Chi-town (fiction)

One time, in September, I went to a bachelor party in Chicago. On Saturday we went to the Wrigley rooftops, and they had like 7 or 8 different Goose Islands on tap. My favorite was the Cubby Bear Blue. Second favorite was the 3-1-2, or as I say, the 'three-one-deuce', which is a Wheat Beer and is really good too. They also have a Green line beer and a Honkers ale and that is all I could remember. It was all you can drink and eat, so needless to say I drank all of them. Then me and my boy Scripps, whom I shared a bed with at hotel (it was Kosher, don't worry) made friends with a group of Puerto Ricans on the rooftop. After the game we went with our Puerto Rican friends to the Cubby Bear Bar across the street, who just happened to have the sweetest DJ in the world bumping the Bone-Thugs and Biggie at like 4:30 in the afternoon....so we took the RedLine back downtown to hotel to meet up with the group we were with that we lost at some point in afternoon. Later that evening we went to a late dinner at this place called the Admiral's Theater, which doesn't serve alcohol (you just go to bar beside place which is annoying, but effective).They put on this show at about 11:30pm and 1am where they get these two girls on stage, and there is a glass shower, and they have water that some how gets in the shower and then girls....use your imagination. I am still having trouble figuring out how on earth they get the water into the shower on stage...perhaps it was the all day drinking, but I wouldnt be so sure... I take that back, the 11:30 scene was two girls in the shower. The 1am was two girls dressed like Egyptians (post-Mubarak era) that were in a tomb that looked like King Tut and really liked each other. A lot. Kinda like what you see online but much better in person. Then the cab driver we got back that night at like 3am was either drunk or asleep or lit up or all of the above. I was shitfaced (obvi) by this point, but this mother F*kr couldnt drive a straight line to save his life and he was driving like 40mph on the interstate or like 80...no middle ground whatsoever. First I asked if he was ok then I just started talking shit to him. I wasnt as confident in his abilities as the actresses at the theater......

The Decline of the Dollar (1977-78)

Case Analysis: The Decline of the Dollar

            The central issue facing the Carter administration in 1977-78 was how to stop the rapidly depreciating U.S. dollar, without hurting domestic employment.  The run on the dollar was primarily a function of high (relative) inflation, increased deficits in the current account, and a lack of confidence in the administration. The theory behind floating exchange rates was that the currencies would self-regulate and provide market based corrections to eliminate deficits and surpluses in the balance of payments.  However, this adjustment often took place gradually, as it took time for policy makers to develop a suitable plan to increase confidence in the currency.  Additionally, the support for the dollar creates a paradox as policymakers must choose between a stronger currency (implying high interest rate strategy) and easy monetary policy to promote the domestic economy.

The era of the mid to early 1970s was characterized by increased deficits in the balance of payments, high inflation and obstructionist policies regarding free trade.  The Bretton Woods system of fixed exchange rates was implemented shortly after WWII and allowed countries to adjust the exchange rate to reflect structural defects in the balance of payments.  In 1971, the Nixon administration reached a deficit in the BOP of $30 billion and dollar liabilities of greater than $50 billion.  In anticipation of large quantities of dollar exchanges (fixed at $35 per ounce of gold), Nixon devalued the dollar by 10% and removed the U.S. from the gold standard.  The Smithsonian accords led to a temporary bounded exchange rate, with a range of 2.25%. The quasi-floating exchange rate was pressured as Nixon relaxed wage and price controls and speculators anticipated inflation.  By March of 1973, the industrialized countries of the West held floating exchange rate systems.

