Memo To: Fed Chairman Alan Greenspan
From: Jude Wanniski
Re: The 1929 Crash and Say’s Law
Dear Alan…. I’d heard that while you were in London for the G-7 meeting this last week you would hop up to Kirkcaldy, Scotland, to deliver the annual Adam Smith Memorial Lecture, and I eagerly awaited the transcript to see how you would celebrate the Granddaddy of classical economics. I wasn’t disappointed, but quite impressed... at least until you got to the 20th Century, the Wall Street Crash of ‘29, and the Great Depression that followed. There you really screwed up. I thought to myself: “Greenspan should be ashamed of himself, treading the sacred ground of Adam Smith’s birthplace and announcing that Smith’s idea of the invisible hand of the marketplace guiding the economy in the right direction only works some of the time!”
Of course I am sure the people hearing you speak thought you were doing honor to Adam Smith, but you and I know you were only saying was correct about the genius of the market a long time ago, but not any more! It came at the very end of your remarks at Kirkcaldy, but here it came in neon lights:
“The inference is not that people always act rationally in commercial transactions. The periodic bubbles in product and financial markets prove otherwise.”
You did not do any favors to Smith by saying every now and then the markets foul up, which means the government must suspend the operation of the markets, intervene, and fix things with wise men like you!!
In order to do this, you had to blow past the Wall Street Crash of 1929, as if it were one of these “bubbles” that Smith's invisible hand did not foresee. Didn't you hear, Alan my old buddy, that I discovered the cause of the Crash in 1977, wrote about it in the WSJournal in October of that year, and nailed it all down in Chapter VII of my 1978 book, “The Way the World Works”?
In this short run, you can make believe you don't know that my discovery rescued classical economics from the dustbin of history, along with Adam Smith and Jean Baptiste Say and his law of markets. But I'm telling you, old man, that history will not treat you kindly for blinking away a perfect defense of Smith and Say. The Crash was not the pricking of a bubble, and you know that, but if you acknowledged my discovery, you would have to elevate my credibility as a critic of your current misguided policies of managing interest rates. If any of the classical economists were alive today, they would laugh at your interventions and tell you to fix the dollar to gold and let that market tell you when you should add or subtract money from the banking system.
Your Scotland lecture should really be read carefully, because up to the point where you really announce that you wiser than Smith's marketplace in managing the dollar, the speech is just fine. Here are the paragraphs where you slide over the reasons why classical economics was trashed:
Yet standards of living of the average worker moved inexorably higher, serving through most of the nineteenth and early twentieth centuries as an effective political buffer to the widespread emergence of socialism. Because agriculture so dominated the world's economies at that time, the industrial recessions, which appeared from time to time, did not provoke a severe enough political response to alter the capitalistic order.
The writings of Jean Baptiste Say, an early nineteenth-century follower of Smith, were significant in this regard. He postulated that supply creates its own demand and concluded that marked contractions in economic activity would, with time, be unwound.7 The widespread acceptance of Say's Law and the associated confidence in the self-stabilizing property of a market-based price system were dominant factors inhibiting government intervention in periods of economic distress, especially during the latter part of the nineteenth and early twentieth centuries.
But the Great Depression of the 1930s subjected the optimistic conclusions of classical economics, especially Say's Law, to a much broader assault. As the economic stagnation of the 1930s dragged on, the critical notion that capitalism was self-correcting fell into disrepute.
The marked increase in government intervention into markets, in effect a partial reversion to mercantilism, was perhaps an inevitable response to the distress of the Great Depression. At the same time, the notions of Marx gained influence in the West, perhaps because the repressions of the Soviet Union, the major avowed practitioner of Marx, were not well known before World War II.
But cracks in the facade of economic management by government emerged early in the post-World War II years, and those cracks were to widen as time passed. Britain's heavily controlled economy, a carryover from the war, was under persistent stress as it encountered one crisis after another in the early postwar decades. In the United States, unbalanced macroeconomic policies led to a gradual uptrend in the rate of inflation in the 1960s. The imposition of wage and price controls to deal with rising inflation in the 1970s proved ineffective and unworkable. The notion that the centrally planned Soviet economy was catching up with the West was, by the early 1980s, increasingly viewed as dubious, though the view was not fully discredited until the collapse of the Berlin Wall in 1989 exposed the economic ruin behind the Iron Curtain.
Now I'm sure almost all of those who are reading this letter to you are puzzled about the subtleties of these arguments. For that reason I argued with myself all day on why I should perhaps just forget your Scotland speech, or risk being seen as a crank. But no, it's the right time now to have these issues discussed. You should do better than you have been lately instead of blaming the market for problems you have been yourself creating. There is not much time left, for either of us, Alan. You should fix the dollar now, which would be a true celebration of Smith, Say and the classical political economists.