LANDY INVESTMENT MANAGEMENT BLOG

A STOCK – BASED INVESTMENT PLAN FOR RETIREES

I. Estimate your annual need for investment income.

A. Add up how much you spent over the past twelve months. Get this from your checkbook or your bank statements.
1. Subtract unusual huge purchases, such as an outlay for a new car. (You should add back an annual amount to save up for the next car if you buy it outright).

2. Subtract monthly items that will disappear due to lifestyle changes, like if you sell your house, stop commuting to work, or if Medicare will reduce your health insurance bills.
3. Add any large future things you want to budget for, like an increased budget for travel.

4. Subtract expected income from non-investment sources, such as pensions and Social Security. After making these adjustments you now have a figure that is your "annual need for investment income."

5. Divide your annual need for investment income by twelve to determine your monthly need, which you will withdraw from your investment account each month. In order to estimate how long your money will last, run simulations, using a financial calculator found on the Internet, assuming various different assumptions for the inflation rate and your investments' rate of return.

II. Set aside enough money in risk-free investments that will provide as much as five years of income during stock market meltdowns.
A. Multiply your "annual need for investment income" (calculated earlier) by five to tell you how much money to set aside in risk-free investments - enough to provide five years of income, if needed, so that you can avoid having to sell stocks for retirement income when stock prices are very low.
B. Invest your risk-free money in either bank CDs (with at least 1/5 of the money accessible each year) or a money market fund. Normally, tax-sheltered money (IRA, 401K, 403B) can also be invested in TIPS (U.S. Treasury Inflation-Protected Securities) or a TIPS mutual fund. Currently (April, 2012), TIPS are priced unattractively for new investors and should be avoided, but that is likely to change as rates on US government bonds recover to more normal levels.

III. Invest the balance of your investment money in a diversified portfolio of stocks (with no one stock initially accounting for more than 3% of the total), or low-expense broad-based stock market index funds.

A. Your monthly income depends on how much you arrange to be sent to you. You can arrange to have a mutual fund liquidate shares, as needed, to send you checks, monthly.

B. Your investment income does NOT depend totally on how much in dividends or interest you receive. It depends on your total return, which includes dividends, interest and capital gains.

C. Total return from stocks has averaged 9 - 10% over the past 50 years and past 100 years, based on growth of the American economy. Even so, there is no telling how stocks will do in any particular year or decade and some years stocks will go down in value. Declines of around 60% from the previous high were experienced in 2007-2008 and 2000-2002. However, future long term growth of the American economy is likely to continue to yield ever higher stock values and dividends, and those with sufficient patience will reap the rewards.

D. Avoid all high-fee mutual funds and closed-end funds. Avoid all leveraged funds. Any and all funds should be low-fee broad-based index mutual funds.

IV. Start monthly withdrawals for retirement income. Withdraw from stocks and stock funds in normal times and when stocks are dear, but not when stocks are cheap - like in 2008. In such times, withdraw from your risk-free reserve fund.

A. Withdraw all monthly retirement income from stocks and stock funds, unless we are in a "bear market" for stocks.

B. Switch to make your monthly retirement income withdrawals from your risk-free reserve funds when stocks enter a bear market. A bear market is generally defined as a 20% or more decline in the S & P 500 below its previous peak. If you don't follow the financial news, you will usually know when we are in a bear market from seeing the news headlines. Once you ascertain that a bear market has started, cease withdrawing your monthly retirement income from your stock market account or stock funds and switch to withdrawing that monthly amount from your risk-free reserve. Keep checking the level of the S & P 500 at least at the beginning of each calendar quarter. When the S & P 500 goes above that 20% decline point from the previous high, which you calculated previously, switch back to making your monthly retirement withdrawals from the stock or stock fund account, again. In this way you avoid selling your stocks when stock prices are cheap and your stock holdings can participate fully in the subsequent recovery.

V. Income tax considerations should be kept in mind both before and during retirement

A. Maximize holdings of stocks in taxable accounts, rather than tax-sheltered accounts to take advantage of the low maximum tax rate on dividends and long-term capital gains.

