influence at Constantinople the bezant was for several centuries the world symbol of sound money, everywhere as acceptable as the gold it contained.

By contrast, the history of the highly developed coinage of Rome itself, as legend has sufficiently established, was one of steady debasement, beginning, it is commonly supposed, in consequence of the financial pressures of the Punic Wars. In time, this had the effect of converting the empire from a gold and silver to a copper monetary standard. By the time of Aurelian the basic silver coin was around 95 per cent copper. Later its silver content was brought down to 2 per cent.Modern coin collectors, it has been suggested, now own the good gold and silver coins that were held back in hoards and which, with the slaughter, urgently compelled departure of normal demise of their owners, were they orphaned and forgotten. In time it would be asserted that the debauchment of the currency caused the downfall of Rome. This historiography - the tendency to attach vast adverse consequences to monetary behaviour of which the observer happens to disapprove - is one which we will find frequently to recur. It should, needless to say, be regarded with the utmost suspicion.

Where Spain is concerned, legend regularly persists against the strong burden of fact. Possibly this is because Spanish historians, unlike those of other countries, have rarely been aroused by national conceit. They have been content to assume the worst. The Holy Inquisition in Spain remains in the minds of all as the paramount example of public cruelty, at least until Hitler. It is not something one would wish to praise. But the number of Jews, Marranos and other heretics who fell victim to its professedly judicial procedures during the three centuries of its sway - a few thousand at most - were fewer than were, on occassion, slaughtered summarily in the Rhineland cities in a single year. The Spanish Armada remains to this day the classic case of overwhelming and pompous military power brought to defeat by an inferior but far more sanguinary and alert foe. Against this belief the truth has never made headway. It is that the English has nearly equivalent tonnage of much better designed men-of-war which were much more heavily gunned and much better manned and thus made up an altogether superior force.

Similarly the accepted view of the American treasure of Spain. The legend holds it to be gold looted from the temples of the Aztecs, extracted as a ransom by Francisco Pizarro for Atahualpa - the wonderful roomful of gold artifacts demanded by Piazarro for the Inca - or surrendered by the Indians after persuasion of a uniquely painful sort. The treasure was then conveyed to Spain by galleons, many of which fell victim to the hordes of pirates that patrolled the Spanish Main and who were justified at least partly in their theft by the yet greater criminality and avarice of the Spaniards.

The treasure looted from the temples or extracted from the Indians was, in fact, a trifling part of the total. The overwhemling part was mined. Nor was the treasure gold. Nearly all, after the first years, was silver. Beginning with the decade of 1531 through 1540, the weight of silver was never less than 85 per cent of the toal and from 1561 through 1570, never less than 97 per cent.San Luis Potosi, Guanajuato and the other rich silver mines of Mexico, some of which continue to operate to the present day, and their counterparts in Peru were the source of the American treasure. Finally, by far the greatest part of it was conveyed safely and routinely to Spain. Two or three bad years apart, the losses to piracy, righteous and otherwise, were slight. This continued to be the case until the 1630s, after which the richest ore having been exploited, exports of silver declined.

Where economic misfortune is concerned, a word on nomenclature is necessary. In the course of his disastrous odyssey Pal Joey, the most inspired of John O'Hara's creations, finds himself singing in a Chicago crib strictly for cakes and coffee. He explains this misfortune by saying that the panic is still on. His term - archaic and thus slightly pretentious - reflects the unfailing O'Hara ear. During the last century and until 1907, the United States had panics. But, by 1907, the language was becoming, like so much else, the servant of economic interest. to minimize the shock to confidence, businessmen and bankers had started to explain that any current economic setback was not realy a panic, only a crisis. They were undeterred by the use of this term in a much more ominious context - that of the ultimate capitalist crisis - by Marx. By the 1920's, however, the word crisis had also aquired the fearsome connotation of the event it described. Accordingly, men offered reassurance by explaining that it was not a crisis, only a depression. A very soft word. Then the Great Depression associated the most frightful of economic misfortunes with that term, and economic semanticists now explained that no depression was in prospect, at most only a recession. In the 1950s, when there was a modest setback, economists and public officials were united in denying that it was a recession - only a sidewise movement or a rolling readjustment. Mr Herbert Stein, the amiable man whose difficult honour it was to serve as the economic voice of Richard Nixon, would have referred to the panic of 1893 as a growth correction

