FDR and George Warren
By Scott Sumner
I am currently about one half way through an excellent book entitled “American Default“, by Sebastian Edwards. The primary focus of the book is the abrogation of the gold clause in debt contracts, which (I believe) is the only time the US federal government actually defaulted on its debt. But the book also provides a fascinating narrative of FDR’s decision to devalue the dollar in 1933-34.
Here’s what I noticed about FDR:
1. His decision to devalue the dollar went against the advice of most experts, although initially there was also substantial support.
2. Over the course of time, FDR became more and more extreme in his views on gold, mostly under the influence of George Warren. Warren was a heterodox economist who was then (and still is) viewed as something of a crackpot. In my view, this reputation is unwarranted.
3. FDR could be a bit mischievous. He seemed to delight in provoking and shocking conventional opinion. At the June 1933 World Monetary Conference in London, FDR’s advisors worked out a series of tentative agreements with the major European powers to re-establish exchange rate stability. Each time, FDR would reject the agreement suggested by his own advisors, and ask for more. A new agreement would be negotiated which seemed to address FDR’s concerns, and he would then proceed to reject even that agreement. Eventually he made it clear that he would not accept any plausible compromise, and the conference fell apart.
4. FDR put a lot of weight on the reaction of asset prices, especially stocks and commodities, to his policy initiatives.
I don’t know about you, but this sort of reminds me of President Trump. Think of Peter Navarro as Trump’s George Warren. Navarro favors the sort of protectionism that is anathema to most conventional economists. Trump uses the stock market as an index of how he’s doing. Trump can be mischievous, delighting in shocking conventional opinion. Trump can change his views suddenly—seeming to back an agreement and then suddenly walking away, asking for more. Or completely losing interest in making an agreement (on something like DACA.)
Of course I believe that George Warren was a brilliant economist whereas I think Peter Navarro is deeply misguided. But my subjective opinion is not very important. On the other hand I do see one important objective difference between these two cases. While Warren was viewed as a crackpot by respectable opinion, the stock and commodity markets actually supported his policy of depreciating the dollar. (When I say they “supported” the policy, I mean that asset prices rose on unexpected news of further devaluation, presumably markets don’t literally think.)
On the other hand, markets seem opposed to protectionist policies, falling on news that makes protectionism more likely. If Peter Navarro were fired tomorrow, and replaced with Gary Cohn, stocks would probably rise sharply. And this makes the Trump case slightly different, in an interesting way. Trump presumably notices the adverse reaction of Wall Street to protectionist policies. That doesn’t stop these policies entirely, but may put a sort of brake on how far he goes.
This is the familiar “circularity problem” with monetary policy. What if the markets watch the Fed, and the Fed watches the markets for signs that policy is too easy or too tight? Then in the case of an excessively tight policy, the markets must take account of not just the likely effect of the policy on the economy, but also the likely effect of any resulting market crash on Fed policy. Thus the market response may understate the true impact of the policy, if carried through unmodified. Markets are already looking ahead to the policymaker repairing the damage.
In a perfect world, I would not want policy being made in response to the stock market. But if the policymaker’s instincts are misguided, it’s probably better that they do pay some attention to how markets are reacting to their initiatives.
I’ll have more to say about Edwards’ book in future posts–I encourage people interested in economic history, gold, and the Great Depression to take a look—it’s much more readable than my Depression book.
PS. The book is also of interest to people who follow the law, as the last part of the book focuses on a key Supreme Court case on the abrogation of the gold clause in contracts. Spoiler alert!! The outcome was quite similar to the Obamacare case, where one conservative justice swung to the liberal side for pragmatic reasons, to prevent a controversial rejection of an important public policy initiative.
PPS. There is a related post over at TheMoneyIllusion.