Steve Reads

On one side of the world is a broad swath of professional mystery-makers, who stand in awe at the world’s complexity, quite often view it as unanalyzable or irreducible, and let it stand pretty much as it was before. Then there are people in this world who want very much to take apart all the world’s complex systems and machines, show you what they’re made of, and say, “See? It’s not all that awe-inspiring after all.” I’ve decided that John Kenneth Galbraith, on the basis of Money: Whence It Came, Where It Went, is one of the latter.

Among those peddling mystery rather than clear thinking around money are some of Galbraith’s own economist colleagues, who enshround the topic in hefty terminology and bestow upon money men an authority that, as it turns out, they don’t deserve. Here’s Galbraith clarifying a couple often-heard terms from the world of finance:

A rapid expansion of commercial bank loans and resulting deposits and the spending of the latter would, as we have seen, cause prices to rise. The effect on England, exposed as it was to the full force of foreign competition, was to encourage purchases from abroad. And it made England a more costly market from which to buy. A signal of an unduly rapid expansion of bank lending, accordingly, was an outflow of gold for overseas purchases or for investment in supplying them. This the bank now anticipated and forestalled by raising the bank rate — the rate at which, in one manner or another, it loaned funds to other banks or at which it accepted credit instruments from those seeking funds to finance commercial transactions…. Such an increase in the bank rate now became a signal to the banks that they should restrict their lending. In case the signal was missed, the Bank of England could sell government securities in the open market and allow its other investments, including its commercial paper, to expire and be collected. So instead of an investment portfolio it now had cash. And this cash not being in the other banks, they had fewer reserves against their deposits and were thus forced to be more restrained in making new loans. They could replenish their cash by borrowing from the Bank of England. But here the bank rate entered. Having been increased, this discouraged such borrowing — and discouraged borrowing by ultimate customers when passed on to them. Thus did the Bank of England come to regulate the lending — and therewith the making of deposits and money — by the banking system as a whole.

Few phrases have ever been endowed with such mystery as open-market operations, the bank rate, the discount rate. This is because economists and bankers have been proud of their access to knowledge that even the most percipient of other citizens believe beyond their intelligence. Open-market operations are the sale of securities just mentioned by the central bank which removes the loanable cash or reserves from the commercial or ordinary banks. The bank rate and the discount rate are the same; they are what prevent the banks from too painlessly recouping their cash by borrowing from the central bank. This is it. Viewed in the context of their development in the last century [i.e., the 19th], it is hard to regard these mysteries as anything but a simple, even obvious, accommodation to circumstance.

That same tone, in a couple of particulars, is what makes Money such a tremendous book. First there’s the persistently arched eyebrow, aimed at other economists. Then there’s the urge to make the world clearer. The whole book is quite admirable in this way.

Money‘s pace is a little funny: perhaps 80 pages get us from the start of world history up to the Bank of England, then another 100 pages from the 19th century to World War I. The remaining 150 pages covering the practical collapse of the gold standard through the Depression and its aftermath. It’s like Zeno’s Monetary History.

Galbraith’s central observation about banking is that, beyond its most primitive forms, all banks suffer from one single, ineradicable problem: they have more money on the books than they actually have on hand. And every now and again, panic spreads from bank to bank, justly or unjustly: a nearby bank fails, so all my depositors rush to empty out their accounts. They are all shocked to discover that I don’t have a special bag of gold coins labeled “Doris’s savings account.” My bank fails, as do all the other banks. My bank wasn’t necessarily any worse just before the failure than it was a week earlier, but expectations combined to make it collapse. If I’m not mistaken, observations of this form are distinctly Keynesian.

Indeed, Galbraith is an old-school Keynesian, responsible in some fashion for price controls during World War II. Some of the most interesting parts of Money, to me, were Galbraith’s defenses of this centralization. It all worked quite well, says Galbraith, and people seemed generally satisfied with it. When the price controls were lifted, inflation did not go through the roof; there was no pent-up demand waiting to explode, but for the evil central planners. This, and much of the rest of the book, is a more or less direct response to Milton Friedman, maybe especially Friedman and Stigler’s “Roofs or Ceilings?”

Part of Money is in fact a direct attack on Friedman’s monetarism. The standard Keynesian attack seems to go like this: there comes a point in an economic crisis when the interest rate just cannot be productively lowered any more — we are at the “zero lower bound”. Banks are afraid to lend out any more money, so they hoard it. Lower interest rates near the ZLB just lead to more hoarding. The distinctive Keynesian response is to emphasize fiscal policy here over monetary policy: the government should actively spend money to put it in consumers’ pockets to get people spending, get them borrowing (clear out those hoards), etc. (Paul Krugman brought an early-twenty-first-century perspective to this dispute, including the Japanese experience of the late nineties, in his critical obituary for Friedman. It’s really a gem of an article. I’m no professional economist, but it looks to me like he got the better of the exchange with Anna Schwartz.) When read today, Keynes sounds somewhat naïve about the prospects for apolitical control of the economy by a technocratic élite; so does Galbraith.

Some of Galbraith’s naïveté comes from a belief that the world is moving to greater centralization: fewer corporations controlling production, and unions representing workers in bulk. It sounds like commerce really was more concentrated during World War II, and consequently that the central planner had a much easier task than he would now. Galbraith doesn’t seem to have updated this picture of the world since 1945, and Krugman gives him hell for it.

Still, Galbraith’s Money is a terrific read. A lot of what Galbraith says makes perfect sense, and I have a much better picture of how monetary policy works. He’s maybe less reliable on Keynesian demand management; just read the final 50 pages or so with the same skepticism that you brought to the rest of the book, and you’ll be fine.