The policy of a fixed exchange rate was difficult to maintain and relied on a proactive government to constantly buy and sell currency to maintain a fixed market price.  In the event that a country such as France or Britain would run a large deficit, speculators would sell that country’s currency and buy stronger ones.  Speculators played an active role in promoting market based pricing, constraining the government’s ability to maintain a fixed rate.  Speculators often had more access to capital than governments, forcing devaluations by buying and selling large quantities of currency. Other constraints included inflation and U.S. demand for foreign goods (oil).  The result was reflected in the large deficit in the U.S. current account.   The current account balance went from a surplus of $4.3 billion in 1976 to a deficit of $15.3 billion in 1977, followed by consecutive negative balances in each quarter of 1978.  Meanwhile, Germany and Japan managed current account surpluses, while the United Kingdom broke even.  The theory behind the floating exchange rate system was currencies would self-regulate.  

President Carter’s first policy move was to obtain swap lines of credit with various central banks. According to the supplement, aggregated swap lines were approximately $30 billion.  The purpose of this policy was to use borrowed money to buy dollars (and sell foreign currency), stabilizing the value of the dollar.  This policy provided direct access for intervention in capital markets, much like a fixed exchange rate system.  This policy did not address underlying causes of the declining value of the dollar – appetite for foreign products (oil), current account deficits and inflation. The effect of this policy is shown in Exhibit 9, as net dollar support approached $2 billion.

President Carter’s administration also announced they would sell gold and reduce the size of the federal deficit.  Selling gold would imply devaluation relative to gold – using proceeds from gold sales to prop up demand for the dollar.  The effects from BOP deficits and inflation outweighed the ability of the administration to intervene in gold markets.  The attempt at reducing the federal deficit did little to quell market expectations for the future of dollar because neither addressed the root cause.  Current account surpluses from Germany and Japan also hindered Carter’s strategy.  The strong currency of Germany and Japan did not adjust ‘automatically’ as the theory suggested.  The countries with the strongest currency maintained surpluses in 1977-78 as the dollar declined dramatically.  U.S. consumers had a strong demand for foreign products.  The ability of Japanese and German to exporters to produce quality goods supported the value of their currency, even with higher prices for their exports.

            The Federal Reserve conducted monetary policy by raising interest rates (discount and fed funds rate) and increasing reserve requirements for banks, therefore increasing the amount of leakage in the system.  The policy was a direct response to inflation—higher leakage in the system would imply a tighter supply of money and reduce the multiplier effect of money.  Inevitably, the interest rate policy would provide confidence and support for the dollar by attracting foreign capital.  Inflation in the U.S. was running about 8-10% annual growth in the CPI in 1978.  The discount rate was increased to 9.5%. Fed Chairman Paul Volker was largely credited with breaking inflationary cycle and restoring faith in the dollar. 

            The policy of high interest rates and an independent Federal Reserve System allowed the U.S. to implement a strategy for contesting the market devaluation of the dollar.  The unique independence of the Fed was vital to restoring confidence.  Inevitably, devaluation of currency implies that imports become more expensive and exports will increase due to the relative affordability.  As interest rates rise, foreign capital flows into the domestic economy and increases the demand for dollars.  Currency speculators played a large role in the decline of the dollar, as did the strength of Japanese and German exports.  The market often takes time to adjust to new policies and can act rationally or irrationally in the short run. The long run effect of supporting the dollar was shown through a stronger currency and stronger domestic economy.  Ultimately, the Carter administration was troubled by the paradox of choosing between a strong dollar and a strong domestic economy. 

The Barry Bonds Witch Hunt

Steroid Facts:

• FDA did not send Andro warning letters until March 2004: http://www.fda.gov/NewsEvents/Newsroom/PressAnnouncements/2004/ucm108262.htm
• MLB Drug Policy on Andro, June 2004:  http://mlb.mlb.com/news/article.jsp?ymd=20040629&content_id=783595&vkey=news_mlb&fext=.jsp&c_id=mlb
• Barry Bonds Single Season OBP 2004: 0.609; OBP 2002: 0.589: http://www.baseball-reference.com/players/b/bondsba01.shtml
• Waxman committee hearings begin Feb 2005: http://oversight-archive.waxman.house.gov/investigations.asp?start=25&ID=244, http://democrats.oversight.house.gov/index.php?option=com_content&id=2332&Itemid=2
• Mark McGwire interview, USATODAY, June 2010: http://usatoday30.usatoday.com/sports/baseball/2010-01-11-mcgwire-steroids_N.htm

