Solving a problem starts with understanding it

Bank of England notes printed on denominated watermarked paper, like this 1914 example, often appear at auction.

By Jim O’Neal

The venerable Bank of England, established in 1694, was known colloquially as “The Old Lady of Threadneedle Street.” This moniker derived from its address in Central London and the English propensity to “tut tut” anything considered disdainful. She took deposits, made loans and financed wars. None of the directors was a banker or even an economist. It was essentially merchant/businessmen who guarded the precious pound sterling, the lifeblood of the economy.

In August 1931, the bank issued an odd press release: “The governor of the Bank of England has been indisposed as a result of the exceptional strain to which he has been subjected in recent months. Acting on medical advice, he has abandoned all work and has gone abroad for rest and change.” That governor was Montagu Norman, the last of the four great Central Bankers (Britain, France, Germany and the United States) to still be alive. Governor Norman had a strange aversion to the press and was notorious for his clever ways to avoid them.

So it was a surprise when he openly explained his trip by ship to Canada: “I need a rest … suffered very difficult times … my health is poor, etc.” What he failed to mention was his incapacitation due to a nervous breakdown or that the world’s financial system was on the verge of collapse. This was especially true of the European banks, where he was revered as the world’s most powerful banker and, as he would later be forced to admit, he was unquestionably “the dictator of European currency,” a role he cherished to all others.

The bank’s press release had been received in Asia, the United States and, naturally, Europe and had further spooked anxious investors since this man was considered the thought leader of “the most exclusive club in the world” … Central Bankers. And 1931 was just the second year of what would become the unprecedented Great Depression that followed the collapse of the U.S. stock market on “Black Tuesday” in 1929. The effect on the United States can be explained by four simple indices from 1929-32: industrial production (46 percent), wholesale prices (32 percent), foreign trade (70 percent), and unemployment (607 percent!).

Supply-demand economists typically point to the event when a stock-market bubble bursts (as in the U.S.) and results in bank failures, bankruptcies and widespread economic devastation. Later monetarists led by Milton Friedman point to the contraction in money supply as a bigger culprit. Ex-Federal Reserve Chairman Ben Bernanke now agrees with Friedman and we’ve seen the results of quantitative easing during the 2008 Great Recession followed by 10 years of slow recovery.

I have a different perspective. The cause was pure greed. “Virtual casinos” inside banks were making big bets using customers’ money and outrageous leverage. A housing bubble combined with subprime lending was accompanied by exotic structured products like collateralized debt swaps, mortgage-backed securitization, and a slew of other complicated derivatives that nobody truly understood. They were approved by rating agencies and sold to unsuspecting investors (including other financial firms). Once the housing market collapsed, it exposed all the other high commission, risky products.

This difficult-to-understand situation was simplified by writer Michael Lewis in his book and movie The Big Short. My idea is to have him do something similar to our health-care system (which everybody agrees is terrible … like most of the ideas to fix it). I suspect it could all be cleaned up by having a truly transparent price-based system and eliminating an incomprehensible fee structure that lacks an outcome-based tracking system by hospital, doctor or other caregivers. It is too important to leave to Congress.

Mr. Lewis, I hope someone can get your attention … I am busy this week.

Intelligent Collector blogger JIM O’NEAL is an avid collector and history buff. He is president and CEO of Frito-Lay International [retired] and earlier served as chair and CEO of PepsiCo Restaurants International [KFC Pizza Hut and Taco Bell].

Cotton Gin Extended America’s Abhorrent Practice of Slavery

The 1796 patent signed by George Washington for “new machinery called the Cotton Gin” realized $179,250 at a May 2011 Heritage auction.

By Jim O’Neal

In 1776, Scottish economist, philosopher and teacher Adam Smith wrote The Wealth of Nations, a book that helped create a new understanding of modern economics. A pervasive theme was the idea that any economic system could be automatic and self-regulating if it was not burdened by monopolies or artificial trade barriers. This theory has become widely known as “the invisible hand.” It heavily influenced my favorite economist Milton Friedman and his Free to Choose basic philosophy.

One highly topical insight was that slavery was not economically viable and contributed to inefficient markets. Aside from the obvious moral issue, Smith believed slave owners would benefit by switching to a wage-labor model, since it was much more inexpensive to hire workers than own them and provide decent conditions. Buying slaves was much more costly due to ongoing expenses of feeding, housing and caring for workers with a high mortality rate, workers who eventually would have to be replaced.

In the United States, there was also a major disconnect between the concepts of all men being created equal and the cruel practice of slavery, which was prevalent especially in the agrarian states of the South. Although many sincerely believed that slavery would gradually die out, powerful Southern states needed some kind of assurances before they agreed to the new federal Constitution. Section 9 Article 1 of the Constitution barred any attempt to outlaw the slave trade before 1808. Other provisions prohibited states from freeing slaves who fled from other states, and further required them to return “chattel property” (slaves) to their owners. Kicking the issue down the road 20 years enabled the delegates to reach a consensus.

Historian James Oliver Horton wrote about the power slaveholder politicians had over Congress and the influence commodity crops had on the politics and economy of the entire country. A remarkable statistic is that in the 72 years between the election of George Washington (1788) and Abraham Lincoln (1860), in 50 of those years, the president of the United States was a slaveholder; as was every single two-term president.

The passage in 1807 of the Act of Prohibiting Importation of Slaves in America, and the Slave Trade Act in Great Britain marked a radical shift in Western thinking. Even as late as the 1780s, the trade in slaves was still regarded as natural economic activity. Both U.S. and European colonies in the Caribbean depended on slave labor, which was relatively easily obtained in West Africa.

However, it was really the invention of the cotton gin by Eli Whitney in 1793 that dramatically extended the abhorrent practice of slavery. Cotton was suddenly transformed from a labor intensive, low-margin commodity with limited demand into a highly lucrative crop. Production in Southern states exploded as demand skyrocketed. The number of slaves grew concurrently from 700,000 in 1790 to 3.2 million by 1850. The United States quickly grew into the largest supplier in the world and snagged 80 percent of the market in Great Britain, whose appetite seemed insatiable.

As an economist, Adam Smith was undoubtedly right about hiring workers versus owning them, but everybody was too busy getting rich to worry about optimizing labor costs. And the more demanding abolitionists in the industrializing North denounced slavery the more Southern states were determined to retain it. It would take a bloody four-year Civil War and 630,000 casualties to settle it.

Harry Truman once explained why he preferred one-armed economists: It was because they couldn’t say “On the other hand…”

Intelligent Collector blogger JIM O’NEAL is an avid collector and history buff. He is president and CEO of Frito-Lay International [retired] and earlier served as chair and CEO of PepsiCo Restaurants International [KFC Pizza Hut and Taco Bell].