B. Interest earning investments should be directed to tax sheltered IRAs, 403Bs (teachers' annuities), and 401Ks, as much as possible.

1. Interest from fixed income investments is taxed fully, whether in a taxable account or when withdrawn from a sheltered retirement account.

2. Stock gains and dividends also are taxed fully when withdrawn from a sheltered retirement account and you miss out on the reduced maximum tax rate.

V. Confront Inflation

A. Avoid investments in long-term bonds, except for considering tax-sheltered (IRA, 401K, 403B) investments in TIPs or TIPs funds when their valuations are reasonable.

B. Interest - earning investments in money market accounts, bank CDs and TIPs will not be hurt by inflation.

C. Stock investments will not be hurt by inflation, in the long run, as costs, selling prices, dividends, stock prices, and the value of assets owned by the companies you invest in will all rise with inflation.

D. Adjust your monthly investment income need once a year, based upon expected inflation, your past twelve month's spending and your future plans. THE END

AUSTERITY OR STIMULUS: THE RECENT EVIDENCE

The 2009 Obama stimulus package had a positive effect on our economy, although  there is no telling exactly  how much.  Obama's economists argued that Congress needed to enact it in order to prevent the unemployment rate from soaring above 8%.  Of course, after enactment the rate actually rose above 10%, at its peak.  We just do not know what the rate would have been in the absence of stimulus.  At this point, the stimulus package has run its course and we are left with its $800 billion cost added to our national debt.  And one can argue that an economic recovery already was in the cards in 2009, stimulus package or not, since the recession officially ended in June, 2009, just four months after passage of the stimlus package and well before much of the stimulus money had been spent.  While we can presume that the stimulus muted our economic decline, we must now ask the follow-up question:  How much better off are we today, compared to the counterfactual?  Nobody knows the answer.
 

One reason that I supported Obama's stimulus package was that the country was in a panic and we needed something positive to believe in.  The stimulus package stemmed the panic and raised the economy's animal spirits, somewhat.   In addition to actually saving some jobs (especially through direct aid to the states),  it helped the economy because the public  believed it would.  The placebo effect.   But will it work the next time?  The public seems to think that we are still in recession and that our government's efforts have failed to turn around the economy.  I recall hearing of a poll that found that more people believe that Elvis is alive than believe that deficit spending boosted our economy.  So, next time we have a financial crisis, or even a recession, there likely will be little support for Keynesian stimulus.  And, lacking widespread faith that stimulus actually works, its enactment during future recessions may have little positive effect on animal spirits in our economy.
  
 Regarding Europe, austerity (raising taxes while cutting public spending) seems to be contributing to an economic slowdown.   But, it is hard to separate out the effect of austerity alone, since it has been accompanied by a dimunition and, possibly, reversal of capital flows as countries are unable to borrow as much from outside their borders as previously.  Loan money is no longer flowing into Ireland and Spain to finance their real estate bubbles.  Likewise, capital flows into Greece are diminishing as the government curtails its spending and indivduals and businesses become motivated to send their capital beyond its borders.  So, Greece's decline is unavoidable, but it is hard to say how much is due to tax increases and government cuts, as opposed to the severe tightening of its capital infusions.   The German economy, too,  is slowing, even with no sudden changes in fiscal policy, tied as it is to the Eurozone.
 

     The best test of the impact of austerity lies in a comparison of the US with the UK.  Both countries control their own currency, both dealt with their credit contractions, but the UK switched to austerity after its last election, while the US has put off tax increases and meaningful spending cuts until at least 2013.  So far, growth in the US is marginally higher and is starting to accelerate, while the economy in the UK remains moribund.  Austerity or stimulus?  So far, the US appears to be on the preferred course.  Let's see what 2012 brings.  The jury is still out.

 

THE FED ACTS TO HEAD OFF DEFLATION

This week's (July 8, 2010)  "U S Financial Data" from the Federal Reserve Bank of St. Louis shows that the two-month growth rate of M2 money supply is 9.5%, up from 9.2% last week.  Likewise, the year - over - year growth rate has moved up to 1.8% (still sluggish)  from 1.7%,   The trend toward acceleration in this broad measure of the money supply is very recent, but unmistakeable.  Over the first four months of 2010, M2  actually had fallen at a 2% rate.  The sudden reversal from shrinkage to robust growth in M2  is likely the result of a purposeful effort by the Federal Reserve to head off deflation.

