The Bear’s Lair: Economic ineptitude reaching 1690s levels

There is no question the quality of economic policymaking peaked under Robert Banks Jenkinson, 2nd Earl of Liverpool (1812-27) and has gone into sad decline ever since. But hills have two sides. So, the question is: how far back must you go to find economic policy as bad as that in today’s United States, to pick an example? I think the answer is: about 330 years, to the chaos of the doubtfully legitimate and suddenly war-torn Whig regime of the 1690s.

A policy as bad as today’s must have three elements: (i) the state must be running a massive budget deficit, in excess of all those previously known; (ii) its monetary policy must be a mess, causing all kinds of damaging innovations in the capital market and (iii) tax and spending policy must be set on a thoroughly political basis, ignoring the view of the large minority of the electorate who recently lost a battle for power that many still consider illegitimate, and imposing taxes and regulatory burdens unequally on those opposing forces.

That combination of hurdles is a difficult one to jump. Nevertheless, today’s policy manages it, or seems likely to. Fiscal and monetary policy are far beyond all precedents, and indeed in themselves have no non-wartime match anywhere in U.S. or British history, although the budget policies of the French and Russian revolutionary governments came close. Capital market innovations proliferate, with numerous signals of unsoundness. Finally, it appears clear that tax is about to be set on a thoroughly political basis, although I grant you that is as yet the weakest of the three claims.

We can now look back in history for matches to the current policy mess. In the 20th century, the British and U.S. governments that led their countries through two World Wars ran larger budget deficits than those of recent years, and in the case of World War II, the U.S. Treasury also controlled the Fed, making monetary policy the feeble instrument of government bloat. However, the capital markets remained remarkably orthodox in both countries, and there were no politicized tax bills – in Britain, at least both World Wars were won by coalition governments. Thus, even under the stresses of world wars, U.S. and British economic policies did not become as extreme and damaging as they are today.

Other belligerents were less careful. In Germany after World War I monetary policy was allowed to run riot by Reichsbank president Rudolf von Havenstein, resulting in the hyperinflation and currency collapse of 1923. The Soviet Union, of course was in World War II running its economy on entirely different principles — indeed, expropriating its political enemies had been a central principle of Soviet economic policy since the earliest days. However, it is less fashionable now than it was in 1950 to hold the Soviet Union up as a shining example of the policies we should follow.

The 19th century was closer to the wellsprings of classical economics, and so economic policy was in general correspondingly better. In the United States, Andrew Jackson was not conspicuously economically literate, and he made a frightful mess of the Second Bank of the United States, but on the other hand he paid off the Federal debt entirely, a feat no other President has matched. Abraham Lincoln had an unhealthy belief in high tariffs and he instituted the greenback nonsense, but he managed to get through the Civil War without hyperinflation unlike in the Confederate States.

Further back, the Continental Congress is a better match for current policies. It over-expanded the money supply, thus causing hyperinflation, but it cannot really be blamed for spending more than it took in, and its debts were eventually repaid by Alexander Hamilton. Its best match for current policy was its tendency to seize the property of its political enemies, the Loyalists. Maybe Biden and his staff are merely reverting to the ur-pattern of U.S. public finance.

On the other side of the Atlantic, the late 18th and early 19th century marked the apogee of British economic policy, far above the level of any economic regime since at least 1900. (The Victorians in certain respects messed up the magnificent legacy they had been left by Lord Liverpool’s generation – unilateral free trade was a bad idea from the start and Repealing the Corn Laws did nothing whatever for the Irish except destroy their nascent corn growing capability.) However, by winning a major war primarily through economic means, dealing with a gigantic debt, preserving sound money, sparking the Industrial Revolution and moving towards free trade, the Regency generation, primarily Liverpool and his Chancellor of the Exchequer Nicholas Vansittart, were unequalled before or since.

Moving back through the 18th Century, the quality of economic policymaking declines, as you would expect. There was in fact a well-thought-out treatise on free market economics available, published by Sir Dudley North in 1691. However, North was a Tory supporter of James II, so his thought was intellectually available only to his Tory great-grand-nephew Lord North, the true instigator of free-market, free-trade economics in Britain, although he made other mistakes that prevented him implementing it (he did however give Adam Smith a lucrative sinecure Customs post after the publication of “The Wealth of Nations”).