The United States Financial Crisis of 1931

Case Analysis:

The United States Financial Crisis of 1931

The United States Financial Crisis of 1931

            The rapid deterioration of the economy in September of 1931 was sparked by Great Britain leaving the gold standard, in addition to the US policymakers’ inability to use decisive measures to combat the currency runs.  Policy solutions available today such as insuring bank deposits, a floating exchange rate and the Federal Reserve’s use of open market operations are essential to the strength of the financial sector and overall economy. 

            Fearing a debasement of the dollar in relative terms of gold, the article highlighted the willingness of investors to exchange dollars for gold in a time of panic.  The policy of refusing to exchange currency for gold in Great Britain on September 21st resulted in a direct loss of $116 million in U.S. gold reserves the following day.  By the end of October, the U.S. banking system lost approximately 15% of bullion reserve, or $727 million.[1]  The lack of deposit insurance was devastating to bank shareholders, leading to over 500 bank failures and a severely constrained money supply.  The advent of the Federal Deposit Insurance Corporation in 1933 was a direct response to the massive bank failures that occurred during the crisis (Harvard Business School 1983).

The Federal Reserve System

            The structure of the Federal Reserve System played a fundamental role during the panic.  Established by the Federal Reserve Act of 1914, the Fed used a decentralized structure of member banks in each region of the country, with the Federal Reserve Board located in Washington, D.C. The relationship between the member banks and the Board was complex and undefined, with a profound effect on the way the supply of money and credit was allocated throughout the system (Moss 2007). 

            The Fed used three primary tools to control the supply of money- the discount rate, purchasing acceptances in international transactions and conducting open market operations.  Of the three measures, the discount rate was the most widely used policy tool for controlling credit (at the time of the crisis).  The discount rate was a lever used to inject liquidity.  A higher discount rate would imply less borrowing in the banking system through higher interest rates.   Through acceptances, the New York Fed had the autonomy to guarantee short-term loans by charging a fee, or acceptance rate.  The New York Fed created friction among other Reserve banks by their unique position in the market, justifying the need to meet constantly-changing market conditions.  Open market operations were an unrestricted monetary policy tool of buying (or selling) securities in the market. The open-ended nature of open market operations was the most controversial at the time and not fully realized under fixed-rate exchange system. The conflict between the New York Fed and the Board among acceptances and open market operations led to reorganization with diminished political clout and more direct control in Washington (Harvard Business School 1983).

Like other banks, the Fed’s position in providing credit was stipulated upon receiving productive assets.  In turn, the Fed held a gold standard equal to a minimum of 40% of the value of bank notes, along with 35% of the deposit base.  Additionally, government securities purchased in the market were not valid forms of collateral or insurance.  These stringent collateral requirements were instrumental in restricting the ability of the Fed to deal with the crisis sufficiently and hindering the effectiveness of open market operations.  When inevitable bank runs occurred, depositors demanded gold putting significant pressure on the Fed’s reserves.  This resulted in political pressure by the Fed to raise the discount and acceptance rates to stop bank runs in October of 1931.[2]

The false sense of security in higher interest rates may have helped the Fed retain gold reserves, but it hurt the ability of commercial banks to borrow money and expand the economy.  The belief that tight money was a sufficient response to a liquidity crisis proved to be a disastrous form of monetary policy, even though the Fed won approval from the Hoover administration and news organizations such as Business Week and the Commercial and Financial Chronical.  The gold standard was a fixture in U.S. policy at the time, lacking the political capital to follow the British lead.  The foreseeable international crisis that ensued when the British dropped the gold standard was compounded by strict regulations requiring the Federal Reserve to collateralize bank notes the Treasury issued with a deteriorating supply of commercial paper and bullion (Harvard Business School 1983). 

