Grand Pursuit

by Sylvia Nasar

  In the face of financial calamity and misplaced hopes, Keynes was his usual optimistic self. He was certain that the American monetary authorities would inaugurate “an epoch of cheap money” to head off a severe recession.4 Three lunches with the new Labour prime minister, Ramsay MacDonald, whose party had soundly defeated both the Tory incumbents and Keynes’s own Liberal candidate, Lloyd George, in the general election of May 1929, convinced Keynes that the new government would reject what Churchill had called “orthodox Treasury dogma.”5

  The Treasury’s traditional cure for financial crises was to reassert fiscal rectitude by balancing the government’s books while the Bank of England raised interest rates to defend the gold value of the pound sterling. Restoring business and investor confidence, the reasoning went, was the shortest route to recovery. Any attempt by government to act as employer of last resort would merely result in less hiring by private employers. As Winston Churchill, the outgoing Tory Chancellor of the Exchequer, reiterated before Parliament, “Whatever might be the political and social advantages, very little additional employment and no permanent additional employment can in fact, and as a general rule be created by State borrowing and State expenditure.”6 Keynes was confident that the Labourites would embrace Liberal proposals for public works spending and lower interest rates, their effect on the government deficit and the gold value of sterling be damned. An invitation the following July to chair MacDonald’s Economic Advisory Council, the prime minister’s “economic general staff,” confirmed his upbeat expectations.7 “I’m back in favor again,” he crowed in a note to Lydia.8

  Keynes was certain that easier money would stabilize the economy. Unemployment might ratchet up for several months, he wrote in a Times of London column, but as long as interest rates fell even faster than prices, business investment would bounce back and commodity prices and farm incomes would recover. He also had faith in the activism of the new president, Herbert Hoover, in contrast to Calvin Coolidge’s passivity. Hoover had appointed an energetic Federal Reserve chairman, Eugene Isaac Meyer, the future publisher of the Washington Post, and had announced a program to fast-forward federal construction projects. The successful former mining executive and European food aid czar was inviting business bigwigs to the White House for brainstorming sessions. A few weeks after the stock market crash, his treasury secretary, Andrew Mellon, had gone to Congress to ask for a 1 percent tax cut for corporations and individuals.9 And, as always, Keynes was confident enough to back his forecasts with cash. By September 1930, reports Skidelsky, he was once again buying up large amounts of American and Indian cotton.

  Demand for Keynes’s opinions soared, and he used his newspaper columns, radio talks, and newsreel interviews to promote monetary activism to fight the slump. In December 1930, he wrote a long piece for the Nation that began: “The world has been slow to realize that we are living this year in the shadow of one of the greatest economic catastrophes of modern history.” To dispel resignation, he used every public forum to dismiss the popular narrative that cast booms and busts as episodes in a morality play. He vigorously denied the notion that recessions were the inevitable punishment and welcome correctives for extravagance, imprudence, and greed. Instead, Keynes told his readers, “We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand.”10

  The problem, in other words, was a technical one. For Keynes, depressions, like car wrecks, were the result of accidents and policy blunders. They involved permanent losses in output that, like time, could never be recouped and were not restoratives but simply a waste. Bad harvests, hurricanes, wars, and other bolts from the blue did sometimes trigger downturns, but the origin of most recessions was bad or erratic decisions by economic policy makers. In principle, that meant that downturns could be minimized or prevented altogether. Keynes was especially eager to rebut the notion that booms, rather than depressions, were the problem. As he put it a few years later, echoing one of Schumpeter’s sentiments from The Theory of Economic Development, “The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump, but in abolishing slumps and thus keeping us permanently in a quasi boom.”11 He insisted that, contrary to the accusations of moralists, the slump meant that past economic gains had been phantasmagorical. Referring to the investment boom of the twenties, he wrote that “the other was not a dream. This is a nightmare, which will pass away with the morning. For the resources of nature and men’s devices are just as fertile and productive as they ever were . . . We were not previously deceived.”12