Gold advocates have critcized the Fed for printing too much money, but the slow growth in M2 belies this.  Bank reserves have increased many-fold, but that new money remains bottled up within the Federal Reserve system, maintained there to bolster banks' balance sheets.  The near zero rate for Federal Funds has not unleashed any flood of money into the economy, as banks have hoarded reserves, while reducing their net lending.  The trend of bank lending does seem to have flattened out, recently, and may be on the cusp of expansion.

Robust growth in the money supply, if it continues, will boost the rate of inflation and squelch fears of deflation.  The increased liquidity will likely be a boon for stock prices, while putting upward pressure on interest rates.  This is bearish for holders of long term bonds, which have benefited in recent years from the declining rate of inflation.

Too much inflation is to be avoided, of course.  But, a little more inflation than we have now (under 2% and falling)  can be a good thing, given our sluggish economy and moribund credit markets.

INVESTING IN STOCKS IN TIMES OF UNCERTAINTY

Investors today have a heightened awareness of the risks that come with investing in stocks, having lost money, on average, over the last ten years.  This has led many investors to turn cautious, even though stock prices are lower and corporate earnings are much higher than they were ten years ago. Indeed, during 2009, even as the S & P 500 rose by 26%, investors in mutual funds reduced their net holdings in stock funds, while adding to investments in bond funds.

Risk is always with us in stock investing.  But, what has increased during the current period of economic turmoil is not actual risk, but investors’ perception of risk.  The risk was always there, we just didn’t know it. 

 

 In 2007, before the onset of the financial crisis, investors were complacent. Having been shaken by the severe recession and the collapse of Lehman Bros., Fannie Mae, Freddie Mac, AIG, Chrysler and General Motors, many investors remain frozen by the danger of a descent into a double dip recession.

  

We are bombarded with fears that the nascent economic recovery will peter out as soon as government stimulus spending fades away, or when the commercial real estate mortgage market melts down, or when government borrowing crowds out private capital, or when the dollar collapses, or when the house buying credit expires, or when taxes and interest rates have to be raised.  Some of these worries may be valid to some degree, but what is clear is that investors have a sharply heightened awareness of what could go wrong with the economy.  We are like characters in a nightmare walking through Times Square wearing earphones that magnify the volume of sound that we hear by a factor of ten. 

 

When was it more risky to fly on commercial airlines: before 9/11/2001, or after?  Right before 9/11 the risk was the highest ever - we just didn’t know it. 

 

When was it more risky to own a Toyota Camry - in early 2009, before we knew about potential acceleration problems or now as they are fixing them? Obviously, the risk was higher last year, we just didn’t know it.  But, now consumers are leery of buying Toyotas.

 

When was it more risky to buy stocks - in 2007, when investors were complacent, even confident, or in 2009 when, in the midst of economic trauma, both stock prices and the economy turned upward?

 

Nobody knows how stock prices will perform in the near future.  Risks are always there.  But investing in stocks today is no more risky than it was before the financial crisis.  And stock prices are substantially lower.  Indeed, investors’ heightened perception of risk has provided us with a buying opportunity. 

 

If history is any guide, many of those too nervous to buy stocks will wait until the economic recovery has taken hold and growth in employment spreads confidence throughout the land.  Many such cautious investors then will buy stocks because their perception of risk will have declined, even though actual risks may not be lower, at all.   When they finally do come late to the party, they will be paying significantly higher prices for their stocks and we will be closer in time to the next bear market and recession.   Landy Investment Management LLC remains bullish and our clients are nearly fully invested in a diversified portfolio of stocks.

BRIGHT DAYS FOR BERNANKE, BULLS AND BREADWINNERS

With Ben Bernanke's official confirmation as chairman of the Federal Reserve, the bulls on Wall Street can gore and tear to pieces that red flag for stocks waved by recent uncertainty about his reappointment.