Central Issue

The central issue for policy makers and stakeholders was how to shore up the banking system, preventing bank failure and instilling confidence in the financial system.  Underlying this issue was the departure of Montagu Norman from the gold standard, sparking investors to seek safety for their money. The belief that money could be transferred into gold at a fixed value provided stability and insurance. Gold had benefit of being a desirable asset, an alternative to paper money and immune to the decisions of policymakers.[3]  However, this asset class was devastating in a deflationary business cycle- the bullion supply could not be expanded quickly enough to meet the demand of central banks when the asset was needed most. Instead, central banks were forced to contract the money supply, charging higher rates of interest to keep confidence in the system and gold in the vaults. 

When the Bank of England removed the gold facility, Montagu inferred a devaluing of the pound against gold. Because the pound conversion rate was previously fixed at a higher exchange rate than the dollar, the move implied that the fixed dollar rate conversion at $20.67 per ounce was not justifiable – dollars were now worth less, even though the exchange rate remained fixed.  The banking system’s fixed exchange rate proved to be problematic in times of crisis. Based on current policy, the dollar exchange rate was not able to freely adjust to take into account exogenous shocks to the system.  Franklin D. Roosevelt (FDR) ended the policy of exchanging dollars for gold in 1933 (Moss 2007).  Moreover, the Fed lacked the necessary policy tools to maintain confidence in the banking system.

Policy Recommendation #1: Open Market Operations

One policy solution would be to let the New York Fed conduct open market operations more freely, injecting capital into the system, encourage borrowing at lower rates of interest and expanding the monetary base . This has the advantage of creating liquidity through excess reserves that the banking system desperately needed.  The premise of open market operations is that lower rates will spur borrowing, investment and demand for assets as the dollars multiply throughout the system. The disadvantage is that the excess liquidity may not necessarily create new money in the form of loans and capital investment.  According to the case study, borrowing from the Fed declined 83% between July of 1929 and September of 1930.  Unfortunately, the widely assumed theory at the time implied that raising discount and acceptance rates would increase cash flow and earnings, albeit without additional liquidity.  The political desire for open market operations was mute.  The widespread belief by the committee was that money was freely available, where the New York Fed unsuccessfully lobbied for expansion through open market operations in January of 1930 (Harvard Business School 1983). 

Policy Recommendation #2: Free Floating Exchange Rate

Allowing the exchange rate to float is another recommendation for improving economic conditions at the time.  This policy implies that the dollar-gold exchange rate would change dynamically with market conditions. Another advantage was that it allowed the Fed to control how much money was created (Moss 2007).  In reality, the demand and price of gold fluctuated because of its scarcity- indicating downward pressure on real prices (even though the nominal exchange rate remained fixed).  The advantage of a floating currency is the Federal Reserve would not be required to exchange gold at the fixed rate of $20 per fine ounce. For example, a floating exchange rate from a devalued dollar would imply $35 per ounce if the shift in market expectations was drastic. This would alter investors’ decisions about whether they should exchange dollars for gold at the devalued price, since $35 per ounce would not be as attractive (Moss 2007). The effect of a floating exchange rate is the Fed would experience significantly less stress on the excess reserves in deflationary environments, increasing the ability to maintain higher levels of capital. 

The disadvantage of this policy is the possibility of inflation and unpredictable consumer behavior.  Consumers may fear the worse and still end up exchanging dollars for gold at the lower price (driving the price of dollars down further).  Additionally, foreign investors may exchange dollars for other forms of currency with higher rates of return, causing further downward pressure.    Allowing a currency to float had the ability to bring about inflation. With a gold standard, the ability to print money was limited by the amount of gold available in reserves.  On the other hand, a free floating currency could print as many dollars as necessary to devalue the currency, expand the economy and facilitate inflation (or prevent deflation). 

