A Financial History of the World - Beyond "The Great Moderation" by Judy Joyce

How Bernancke Got It Wrong

When Niall Ferguson, Harvard Professor of History and Senior Fellow of the Hoover Institute at Stanford University, was interviewed by Washington bureau chief editor, Adrian Wooldridge , of “The Economist” - the definitive magazine and arbiter of the financial world accessible on this website menu above at hyperlink Read Books Online - the current financial crisis was put into context.

The nature of the interview was the Ferguson book, “The Ascent of Money:And a Financial History of the World”. During Wooldridge's questioning, Ferguson developed his theory about how Ben Bernacke, successor to Alan Greenspan as Chairman of the U.S. Federal Reserve, got it wrong when analyzing the current financial crisis due to Bernancke's limited understanding of the history of finance.

Editor's Note: it is generally accepted that Ben Bernancke has in depth knowledge of the period of history known as the Great Depression of the 30's and has written extensively on the topic.

Professor Ferguson identifies the notion of Bernancke's theory of the 'Great Moderation' as part and parcel of the failed analysis?

Bernancke's Great Moderation Theory: Why It Doesn't Work

Niall Ferguson recalls as recently as 2006 there was a great sense of euphoria in financial institutions generally and within university Economics departments relying as they were on their knowledge of financial markets within their own lifetime or recent history. In this mindset, they remained indifferent and oblivious to the high risk in the existing liquidity markets.

Taking only their own perspectives into consideration, the Great Moderation Theory introduced by Bernancke in 2004 holds that each period of recession and/or period of inflation will inevitably get smaller and more manageable due in large part to the knowledge of these very people who manage the financial markets.

Operating on this theory, Ferguson contends, investors can surmise a virtual “put option” on their portfolio as it is slated to rise if they hold out for recovery which is inevitably within a shorter and shorter period. However, Ferguson points out, when institutions are highly leveraged threatening liquidity and individual households deeply in debt, crisis does happen. It does not happen with enough frequency that it is safe to rely on one's personal database about how to solve it, how long it's duration or the outcome.

Recent Financial History of the U.S.

Despite their own sense of being great masters of finance, even CEO's of major institutions had personal experience to go on that only goes back approximately 25 years or so when the current financial crisis began around 2007.

Interviewer Wooldridge did point to all the financial crisis of the past 20 or 30 years as a touchstone for recent financial history citing the Asian crisis, the European crisis and the U.S. Black Monday as examples.Ferguson sees it as an experience that has taught little else than that the Fed comes and manipulates rates creating the put option and a quick turnaround to the portfolio. He sees it as the rise and fall of the Age of Leverage.

Rise and Fall of the Age of Leverage

In the 1970's, the big crisis was double digit inflation in the U.S. But in some countries it was even more painful at triple digits. That trend to continue to reduce interest rates to deal with the crisis had the effect of encouraging leveraging to acquire more and more liquidity. From this we began a major shift in the economy in the large increase of debt to the GDP (Gross Domestic Product) ratio. By doing so all debt, both public and private, rose from about 150% to something like 300% of GDP.

This signaled the reality that at some point the key term “liquidity”, whether public or private, would not be able to be rolled over. If it suddenly became difficult to sell assets or roll over liquidity, then the Age of Leverage would necessarily come to a grinding halt.

Hyper- Inflation: Power in the Military Sphere and Power in the Financial Sphere.

Having done his Ph.D paper on the connections between geopolitics, grand strategies and finance, Ferguson ties the beginnings of hyper-inflation to WW 1 and how the Germans financed that war saying it is very difficult to understand power in the military sphere if you don't understand power in the financial sphere. Going further, he states that it is precisely the issue of American power and the issue of this financial crisis that makes it so interesting to the historian. He believes that many people wrongly assume that the Rise and Fall of American power is tied to this financial crisis.

The History of Money

Asking why money is so Important to us all, the history of bank notes, and are we going to a cashless economy, “The Economist” editor and chief elicited from Prof. Ferguson a further response. Ferguson stated that we've been moving toward a cashless economy for quite sometime in that most financial supplies no longer consist of bank notes or gold coins but rather current accounts. These accounts are deposit accounts which the bank lends out, receives interest, and we get cash from that interest. People have a tendency to think their money is in the bank when it actually isn't. It's bank money.

Four Thousand Years After "Pay to the Bearer"

The use of money, according to Harvard History Professor Ferguson likely started about four thousand (4,000) years ago in Mesopotamia. There are clay tablets written in hieroglyphics and essentially say “pay to the bearer' a specified amount of silver or perhaps wheat on a particular date. This established a debtor \ creditor relationship allowing a transaction to be extended. It even made transactions transferrable in that the bearer may not be the person originally owed the money or commodity.

Editor's Note: consider earlier bartering transactions where exchanges were \ are immediate.

Bank Notes in the East and West

What came later ie coins, bank notes and bank deposits are really refinements of this original transaction type. Bank Notes in the East existed in ancient China and were used extensively in Imperial finance demonstrating the ease with which the Chinese accepted money. Bank Notes were not used in the West until the American colonial period of the 17th century.

This, according to Ferguson, was a peculiarity of the global economy over many centuries caused by a shortage of coins due to the imbalance of trade. Asia produced many commodities wanted by the Western world. This created a drainage in precious metal from the West to East where coins were used to pay for purchasing. The improvisations used to deal with the problem of the more financially developed East included devaluing coins.

So it is that today, precious metals no longer back up the economy in that both Europe and the US abandoned the gold system in the 30's. The Bank of England sold off the last of it's gold reserves in 1999 and Ferguson says it's now kicking itself.

So viewed historically deposits in banks are low and interest owed the banks for lending out the deposit money is what we actually draw on mostly when getting cash in this day and age. This explains why interest rates to borrow from the bank is higher than the interest on your savings account.

Now, we are trending toward using less and less cash in financial transactions. This has moved us closer and closer to a cashless economy.