  Attention now turns to this week's labor market data.  Thursday morning will yield the weekly report on Initial Claims for Unemployment Insurance, an important Leading Indicator of economic activity, while Friday, February 5 brings us the Employment figures for the month of January.  After two years of dismal reports, the labor market finally is on the verge of showing an increase in jobs - if not this Friday, then a month from now. 

 In recent months, economic data has gotten "less worse."  The stock market will welcome increases in workers on the job as confirmation that Bernanke's "green shoots' of last Spring are morphing into tangible signs of economic growth.  We have seen good news recently on GDP, the ISM survey and corporate earnings.  Even formerly depressed industries, like media/advertising are springing back to life.  But expanding employment will be the key to a sustained economic recovery and news of job creation, likely this month or next, will give a strong boost to stock prices.

Accordingly, Landy Investment Management has moved solidly back into stocks, after a brief hiatus occasioned by the recent uncertainty on Bernanke's confirmation.  We had been heavily invested in stocks nearly the entire time since mid-October, 2008.  We hold important sector positions in (1) large-cap computer industry stocks, including Apple (AAPL), Microsoft (MSFT), and Google (GOOG); and (2)  pharmaceuticals, including AMAG Pharmaceuticals (AMAG), Isis Pharmaceuticals (ISIS), Suremodics (SRDX), and Johnson & Johnson (JNJ); and (3) the oil industry, including Oceaneering (OII) and Occidental Petroleum (OXY). 

Uncertainty on Bernanke Confirmation is a Sell Signal for Stocks

Last week, as the outlook for Federal Reserve Chairman Ben Bernanke's confirmation turned doubtful, I reduced the proportion of stocks in clients' portfolios from over 90% stocks to less than 15% today.   The economic recovery does remain on track, in my opinion, but doubts regarding Bernanke's confirmation by the Senate raise a red flag. 

One might quibble over whether the Fed should have bailed out AIG or supported large investment banking companies, like Goldman Sachs (GS), but I give Bernanke a pass if he made a few mistakes, possibly, while making rapid-fire decisions which averted the Great Depression Round II.  Under his stewardship, Fed innovations stabilized the banking system. 

The Fed's cautiously stimulative  monetary policy will enable the business cycle to continue its natural path, moving  from recession to sustained growth, with little inflation.  If Bernanke is forced to retire as Fed Chairman, uncertainty among investors will rise because his replacement may be regarded as somewhat of a wildcard.  Of course, Christina Romer or Larry Summers would be fine picks, and I would be confident that they would refrain from doing anything dumb, and the economic recovery will continue.

But the stock market is another story. Recent doubts that Bernanke will be reappointed threaten to shatter the confidence of investors and darken the bright light at the end of the economic tunnel that has drawn investors along the track to higher and higher stock prices.  If Bernanke's nomination for reappointment is confirmed by the Senate, I will consider raising stock holdings to near 100% of client portfolios, again.  However, any changing of the guard at the Fed will make for a shaky stock market and I will await signs of stabilization in stock prices or clear improvement in coincident economic indicators before committing more capital to stocks. 

Stock Report on Oceaneering

I wrote an analysis of the stock of Oceaneering international Inc., an oil service industry company, which was published January 14, 2010 as an "Editor's Pick" on the popular financial blogging site SeekingAlpha.com. For those interested, here is the link:  http://seekingalpha.com/article/182456-arnold-landy-s-highest-conviction-pick-a-focused-deepwater-drilling-leader

BANK RESERVES SOAR WHILE BANK LENDING SHRINKS & INFLATION STAYS TAME

The public is mad as hell at the banking industry for cutting back on lending after receiving government funds from the TARP and direct loans from the Federal Reserve .  Banks' fear of losses has led them to tighten lending terms and standards.  At the same time, demand for loans also has declined as employment, consumer spending and business inventories have all fallen.  So, despite public outrage, there is no sign yet of any revival in bank lending.  Indeed, the Fed reported on December 10 that net bank lending has contracted by nearly $1.5 trillion since the start of 2009, with $854 million of that decline coming in the third quarter. 