  The economy was suffering from a mechanical breakdown for which there was a (relatively) easy fix. In one column he wrote that there was nothing more profoundly wrong with the economic engine than a case of “magneto” or starter trouble.13 Prices had fallen so much that farmers and businessmen couldn’t sell their products for what it cost to produce them. Hence, they had no choice but to slash production and investment, setting off another round of unemployment and causing prices to fall still further. To break the vicious circle, all the monetary authorities had to do was to lower interest rates by creating more money until business could raise prices and found it worthwhile to begin investing again. He was convinced that easier money would head off anything worse than a garden-variety recession.

  Keynes used automotive analogies to make the point that, as Skidelsky put it, immense catastrophes could have trivial causes and trivial solutions. To many ears, however, his message sounded counterintuitive, even flippant. While the eminent mathematician and Marxist G. H. Hardy was ridiculing the notion of mechanical solutions to deep scientific problems—“It is only the very unsophisticated outsider who imagines that mathematicians make discoveries by turning the handle of some miraculous machine”—Keynes was reassuring his readers that once the problem was correctly diagnosed, there was a solution—if only the authorities had the conviction to act:

  Resolute action by the Federal Reserve Banks of the United States, the Bank of France, and the Bank of England might do much more than most people, mistaking symptoms or aggravating circumstances for the disease itself, will readily believe . . . I am convinced that Great Britain and the United States, like-minded and acting together, could start the machine again within a reasonable time; if, that is to say, they were energized by a confident conviction as to what was wrong. For it is chiefly the lack of this conviction which to-day is paralyzing the hands of authority on both sides of the Channel and of the Atlantic.

  The lack of conviction was partly, or even mainly, intellectual. Keynes attributed the magnitude of the catastrophe to the fact that “there is no example in modern history of so great and rapid a fall of prices from a normal figure as has occurred in the past year.”15 As Keynes knew, old theories could not be refuted with facts alone. New theories were required. To add ballast to his editorializing, Keynes hurried his two-volume Treatise on Money into print, finishing the preface in mid-September 1930.

  The focus of the Treatise was the possibility of controlling the business cycle by stabilizing prices. When investment exceeded saving, the result was inflation. When the reverse was true, the results were a falling price level, slumping output, and rising unemployment—a recession, in other words. Thus, depressions could be cured by encouraging spending and discouraging saving, exactly the opposite of the medicine that traditionalists such as Churchill extolled. “For the engine which drives Enterprise is not Thrift, but profit,” he argued, asking rhetorically, “Were the Seven Wonders of the World built by thrift? I doubt it.”16

  His upbeat message was that if deflation was driving farmers, miners, and businessmen to slash output, the authorities possessed the cure. In his 1921 book Stabilizing the Dollar, Irving Fisher had argued that the central bank could control the quantity of money and credit by manipulating the interest rate. By raising rates when inflation threatened and lowering them when deflation loomed, the central b
ank could restrain or encourage investment, depending on whether it wished to stimulate or slow economic activity. And by controlling investment, the monetary authorities could keep it in line with saving, and prices in line with costs. This is what Keynes believed in 1931, when he was still confident that concerted action to lower interest rates would end the slump.

  As Skidelsky observes, Keynes failed to appreciate the economic orthodoxy of Socialist politicians. Even though high unemployment had dominated public concerns for at least nine years, Labour still had no program of its own for attacking it. Beatrice Webb was an exception. A vocal critic of the Treasury view, she had criticized “Treasury book-keeping” and annual budget balancing in her controversial 1909 Minority Report.17 In boom times, she had argued, government ought to raise taxes on the rich and create a surplus. In bad times, it should fund public works even if it meant running a budget deficit. But by 1930 she had become convinced that unemployment was intrinsic to capitalism. Ignoring the fact that unemployment in the United States had averaged less than 5 percent for most of the 1920s, she had concluded that it could not be eliminated until private industry had been nationalized.18