Franklin D. Roosevelt accomplished part of this policy by devaluing the dollar against gold by 40% (Moss 2007). Executive order 6102, signed in April of 1933 prohibited the hoarding of gold by private citizens.  The order maintained the Federal Reserve was the only entity allowed to do so legally (Peters and Woolle n.d.). This policy had many of the same benefits as does a freely floating exchange rate system, creating excess liquidity and relieving the Fed of the stress of constantly removing dollars from the system.   

Policy Recommendation #3: Insuring the Consumer Deposit Base

The insurance of consumer deposits was an instrumental policy strategy, manifesting in the creation of the Federal Deposit Insurance Corporation in 1933. The FDIC proved to be a unique strategy, aimed at providing protection to citizens in the event of bank failure.  The bank runs were sparked out of fear that the customer’s money would be lost for good.  The mistrust in the banking system and inability to insure citizens that their dollars were safe led to massive bank failures in the late 1920’s and early 1930’s (FDIC n.d.). 

The main goal of the FDIC was to establish confidence in financial sector, limiting the bank runs and insuring consumers that their money was safe.  The FDIC would be funded by premium charged to banks for insuring their deposit base.   The long-run disadvantage of insuring deposits is that the corporation could go bankrupt in the event of widespread bank failure, exactly what it was designed to prevent.  Moreover, it could be difficult to set guarantee fees to anticipate future crisis. It is inevitable that premiums charged to depository institutions may be too high in times of panic and too low when the economy is expanding (FDIC n.d.).  Despite the disadvantages, deposit insurance could be the swiftest, least controversial and most effective policy tool if issued as Executive Order based on emergency measures.

Conclusion

            The U.S. Financial Crisis of 1931 was ignited by Norman Montagu’s decision to take Great Britain off a fixed gold-pound exchange rate in September of that year.  This led to momentous losses in U.S. gold reserves.  Policymakers eventually implemented powerful solutions to shore up confidence in the financial sector, but were slow to react to the dynamic changes in the market economy.  The gold standard hindered the ability of the Federal Reserve to conduct open market operations and devalue the dollar against the bullion. Ultimately, 1933 saw the creation of the FDIC helped prevent bank runs by insuring citizens that their money was safe.  Furthermore, FDR outlawed the hoarding of gold by private citizens and devalued the dollar against the bullion using an Executive Order, creating desperately needed liquidity.  The timely implementation of these solutions could have helped prevent additional bank failures, job losses and lessened the impact of the Great Depression.

Works Cited

Ahamed, Liaquat. Lords of Finance: The Bankers who Broke the World. 2009.

FDIC. History of the FDIC. n.d. http://www.fdic.gov/about/history/index.html (accessed February 2013).

Harvard Business School. "The United States Financial Crisis of 1931." Harvard Business School. http://www.hbsp.harvard.edu, 1983.

Moss, David A. A Concise Guide to Macro Economics. Boston: Harvard Business Review, 2007.

Peters, Gerhard, and John T. Woolle. Franklin D. Roosevelt: 34 - Executive Order 6102 - Requiring Gold Coin, Gold Bullion and Gold Certificates to Be Delivered to the Government. n.d. http://www.presidency.ucsb.edu/ws/index.php?pid=14611.

Salsman, Richard M. The Bank Runs of the Early 1930s and FDR's Ban on Gold. April 2011. http://www.forbes.com/sites/richardsalsman/2011/04/06/the-bank-runs-of-the-early-1930s-and-fdrs-ban-on-gold/ (accessed February 2013).

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[1] Franklin Roosevelt abandoned the conversion of dollars into gold in 1933. The policy of fixed exchange rate would come back into favor again, but vanished completely during the Nixon administration in 1971.

[2] Raising the discount and acceptance rates had the effect of contracting the money supply when demand for liquidity was at its peak. This is the exact opposite of policy used today by the Federal Reserve Board.

[3] Gold was immune in the sense that it could not be created artificially through policy decisions. Germany’s crisis of hyperinflation in the early 1920’s to repay war reparations with worthless currency left a lasting impression of the dangers of hyperinflation.