 Meanwhile, bank reserves  (banks' deposits at the Fed plus their vault cash) have exploded upward during the financial crisis, as the Fed has pumped money into the banking industry.  Banks used to maintain reserves, on average, that were just slightly higher than the Fed's minimum reserve requirements .  If they lacked sufficient reserves, they would borrow in the Fed Funds market.  If they held unneeded reserves, they would lend them overnight to other banks in the Fed Funds market, where they would earn interest.   But, in October, 2008, the Federal Reserve, itself,  began paying interest on excess reserves  for the first time. This gave the banks an incentive, based on the interest rate offered, to have some excess reserves accumulate beyond the minimum amount required by the Fed, and keep them on deposit at the Fed without making them available to other banks in the Fed funds market.  This change in Fed policy enabled the Fed to pump up bank capital through direct loans and Tarp injections, without having to worry about so much money getting out into the real economy via loans, where it would cause inflation.

      The Fed now uses the rate on excess reserves, as well as the Fed Funds rate  to influence both bank lending and growth of the money supply.  To date, the Fed has been content to see the banks retain excess reserves so as to bolster banks’ capital and improve their financial stability. 

 The Fed has not put any direct pressure on banks to lend out more funds.  To do so, the banks would have to either cut their interest rates, lend to less creditworthy customers, or ease their terms by accepting less collateral or collateral of lower quality as a basis for their lending.  Or, they could increase their financial leverage by borrowing more.  Any of these courses would put the banking system at greater risk, so an ease in credit will probably have to await an improvement in economic conditions and a resurgence in business confidence.

     Observers as diverse as the prominent economist Allan Meltzer   and gold advocate Peter Shiff   have expressed fears that the Fed will keep rates too low for too long while the expansion of excess bank reserves will be maintained and will stoke inflation. Economist Paul Krugman   counters that inflation will not necessarily take off, arguing that Japan’s quantitative easing caused rapid growth in bank reserves there, without boosting inflation.  

Data on the growth of bank reserves are startling  (from the Fed’s H.3 publication: Aggregate Reserves  of Depository Institutions and the Monetary Base ,” 11/28/2008 and 12/10/2009).  The figures show that in August, 2008, a quiet month in America - just weeks before Lehman's bankruptcy - total bank reserves were $45 billion, of which $2 billion were excess reserves.  As of November 18, 2009, total bank reserves stood at $1.1 trillion.   That’s up nearly 25-fold.  As Paul Kasriel of Northern Trust  has pointed out previously, the bulk of this year’s increase in bank reserves has been accounted for by the increase in excess reserves beyond what the Fed requires the banks to hold.  The recent Fed data goes on to show that excess reserves rocketed from $2 billion in August, 2008 to over $1 trillion, up 500-fold, as of November 18, 2009.

     How serious is the danger that banks will draw on the more than $1 trillion in newly created excess reserves and lend the money out into the real economy, wreaking inflationary havoc?  The answer is: no chance at all, as long as the Fed has the will to prevent it.  The Fed will use the Fed Funds rate as well as the interest rate it pays banks for excess reserves as levers to control any expansion of credit.  

     The provision of credit though the banking system remains a demand-driven system. Borrowers apply for loans, depending on their desire for money and the prevailing interest rates.   Banks consider their requests, setting the rates and terms of any loans granted.  As credit expands, borrowers borrow more, with banks first using their own funds, then borrowing excess reserves from other banks in the Fed Funds market, as needed.  If increased borrowing puts upward pressure on rates in the Fed Funds market, the Fed, through its Open Market Committee, pumps new money into the Fed Funds market if it wishes to expand credit while holding interest rates stable.  Alternatively, if the Fed wants to rein in bank lending, it raises the Fed Funds target rate, which raises rates to borrowers and limits their demand for loans.   In this way, the Fed controls the expansion of credit.

  The recent piling up of excess bank reserves does nothing to diminish this role of the Fed because the Fed still sets the Fed Funds target rate, while its setting of the rate on excess reserves influences the amount of excess reserves the banks wish to retain.