  Most members of the Labour cabinet hewed as steadfastly to the Treasury view as had Winston Churchill. One minister wrote to the prime minister, “The captain and officers of a great ship has run aground on a falling tide; no human endeavor will get the ship afloat until in the course of nature the tide again begins to flow.” MacDonald replied that the “letter expresses exactly my own frame of mind.”19 Cutting benefits and raising taxes seemed more prudent than embracing the radical stimulus measures advocated by Keynes and Fisher.

  At the end of 1930, Keynes’s advisory council of economists came up with a hodgepodge of conventional and radical policies: cut the unemployment benefit, adopt a 10 percent tariff on imports, and implement “a big public works program” to create jobs for the unemployed.20 They explicitly rejected the view that any additions to government payrolls would merely displace private employment. “We do not accept the view that the undertaking of such work must necessarily cause any important diversion of employment in ordinary industry.”21 But the Labour cabinet, in which Sydney Webb served as colonial minister, adopted only the first measure and rejected tariffs and public works.

  By early 1931, reports Skidelsky, Keynes’s finances were so strained that he tried to sell his two best paintings, including Matisse’s Deshabille.22 He found no buyers at his minimum asking price.

  • • •

  In the summer of 1929 Irving Fisher had not only splurged on his Stearns-Knight but also watched with satisfaction as a crew of workmen finished a lavish renovation of his and Maggie’s New Haven house. The best thing about it, he told his son, was that he, not his wife, was footing the bill.

  At sixty, Fisher looked fitter and more distinguished than ever, with his thick white hair, trim figure, and a thoughtful gaze that gave no hint that he was blind in one eye. He had borrowed heavily to take advantage of options on Remington Rand stock that came his way as part of his sale of Index Visible. Four years after the sale of Index Visible to Rand, the value of his stock portfolio had multiplied tenfold. His Index Number Institute, still housed in the New York Times Building, had inaugurated a subscriber service for stock indices. Fisher wrote a syndicated weekly column for investors that appeared in newspapers around the country every Monday. In the public’s eye, he was identified not only with Prohibition and the wellness craze, but also with the stock market boom and New Era optimism on the economy.

  As questions about the durability of the bull market accumulated in 1929, he dismissed the dire warnings of professional stock market bears such as Roger Babson by pointing to the remarkable combination of low inflation and rapid economic growth that had characterized the decade. “We have witnessed probably the greatest expansion in history, within any similar period of time, of the real income of a people,”23 he wrote. In mid-October, according to the New York Times, Fisher had predicted that the stock market was poised to go “a good deal higher within a few months.”24

  After the crash, Fisher was by no means convinced that a recession was inevitable. In January 1930 he wrote:

  The fall of paper values was largely a transfer of wealth, not a destruction of physical wealth . . . Physical plans are unimpaired . . . The redistribution of corporate ownership was confined to a very small percentage of the population, and consequently will have little effect upon the purchasing power of the great mass of consumers.25

  His competitor the Harvard Economic Society agreed that a repeat of the severe 1920–21 recession was not in the cards. Days after the crash, the Harvard forecasters informed their subscribers, “We believe that the present recession both for stocks and business, is not a precursor to a business depression.”26

  Fisher wasted little time bemoaning his losses and instead focused his attention on producing a postmortem of the crash. He wrote much of The Stock Market Crash—and After in November and December 1929. He defended his optimism that stock prices would recover by pointing out that they were now only eleven times earnings, below their long-run historical average, and “too low a ratio in view of the expectations of a faster rate of earnings in the future.” He rejected the popular explanation that the inflated stock prices were to blame, arguing that “between two thirds and three fourths of the rise in the stock market between 1926 and September, 1929 was justified” by earnings and productivity gains, a conclusion that some recent analyses confirm. At the same time, he explained how investors like him had been lured by a combination of low interest rates and high returns to take on too much debt: “When new inventions give an opportunity to make more than the current rate of interest there is always a tendency to borrow at low rates to make a higher rate from investment.” Instead of artificially high stock prices, the problem was excessive borrowing:

  Investors found themselves confronted on the one hand by wonderful opportunities to make money and on the other a low rate for loans. They could borrow at much less than they expected to make. In short, both the bull market and the crash are largely explained by the unsound financing of sound prospects.27

  Fisher continued to predict a stock market recovery and to deny that the crash had made a depression inevitable. He pointed out that economic activity had begun to decline before the stock market crash and predicted a typical recession. As long as businesses did not succumb to doom and gloom by scaling back production and firing employees, he insisted, the real economy would weather the storm. Month after month for the next year, Fisher maintained that an upturn was around the corner. Like Keynes, he had confidence in Hoover’s competence and resolve.

  For several months, Fisher’s optimism looked plausible. By April 1930, the stock market was back to the level it had reached in early 1929. Prices were not falling as fast, and unemployment was not rising as rapidly, as in 1921. Indeed, as late as June 1930, the unemployment rate was 8 percent. In 1921, it had been 12 percent. Interest rates were extremely low. But as Milton Friedman and Anna Schwartz observe in their magisterial A Monetary History of the United States, 1867–1960, instead of the anticipated recovery there was a palpable “change in the character of the contraction.”28

  A further plunge in industrial prices offset any benefit to borrowers from lower interest rates. Billions in assets evaporated in a wave of bank failures in the fall of 1930 and the summer of 1931. Even when Fisher was finally forced to admit the severity of the depression, he insisted that the market and the economy were both bottoming. His optimism, overconfidence, and stubbornness betrayed him, and, like so many others who kept hoping that the tide would turn, he hung on to his stock. Had he adopted Herbert Hoover’s cautious formula and paid off his bank loans while Remington Rand stock was climbing to $58 a share in 1928 and 1929, Fisher would still have been a millionaire eight to ten times over. Even if he had sold his stock one year after the crash, he would still have been comfortable. In late 1930 Remington Rand was selling for $28 a
share. By 1933, it would fall to $1 a share. By April 1931 Fisher’s net worth had shrunk to a little more than $1 million. In August he was forced to shutter the Index Number Institute and disband his staff of economists and statisticians. As if this was not devastating enough, the IRS sued him for $75,000 in back taxes related to sales of Remington Rand stock in 1927 and 1928. He was forced to turn to his sister-in-law Caroline Hazard, the retired president of Wellesley, who eventually turned over the management of the loan to a committee consisting of her lawyer and two nephews.

  Public recrimination and ridicule added to the stress and humiliation of financial ruin. The former president of the American Economic Association attacked Fisher in the New York Times for “always insisting that all was well and talking of prosperity, a new era and increased efficiency of production as justification of the high stock prices.”29 The paper also reported that “Secretary Mellon, former President Coolidge and Professor Irving Fisher of Yale were named yesterday as the individuals most responsible for ‘continuing and extending the mania’ ” of speculation which preceded the Wall Street crash.30 When the CEO of a company in which he had invested heavily was indicted for fraud, Fisher sued. The publicity tarnished his reputation further. His son recalled hearing two strangers discuss the lurid details of the case, which were being reported daily in the New York Times. “Gosh, he’s supposed to know all the answers, and look how he got burned.”31

  Instead of running its course, the economic slide accelerated and spread across the globe. US industrial output plunged to less than half its 1929 level, and unemployment shot up to 16 percent. The tone of commentary turned panicky: by midyear, newspapers were referring to “the Great Depression.”32 Fisher confessed that “the most important economic event in the lifetime of all of us here” would be “an enigma” for years to come.33 He and Keynes had both been blindsided, but Fisher had lost his credibility with the public as well.