The panics also brought recourse to two lines of remidial action which have always been much favoured, although with no proof that they have ever been greatly effective. One is to seek to exorcize economic misfortune but affirming it does not exist. In November 1920, a very dark month following the crash of the year before, President Monroe advised the Congress of the 'prosperous and happy' condition of the country, adding that 'it is impossible to behold so gratifying, so glorious a spectacle, without being penetrated to the Supreme Author of All Good for such manifold and inestimable blessings'. The government of the time was known to be deeply concerned over the economic crisis. In March 1837, as the trials of that terrible year were becoming felt, Andrew Jackson said in his farewell address: 'I leave this great people properous and happy.' In June of 1930, Herbert Hoover was visited by a delegation of public-spirited men who urged an expansion of public works to ease the plight of the unemployed, who were then rising into the millions. 'Gentlement,' the President said, 'you have come sixty days too late. The depression is over'. In the sincerity of manner with which they endlessly proclaimed the end of inflation, Mr Nixon and his economists were acting in a tradition that was older than they knew.

The other favoured response is to urge resort to religious solace as a substitute for more expensive action. In 1837, a thoughtful divine urged sufferes to use the bad times to 'Lay up treasure in Heaven', adding helpfully that. 'All this may be done on a small income.' in 1857, another bad year, the Journal of Commerce offered similar counsel in an approximation to verse:

Steal awhile away from Wall Street

and every worldly care,

And spend an hour about mid-day

in humble, hopeful prayer.

In 1878, Archbishop Williams of Boston took the more practical step of circulating an address to his churches asking his people not to react to their fears by going to the banks for their money. That caused runs. In October 1907, as the cumulating step was make to arrest the panic of that year - manifested in heavy runs on the New York trust comapnies and banks - J.P. Morgan, himself high in Episcopalian councilsm called the leading divines of the city to his office and asked them to give encouraging sermons the following Sunday. 'Religious leaders of all denominations agreed to paint cheerful pictures that weekend.' A long history thus introduces the Reverend Dr Peale and the Reverand Dr Graham, the latter-day exponents of the economically useful and socially tranquillizing gospel.

From the spring of 1920 to the summer of 1921, German prices were, for all practical purposes, stable at about fourteen times the pre-war level. J.M. Keynes was backing his by now widely advertised judgement that the Versailles requirements were far beyond the capacity of the German economy by speculating heavily on the margin against the mark. He narrowly escaped financial ruin, was saved by loans from his publishers and a friendly financier. 'It would have indeed have been a disaster if the man who had so recently set world opinion agog by claiming to know better than the mighty of the land had himself become involved in backrupcy'. Yes, indeed.

Late in July the Daily Mail man told of this problem:

It is difficult to get a cheque cashed. The 10,000-mark note is the highest denomination printed and the banks are denuded of them. This morning motor-lorries loaded with paper money kept on arriving at the Reichsbank but messengers with handcarts were also there to take away the bundles of notes passed out by the Bank . . The cashier of my bank handed me 4,000,000 marks in 1000-mark notes, each worth less than half a farthing . . He obligingly did them up for me in a neat paper parcel which I afterwards put on the table of the restaurant where I lunched and unpacked when the waiter brought the bill. But this difficulty will soon disapper for we expect to have 4,000,000-mark notes by the end of next week.

In the next weeks there were many such tales. At the end of October the New York Times told of a stranger in one of 'the lesser restaurants' in Berlin who flourished a dollar bill and asked for all the dinner it would buy. He was amply provided, and, as he was about to leave, the waiter arrived with another plate of soup and another entree and bowed politely: 'The dollar has gone up again'.