The best of the Whig economic policymakers of the early Georgian period was Henry Pelham, who finally stabilized the National Debt, inventing 3% Consols and devising a method of financing wars, by issuing those 3% Consols at a discount, that was to reap great rewards for both Britain and its bankers in the generations ahead. Walpole and his Whig predecessors were heavily protectionist – the only free trade attempt was made by the glorious but doomed Tory ministry of 1710-14. Nevertheless, Walpole’s management of the South Sea Bubble’s aftermath was truly masterly; everybody involved lost money, but the nation’s debt service costs were greatly reduced, which was Walpole’s own primary objective other than self-advancement.

So, we come back to the 1690s. There was no reason why economic policy would be especially bad then; the last 15 years of the Restoration period, 1673-88, had been ones of peace and rising tax yields, as tobacco, sugar, coffee, tea and chocolate were all imported in strongly expanding quantities, attracting lucrative excise duties. Sir Dudley North, as Chairman of Ways and Means in the splendidly Tory 1685 Parliament, ensured that James II had ample revenues for all his needs, provided he kept out of Continental wars.

Alas the 1688 Revolution, whatever it may have done for Britain’s constitution, played merry hell with its economic policy. William III promptly involved Britain in his endless war with France (for him, that had been the main purpose of invading) which was carried on far more intensely than previous wars, seriously unbalancing the budget, producing deficits far above any seen before.

For a few years the Whigs, who ran the country for most of William’s reign, could solve the deficit problem with short-term borrowing, but by 1693 the country’s short-term borrowing capacity was exhausted and it was becoming unable to pay its bills. The Whigs came up with two remedies. One was the Land Tax, an impost at 20% on incomes from real estate, designed to attack almost solely the opposition Tories, who were mostly country gentry with almost all their wealth in land. The Land Tax did not fall on earned incomes or “movable” incomes, thus allowing the Whig “monied interest” to escape free of this burden, which contributed more than half the state’s revenues in its early years. (Interest and dividends were free of any tax until Pitt’s Income Tax of 1798.)

Even with the Land Tax having doubled the state’s income, the result was still not sufficient to finance William III’s wars. The appropriate solution, then as now, would have been to resort to long term borrowings, of which the British state had almost none – William’s own Netherlands had been financing its wars perfectly steadily at around 4% per annum for more than half a century. With the Dutch precedent available, a long-term bond issue, perhaps initially of 10 years maturity, would have been possible at no more than 5% per annum, the current yield on first-class mortgage loans in the private sector (the obligors of which were mostly the same unfortunate Tories impoverished by the Land Tax.) Instead, the Whig leaders, led by Charles Montagu, later 1st Earl of Halifax, resorted to an extraordinary series of (i) annuity issues, in which annuities were paid for the lifetime of the holder, or for two or three lifetimes, or for 99 years, in dazzling profusion of structures, and (ii) lotteries (what they sound like, but with lottery tickets in bond-like denominations and prizes paid every year for say 28 years). Then there were (iii) tontines (annuities on which interest payments were divided between fewer and fewer people as holders died, making it attractive to knock off one’s fellow tontine holders).

Finally, in a triumph of modern finance they resorted to (iv) the SPAC, special-purpose companies which would buy long-term government debt and finance themselves by issuing shares. There were several of these, one of which, the Million Bank, specialized in buying lottery tickets and the reversions of annuities (the remainder of a 99-year term after the holder had died – these reversions were issued and traded separately at one point). The Million Bank did quite well; it expired only in 1796, when the last 99-year annuities were paid off. However, the longest-lasting SPAC in retrospect gave a spurious respectability to all this wheeling and dealing – formed in 1694 to buy a £1.2 million loan, it became the Bank of England, acquiring various damaging monopoly privileges in subsequent decades. The Bank of England’s birth is now sanctified by history, but initially it was a SPAC – and indeed a scam!

You have probably spotted the problem with all this funny paper being thrown around the market. With modern computer technology and calculations of the various optionalities involved, it could probably be valued, but that certainly was not possible in the 1690s. Hence your investment’s value in the secondary market was what the very dodgy bewigged and be-Whigged broker (probably some kind of foreigner, too) at Jonathan’s Coffee House would pay you for it. Naturally, people would only buy this rubbish at a very high yield, about 8.8% on average by 1700, more than double what the Netherlands paid on its long-term debt, even though the Netherlands had a much higher debt to GDP ratio at that stage. For the monied interest, who held most of this paper and controlled the SPACs, this was pure profit.

As the Tories complained to each other increasingly drunkenly as the port circulated, the Whigs and the “monied interest” were bleeding the country dry — and the Tories were paying for far more than their fair share of the cost. The economic policy and rough-house politics of the 1690s would make Nancy Pelosi proud, particularly the Land Tax falling almost entirely on the regime’s opponents. Thank goodness we have left them far behind us – or at least, we had until recently!


(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)