     If banks, for some reason, failed to respond to the Fed’s strong interest rate incentives in favor of going wild with lending irresponsibly (would banks ever do that?) , the Fed could simply call in its loans to the banks, which would drain excess reserves from the system while impairing banks’ liquidity.  That would put a damper on excessive lending, wouldn’t it?  Furthermore, the Fed has the ability to "lock down" lending in the Fed Funds market by raising the rate it pays on excess reserves to a level that is higher than the Fed Funds rate.  Banks would prefer to lend risk-free to the Fed, rather than lend at a lower rate to other banks.  This would effectively freeze excess reserves and banks would find it difficult to secure additional funds in the Fed Funds market in order to lend amounts beyond their other sources of capital and their own surplus reserves. 

     The Fed’s challenge remains to get credit flowing in the economy again, without going overboard.  The accumulation of excess bank reserves has strengthened banks’ financial stability and it poses no special risk of an outbreak of runaway inflation.  As in the twentieth century, prospects for future inflation continue to reside in the Fed’s setting of the Fed Funds target rate, as it influences the flow of credit and money in the U. S. economy. 

THE DUMBNESS OF DIVIDENDS

    Dividends are not a positive factor in deciding whether or not to own particular stocks. That’s because dividends reduce the value of the underlying shares by the amount of the dividend. Suppose there exists a corporation that consists of a broken hot dog cart, with no regular place to sell hot dogs, and it has no other assets or liabilities. This company would not be worth much. But, suppose this corporation had $1 million dollars in its corporate bank account. Then, the company would be worth nearly $1 million.  A person could do very well buying the company for less than $1 million, then disposing of the hot dog stand, closing the business, then withdrawing the $1 million from the bank account. But, if the current owner of this business paid out in dividends to herself the $1 million that was in the bank account, the business would be left with roughly zero value. So, the business is worth a great deal before the dividend, but not much afterward. Likewise, publicly traded stocks trade at prices set by investors’ evaluation of what the company is worth. The value of any company depends on its earnings, prospects for the future, assets and liabilities. Cash is part of the assets. And each dividend paid out translates into either more borrowing or less cash on the balance sheet.

     Clearly, dividends do NOT provide a cushion under the stock price, as investors have found out painfully in recent years. And their payment has further weakened many companies already suffering from declining profits.

     However, paying dividends does make great sense when a financially strong company earns more than it needs to use for working capital or for its capital budget. Here, the cash would just continue to grow.  An example would be Microsoft (MSFT).   Better to pay out the excess cash in a dividend to shareholders (your maximum tax rate on dividends is only 15%) than to let it pile up in the company treasury while incurring the high corporate income tax rate on the interest that it earns.

     Dividend payments are fine for companies that are strong, financially.  Examples are:  Diamond Offshore (DO),  Intel (INTC), Lockheed-Martin (LMT), Lowe's (LOW), Microsoft (MSFT), Johnson & Johnson (JNJ), 3M Company (MMM), Stryker (SYK), Wal-Mart WMT), and Walgreen (WAG).   But cash is part of a company’s assets. Once paid out in a dividend, that cash is no longer part of what the company is worth. The bottom line: dividends are efficient and appropriate when companies have excess cash, but a dividend payment does not increase shareholder value because it subtracts a like amount from the what the company is worth, which is expressed in its stock price. Therefore, investors should not consider a dividend as a positive factor, in and of itself, in evaluating whether or not to own a particular stock.

     Disclosure: My clients or I own shares in: Intel (INTC), Microsoft (MSFT), Lockheed-Martin (LMT), Lowe's (LOW), Johnson and Johnson (JNJ), Stryker (SYK), 3M Co (MMM), Wal-Mart (WMT), and Walgreen (WAG).