That the great German inflation, like the ones elsewhere in central Europe, produced a large transfer of wealth from those who possessed saving accounts, money, securities or morgages to those who had debts or tangible property is assumed. And, despite a shortage of affirming statistics, that such transfer occurred does seem plausible. The loss so involved, the parallel lost by people of their stake in the social order and the companion anger and frustration were, in turn, thought to have much to do with the rise of Fascism or Communism. These are matters on which there is no proof, and it is unbecoming, however customary, to substitute certainty of statement for hard evidence. But the simple facts are worth a glance. All of the countries of central Europe that suffered a collapse of their currencies following the First World War were eventually to experience Fascism, Communism or in most cases - Poland, Hungary, East Germany - both. The countries that did not experience such a breakdown in their money were almost uniformly more fortunate. What is not in doubt is that the German inflation left Germans with a searing fear of its recurrence. And whatever the effect of inflation in paving the way for Fascism, measures taken later out of fear of inflation were certainly not without effect. We have noticed, and will see again, that the strongest action is taken against inflation when it is least needed. On 8 December 1931, with one-sixth of the total German labour force out of work, the government of Heinrich Bruning decreed a reduction of from 10 to 15 per cent in most wages, this being a rollback to the level of four years earlier. It decreed also a reduction in industrial prices of 10 per cent, a similar reduction in rents, railway fares, rail freight charges and charges for municipal services. Earlier, wages of public employees had been reduced by a fifth, and taxes on wages, salaries and on incomes had been sharply increased. Unemployment benefits were also reduced. In the following year unemployment rose to one-fifth of the German labour force, and in the next year came Hitler.

In the 1930's, the vivid recent experience of economists, financial experts, bankers and politicians was with inflation. A mere fifteen years before, during the First World War, prices had doubled. The reaction was deeply advers. And only a decade earlier in Germany and eastern Europe, prices had run away, money had become worthless. In the twenties and thirties, also, there was the great migration of economists from Austria, Germany and central Europe to England and the United States. Add had had first-hand experience of hyper-inflation. In normal consequences, then, the reputable warnings in these years of extreme deflation were of the grave danger of inflation. The perception of this non-existent danger was expecially sharp in the Federal Reserve Banks; these, above all, were the approved centres of the conventional financial wisdom. This perception kept the Federal Reserve System from easing more adequately the position of the increasingly beset commercial banks.

Although the fear of inflation was the most important force immobilizing the financial mind, two other factors were strongly at work in these years. One was the purgative conception of economic policy. This held that the boom built damaging, though often unspecified, distortions into the economic system. Recovery could only come as these were eliminated. Deflation and bankruptcy were the natural correctives. Joseph Schumpeter, his country's Finance Minister during much of the Austrian inflation, was now emerging as a major figure on the American economic scene. He argued that the economic system had, through depression, to expel its own poisons. Looking at the history of business cycles, he concluded that no recovery was ever permanent until this happened and that any public intervention to speed recovery merely postponed the therapy and therewith the recovery. Lionel Robbins, as noted the most admired voice of British orthodoxy, offered essentially the same advice in the most famour book on the Depression: 'Nobody wishes for bankruptcies. Nobody likes liquidation as much . . . [But] when the extent of mal-investment and over-indebtedness has passed a certain limit, measures which postpone liquidation only tend to make matters worse.'(5) A rather cruder formulation came from the Secretary of the Treasury Andrew Mellon. To promote recovery, he advised, the country needed to 'liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate'.

Finally there was the business confidence syndrome. This, a powerful thing at the time, of which traces still remain, held that the views of bankers and business man had to be respected even when they were wrong and positively inimical to recovery. For if action were taken in opposition to these views, business confidence must be impaired. Impaired confidence would mean reduced investment, reduced output, reduced employment and worsened depression. It followed therefore that the right steps, if taken in opposition to the views of businessmen and the financial community, would be the wrong steps. Since the more reputable bankers and businessmen feared action by the government to provide relief for the indigent, employ the unemployed and otherwise expand demand, the confidence syndrome powerfully favoured inaction.

Herbert Hoover was deeply committed to the confidence syndrome and, to the end, sought to convert his successor. Writing to Roosevelt in early 1933, he expressed his conviction that 'a very early statement by you upon two or three policies of your Administration would serve greatly to restore confidence and cause a resumption of the march of recovery'. Among the promises that he thought would do most for confidence would be that of a balanced budget with all that implied as regards spending for relief and employment and 'no tampering or inflation of the currency'.

