Of the contemporaries we have Irving Fisher, Maynard Keynes, Friedrich von Hayek, Joseph Schumpeter and a group of less well known figures, including the disciples of Keynes, such as Roy Harrod, who became his first biographer. The post war writers include J.K. Galbraith and Milton Friedman. These are among the distinguished economic theorists of the twentieth century. The explanations and policy proposals include Fisher’s Debt Deflation theory, Schumpeter’s theory of “creative destruction”, Hayek’s theory of the cycle of expansion and decline – written in 1927, Keynes’s General Theory, published in 1936, monetarist and psychological explanations, pro-gold and anti-gold, pro- and anti- inflation and deflation. The statesmen who took the decisions at the time include Herbert Hoover, who did better than the myth of his inadequacy, Roosevelt, who was an inflationist, but probably at the right moment, Neville Chamberlain in the U.K., and the combination of Hjalmar Schacht and Adolf Hitler in Germany. Roosevelt believed in large scale Government intervention for infrastructure projects, Chamberlain believed in low interest rates and Government economy, Hitler believed in trade autarky and massive rearmament; there was even Pierre Laval in France and Benito Mussolini in Italy, both of whom could politely be described as pragmatists. If one had to award prizes for success in restoring growth to national g.d.p. one would have to award the top prizes to Schacht, for successful manipulation of the Central Bank role, and, however distasteful if may be, to Hitler for reflating the Germany economy through rearmament.

I have been more and more struck by the lack of progress, not only in the period since 1929, but in the period since the Panic of 1907. In 1907, there was no Federal Reserve Board, and the resources of the Federal Government itself were limited by the small size of the tax base – the Supreme Court had previously declared that a Federal Income Tax would be unconstitutional, and the constitutional amendment which made income tax possible only came after 1907. In the absence of a Central Bank and of taxing power, the U.S. Government in 1907 could not use either of the two modern weapons of control, interest rates or Government spending. In fact, the panic was stabilised by the action of a small consortium of New York banks, led by the great banker, J.P. Morgan himself. He divided the sheep from the goats. The Knickerbocker Trust went down as too insolvent to be saved. Other houses were declared sound, and J.P. Morgan made good his word. In 1907, the panic was halted and the subsequent recession was comparatively mild. The management of the 1907 panic was firmer and better defined than that of 1929 or 2009.

We still do not know what causes a depression, how to prevent it or – short of a rearmament programme – how to reverse the momentum of the contraction. We do not even know whether to inflate or deflate, or when to do so. These will be the questions for debate after 2009, just as much as they were after 1933, or indeed after 1907.

William Rees-Mogg
for The Daily Reckoning Australia

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However, the classic theory broke down in the period between 1914 and 1933, in which period it failed to develop a satisfactory doctrine of war economics, failed to prevent the post war inflations in the defeated countries, particularly Germany, failed the foresee or prevent the Great Depression, and failed to maintain the Gold Standard. Before 1914, orthodoxy meant Ricardian theory and Ricardian finance. The Great Depression destroyed the Gold Standard and undermined the authority of the classic school.

That would not necessarily have surprised Ricardo himself. He had been a Government loan broker on a scale almost comparable to the Rothschild family, during the period of the Napoleonic War, and had raised millions of pounds for the British struggle against Napoleonic France. He had experienced the 1797 suspension of convertibility by the Bank of England. The 1797 panic was partly caused by the fear of a French invasion; it led to demand for gold from citizens who did not trust the banks and were afraid that the invasion might mean that bank notes could no longer be cashed in terms of gold.

Ricardo, in various writings, makes it quite clear that he thought that the banks could never have complete security against a panic of this kind. He argued, as it is again being argued today, that banks can never have enough cash in their balance sheets to provide for the cashing of all deposits. Banking depends upon lending more money than the banks will ever have in their vaults. To this point, Ricardian economics have remained current orthodoxy.

Nevertheless, the controversy in Britain seems again to be centred on the differences between Ricardo and Keynes. David Cameron, the leader of the Opposition, is not keen to be described as a Ricardian, presumably because Ricardo died nearly two hundred years ago, but his rejection of stimulus through Government debt would have seemed orthodox to 19th century Ricardians. An earlier Conservative leader, Ted Heath – the man who took Britain into Europe - dismissed Ricardo on the grounds that he died a hundred and fifty years ago. Politicians believe that even the logic of money becomes redundant with time.

The Labour Party have adopted Maynard Keynes as their champion in the battle of deceased economists, and use his powerful name as a cover for their policy of borrowing and spending in order to restart the British economy. Other interesting economists, either American like Irving Fisher or Austrian like Schumpeter, have become recruits to one side or the other, to inflation or stabilisation, to stimulus or sound finance. The international Central Banking community has also been split, with Germany, like the British Conservatives, supporting sound money, and France, like the British Labour Party, supporting stimulus. The United States, both Republicans and Democrats, are Keynesian, as are the Federal Reserve, Britain and France. The European Central Banks, Germany, the British Conservatives and China can be described as Ricardian.

It all depends on what one is trying to achieve. The left want – as who would not? – to reflate the world economy. The right – if one can call them the right – want to stabilise the world economy. Both sides nominally accept that their aim is to restore confidence. The left believe that large injections will restore confidence, by making money and credit plentiful. The right believe that confidence depends on a return to sound finance and sound national balance sheets. In the argument one can see the case for Keynes and the case for Ricardo. The Keynesian Budget produced by Gordon Brown and Alistair Darling cut VAT for 2009, but promised to restore it to its present level in 2010. That will provide a little extra cash for the market place in 2009, but lowers the expectation for 2010. That is not good Keynesianism. Maynard Keynes managed wartime finance in the Second World War by managing expectations. I fear that one cannot play around with Budget deficits in an arbitrary manner without rational expectations being damaged. One cannot have a surplus of debt by gratuitously cutting the Government’s revenue.

William Rees-Mogg
For The Daily Reckoning Australia

• Discussing the Scale of the Global Economic Crisis
• David Ricardo’s Economic Theory is Sound Doctrine
• What Caused the Economic Crisis
• Economic Crisis Discussions in the House of Lords
• Financial Crises in History