Galbraith on Goldman Sachs and the Fed

It was clear by 2008 that more remained to be learned about the management of money.

Order The Age of Uncertainty from The Age of Uncertainty

(CALGARY, Alberta) - I am just rereading John Kenneth Galbraith’s 1977 book, Age of Uncertainty which came out of a BBC series of the same name. While there was much of interest a second time around, a couple of items jumped out at me. The first was the role that Goldman Sachs played in the run up to the 1930s Depression; not unlike it’s role in the current Great Recession. Galbraith wrote:

Goldman Sachs

“Most exciting of all were the holding companies and the investment trusts. Both were companies formed to invest in other companies. And the companies in which they invested, invested in yet other companies that, in turn, invested in yet others. The layers could be five or ten deep. Along the way bonds and preferred stock were sold. The resulting interest payments and preferred dividends took some of the earnings of the ultimate operating company; the remaining earnings came cascading back to the common stock still held by the promoters. Or this happened as long as the dividends of the ultimate companies were good and rising. When these fell, the bond interest and preferred stock soaked up all the revenues and more. Nothing was left to go upstream; the stock in the investment trusts and holding companies then went, often in a week, from wonderful to worthless. It was an eventuality that almost no one had foreseen.

“The metaphor for all these promotions was Goldman Sachs. There had been nothing like it since the South Sea Bubble…

“The golden age of Goldman Sachs was the nearly eleven months beginning December 4, 1928. On that day the Goldman Sachs Trading Corporation was formed. This was an investment trust with the function only of investing in other companies; $100 million of stock was issued, of which 90 percent was sold to the public. [More than $1.3 billion in 2011 dollars. Multiply all figures by 13 for an approximate 2011 dollar amount] This was put in other stock selected in accordance with the superior insights of Goldman Sachs. In February, the Trading Corporation was merged with the Financial and Industrial Securities Corporation, another investment trust. Assets were now $235 million. In July the combined enterprises launched the Shenandoah Corporation. Preferred and common stocks to a total of $102.3 million were authorized, again for investment in other stock. The public share was oversubscribed sevenfold so yet more was issued. In August Shenandoah, in turn launched the Blue Ridge Corporation—for $142 million. A few days later, back at the [Goldman Sachs] Trading Corporation $71.4 million more in securities was issued to buy another investment trust as well as a West Coast bank.

“Shenandoah, which had been issued at $17.50 and had risen to $36.00 eventually went down to fifty cents. This was quite a loss. The Trading Corporation did worse. In February 1929, aided by some purchase of itself, it had reached $222.50. Two years later it could be had for a dollar or two. ‘He took my fortune,’ said one saddened commentator of his broker, ‘and ran it into a shoestring.’ A principle in this vast expropriation—a director of both Shenandoah and Blue Ridge—was John Foster Dulles. A more introspective man might have wondered. Dulles emerged with his faith in the capitalist system unshaken.” (Pp. 208f of first edition)

Conservatives support, as a position of principle, the unfettered operation of business. As Nobel economist Milton Friedman, patron of modern conservatism put it:

"Few trends could so thoroughly undermine the very foundations of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible."

The operation of Goldman Sachs, however, demonstrates beyond a doubt that business, as a public trust, must be accountable to the larger community.

The Federal Reserve System

“The United States set up a central bank [in 1914]. More exactly, in a compromise designed to overcome the old hostility, it established twelve central banks and a co-ordinating body of ill-defined power in Washington. This was the Federal Reserve System.

“The Federal Reserve System has always been greatly loved by economists; it even has a nasty but affectionate nickname, The Fed. There was little to be loved in its early performance. No one knew for sure who was in charge—Washington, the regional banks in Kansas City, St. Louis, San Francisco. Or was it the New York Bank with its special advantage of being in the financial capital?

“More serious was an instinct, one that was evident in the earliest days of the Bank of England, for whatever action made things worse. In the years following World War I, there was a sharp speculation in farm commodities and farm real estate—the boom of 1919-1920. The Federal Reserve Banks looked on tolerantly while banks made loans that financed this boom. Then came the crash of 1920-21. Now the Federal Reserve clamped down on bank lending and helped to make the resulting depression worse. In 1927, as the great stock market boom was getting under way, it eased credit… This helped finance the stock market boom and thus made more severe the crash of 1929, although other factors were more important. After the Crash, during the great deflation of 1929-32, the Federal Reserve continued to worry about inflation.…

“Gradually during the Depression interest rates were brought down; by 1931 the discount rate at the New York Reserve Bank—that rate at which banks could borrow—was 1.5 percent, hardly a usurious charge. The Federal Reserve bought government bonds on a considerable scale, and the resulting cash went out to the banks—open market operations again. Soon the commercial banks were flush with lendable funds. All that remained was for customers to come to the banks, borrow money, increase deposits and enhance the money supply. Recovery would then be prompt. Now came a terrible discovery. The customers wouldn’t come. Even at the lowest rate they didn’t think they could make money. The banks wouldn’t trust those who were so foolish as to believe they could. That is how it was during the Depression. Cash simply accumulated in the banks. Soon they had billions which they were able to lend but couldn’t. The banking system had worse the boom and made worse the crash. Now, when the Federal Reserve decided to act, nothing happened. Yet more remained to be learned about the management of money.” (Pp. 191f)

And by 2008-9, it became clear that yet more remained to be learned about the management of money.

(Note: There has been a commenter spreading disinformation on the Fed. I choose to believe Galbraith over some anonymous person.)

Daniel Johnson was born near the midpoint of the twentieth century in Calgary, Alberta. In his teens he knew he was going to be a writer, which is why he was one of only a handful of boys in his high school typing class — a skill he knew was going to be necessary. He defines himself as a social reformer, not a left winger, the latter being an ideological label which, he says, is why he is not an ideologue. From 1975 to 1981 he was reporter, photographer, then editor of the weekly Airdrie Echo. For more than ten years after that he worked with Peter C. Newman, Canada’s top business writer (notably on a series of books, The Canadian Establishment). Through this period Daniel also did some national radio and TV broadcasting. He gave up journalism in the early 1980s because he had no interest in being a hack writer for the mainstream media and became a software developer and programmer. He retired from computers last year and is now back to doing what he loves — writing and trying to make the world a better place