In the baning legislation passed in 1933, there was one provision that was opposed by conservatives and the new Administration alike. This was written by Representative Henry B. Steagall of Alabama, who had a reputation for eccentricity, even crankiness, where money was concerned, and by Senator Arthur Vandenberg of Michigan; it provided for the insurance of bank deposits. A special corporation, the Federal Deposit Insurance Corporation, would be chartered and capitalized by the Treasury and the Federal Reserve Banks. Insurance would be available to the depositors of all banks - state or national, members or non-members of the Federal Reserve - which chose to join. The dangers of the proposal were evident to all. The best banks would now have to accept responsibility for the recklessness of the worst. The worse, knowing that someone else would have to pay, would have a licence for reckless behaviour that the supervision authorized by the legislation could not hope to restrain. The American Bankers Association led the fight against the plan 'to the last ditch', holding it to be 'unsound, unscientific, unjust and dangerous' (17) as well as otherwise unsatisfactory. Perhaps it would even mean a return to the wildest days of wildcat banking. In all American monetary history no legislative action brought such a change as this. Not since, to this writing, have the lines formed outside one bank and then spread inelcutably to the others in a town. Almost never have the lines formed at all. Nor was there reason why they should. A government insurance fund was now back of the depositors; no matter what happened to the bank, the depositors would get theirs. And since the insuring agency, the Federal Deposite Insurance Corporation, had to pay for recklessness, it had an iron-clad reason for the supervision and intervention that would preclude recklessness. In a further sense the F.D.I.C was what the Federal Reserve had not succeeded in being - and utterly reliable lender of last resort, one that would immediately and without cavil come forward with whatever money was needed to cover the insured deposites. In 1933, 4004 banks failed or were found unfit to reopen after the bank holiday. In 1934, falues fell to sixty-two, only nine of which were insured. Eleven years later, in 1945, failures in all of the United States were down to one. The anarchy of uncontrolled banking had been brought to an end not by the Federal Reserve System but by the obscure, unprestigious, unwanted Federal Deposit Insurance Corporation.

By the mid thirties there was also in existence an advanced demonstration of the Keynesian system. This was the economic policy of Adolf Hitler and the Third Reich. It involved large-scale borrowing for public expenditures, and at first this was principally for civilian works - railroads, canals and the Autobahnen. The result was a far more effective attack on unemployment than in any other industrial city. By 1935, German unemployment was minimal. 'Hitler had already found how to cure unemployment before Keynes was finished explaining why it occurred.(17) In 1936, as prices and wages came under upward pressure, Hitler took the further step of combining an expansive employment policy with comprehensive price controls. The Nazi economic policy, it should be noted, was an ad hoc response to what seemed over-riding circumstance. The unemployment position was desparate. So money was borrowed and people put to work. When rising wages and prices threatened stability, a price ceiling was imposed. Although there had been much discussion of such policy in pre-Hitler Germany, it seems doubtful if it was highly influential. Hitler and his cohorts were not a bookish log. Nevertheless the elimination of unemployment in Germany during the Great Depression without inflation - and with initial reliance on essentially civilian activities - was a signal accomplishment. It has rarely been praised and not much remarked. The notion that Hitler could do no good extends to his economics as it does, more plausibly, to all else.

Beginning in 1966, there were lage increases in spending for the Vietnam war. To the natural reluctance to increase taxes there was added the greater reluctance to increase them for an unpopular war. Not until 1968 was a surtax for war spending finally voted. Meanwhile expanding demand put pressure on prices and living costs. As these rose so did the pressure for higher wage settlements. It was part of the bargain, after all, that prices would be stable. At the same time, the moral authority of the government, which had now to recruit support for a widely rejected war, had been sadly weakened. So, as the need for the guideposts increased, their effectiveness dinimished.

Thus the flaw. The experience of the good years showed that economic power - that of the corporations and unions - could defeat efforts to combine high employment with stable prices. So in practice intervention was essential. But the practice never became part of the principle, and the principle became highly influential. There is a hopeful myth that, on matters as deeply of concern to the citizen as economic policy, the citizen decides. Perhaps in the long run he does; he retains the happy right eventually to expel from public office those who fail. But in the interim before failure becomes evident or the expulsion becomes possible, economic policies, like open-heart surgery, are in the hands of the specialists. Thus what economists believe or wish to believe - the economic principles to which they repair - are not matters of passing detail. They are decisive.

The next flaw was the fatal inelasticity of the Keynesian system.