Merryn's Blog

Extreme solutions work... if you have an exit plan

Emergency stimulus measures are fine so long as it is a means to an end. But the problem for America is that there's no end in sight. That could prove disastrous.

William Gibbs McAdoo. My guess is that it isn't a name you know that well. Perhaps you should. According to a book out in 2007 When Washington Shut Down Wall Street by William Silber he was a "financial superhero" who "saved the American economy" back in the early days of WWI.

According to Daniel Gross (who reviewed Silber's book on Slate.com), it was his actions in the chaotic autumn of 1914 that"enabled the US to seize the mantle of economic leadership from London".

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How? At the time, the US was a "global debtor nation with an unloved currency that was subject to recurring panics". It had also recently started setting up its own central bank the Federal Reserve (in response to the most recent unpleasant panic of 1907) although not all the details were in place.

McAdoo was in charge of it. The problem or opportunity began as war broke out in the summer and the Europeans (particularly the British and French) began to liquidate their US assets to finance the fight. The US dollar was backed by gold so they needed to be paid in gold. America did not have enough gold. The result, says a recent note from Chris Andrew and Mustafa Zaidi of Clarmond House, looked predictable.

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There would be a currency crisis, a stock market collapse, a run on all the banks and an "all encompassing financial calamity". None of that happened. Instead, McAdoo simply shut down Wall Street.

No one could sell, there was no more capital flight and no more gold was required. Simple. He then provided liquidity to domestic banks to get them through the crisis by flooding them with new currency which he made a big deal of delivering in armoured convoys ("the QE of his day"). This prevented there being any bank runs. And finally he urged congress to set up what became the Bureau of War Risk Insurance which offered government-backed insurance to exporters shipping goods to war-torn Europe.

It was all risky stuff, and McAdoo (who was by then engaged to Woodrow Wilson's daughter) knew that if he didn't have an exit route in place, his actions and in particular the flooding of the country with money would "wreck America". But he did have a plan, say Andrew and Zaidi.

He told the Europeans that he would lift the sales ban on the condition that all parties to the new war allowed the US to sell war materials and commodities to everyone the British, French and Germans. Everyone accepted in the end and (fully insured) US merchandise was soon landing everywhere from Le Havre to Hamburg: the security sales were offset by the exports; America's gold was safe; and the US eventually emerged from the war as a creditor rather than a debtor nation.

The key point here is that the "shock and awe" actions worked because they were emergency actions taken in the very short term with an end in mind. That's not so much the case today.

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If you ask now, say Andrew and Zaidi, what the exit plan from the emergency measures the Fed and other central banks started taking four years ago the answer is "ambiguous, imprecise and uncertain". It depends on consumer spending. Or perhaps the stock market. Or maybe house prices. The truth is that there isn't really an exit plan: "emergency measures have become routine".

That's a problem. So much so that it might even mean that today's actions "bring to a finale the US dollar's monetary hegemony that McAdoo's exit plan established".

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