Review of "Globalizing Capital" by Barry Eichengreen

Economist Barry Eichengreen offers great insights into the workings of the international monetary system from 1850-2008 in the second edition of Globalizing Capital, published 2008 by the Princeton University Press . While it does not exactly read like a great novel, it is well worth the effort to uncover the great influence that the monetary system has had on the world economy at various points in history. For example, beginning in 1929, nations’ rigid reliance on the gold standard facilitated the spread of the Great Depression from country to country. Under the gold standard, the major countries of the world were linked by a common policy whereby nations pledged to convert their currency into gold at a fixed price upon demand by anyone who would present it for such an exchange. This system maintained the value of paper money relative to gold and relative to the currency of other countries. Countries saw that maintaining fixed currency values facilitated trade with other countries, as importers and exporters were freed from the risk of financial ruin that might otherwise result from fluctuations in currency values between the time of an order and the receipt of payment. The rigid link of currencies to gold was thought to prevent trade imbalances among countries. If a country imported much more than it exported, the flow of money outward would cause the general price level to drop, which would make additional importing less attractive and make one’s exports more competitive. Another benefit of the gold standard was that the promise to exchange for gold gave the public confidence in paper currency printed by central banks. Unfortunately, this became a double-edged sword.

Here is the Eichengreen script (simplified) of the Great Depression. In 1927, the U.S. Federal Reserve began to raise interest rates in order to curb stock market speculation. The increased rates attracted savings from overseas, which caused declines in economic activity in Europe, which had previously been awash in loan capital from the U.S. This, in turn, caused other countries to raise their own interest rates in order to keep their capital and their gold (gold was money) from fleeing to the U.S and to the other countries that had already raised their rates. Rising interest rates spread from country to country and depressed economic activity. The economic decline led to bank failures which shrank the money supply and led to deflation, which further suppressed the economy. Nations hesitated to step in as lender of last resort to banks because that required them to print quantities of money, which would detract from their ability to maintain the link between their currency and gold (there’s that pesky gold standard, again). In fact, rescuing banks might have been counterproductive, as the printing of money not backed by gold would lead to fears of devaluation and cause investors to withdraw their national currency - denominated bank deposits, which would worsen the crisis further. In other words, reliance on the gold standard threw the world into what would now be called a negative feedback loop.

Eichengreen finds confirmation of the gold standard’s role in transmitting the Depression among countries, as he ties the eventual recoveries by various countries to their abandonment of the gold standard, together with reflation and their embrace of flexible exchange rates: first the U.K., then the U.S., then France.

Later chapters in the book cover the Bretton Woods Agreement (1944-1973, the subsequent breakdown of pegged exchange rates, and the various currency crises through 2008. Bretton Woods was an attempt to peg currency exchange rates within a 1% range, while providing mechanisms for cooperation and policy coordination among the member countries. Its purpose was to facilitate trade. It broke down for the same reason that all such rigid systems break down - it failed to accommodate the changing economic experiences and political needs of its members. The Asian currency crisis of the late 90s was similar to earlier crises in that it consisted of the cracking of a framework of pegged exchange rates. This book also provides brief, but instructive treatment of countries that have used currency boards to peg their exchange rate to the dollar (like Argentina, which did it until pressures caused them to devalue and abandon the peg, and Hong Kong). There is also some discussion of our ongoing trade imbalance with China, wherein China exports goods to the U.S. and keeps its currency exchange rate low by investing in U.S. government debt.

Eichengreen summarizes the factors surrounding the creation of the Euro currency, whose purpose (which has succeeded) was to promote trade and economic growth among its members. He provides an insightful case for its continued survival, even as individual members may find themselves under strain from time to time, unable to accelerate the printing of money to prime the national economy. His point is that any country that seriously considers pulling out of the Euro family in order to engage in monetary stimulus will experience an outflow of funds from its banking system as investors will want to avoid having their Euro bank deposits converted to a new national currency that will almost certainly lose value. The decline of bank deposits would depress that nation’s economy even further. This scenario will likely keep the Euro family together for the foreseeable future.

Globalizing Capital presents a comprehensive story. Eichengreen’s insights on the mechanisms by which the Great Depression traveled from country to country have been quoted extensively by such experts on the Great Depression as Christina Romer and Ben Bernanke. Overall, reading this book requires some effort, but it gives the reader a good understanding of how evolving changes in the international monetary system have directly affected the course of economic history.

    Review by Arnold Landy