A Bubble that Broke the World

April 22, 2000

[Note: What follows is an installment series based on the 1932 book, "A Bubble that Broke the World," by Garet Garret, and its application to our present financial environment.]

In the period that immediately followed the Great Crash of '29 and the ensuing Great Depression, there arose a plethora of books and essays dedicated to examining the perceived causes of the immense speculative bubble that eventually led to the worldwide financial panic. A handful of these books, for a time, were required reading for students of the financial markets and the economy, but most have since been cast into desuetude and have been long since forgotten. In an effort at reviving interest in these forgotten, yet fascinating and insightful books, we have begun a lengthy installment series, including in-depth examinations of the books "The Great Crash 1929," by John Kenneth Galbraith, "A World in Debt," by Freeman Tilden, and more recently, "The Great Boom and Panic," by Robert T. Patterson. It follows that our latest series of installments will examine the book, "A Bubble that Broke the World," by Garet Garrett (Fraser Books, 1996, originally 1932).

What separates Garrett's book from all the others which address the subject of the causes and consequences of the speculative mania of the late 1920s is that Garrett lays special emphasis not only on the supreme role that excessive credit played in contributing to the bubble, but he examines the effects of America's dangerous—and ultimately fatal—tinkering with its gold reserves in those years leading up to and immediately following the Crash. As well, he traces the bubble and its consequences to America's first efforts at globalization via world war and through international lending. All of this provides Garrett's book with a rare and stunningly refreshing look at the anatomy and cosmology of a bubble.

"Mass delusions are not rare," begins Garrett. "They salt the human story. The hallucinatory types are well known; so also is the sudden variation called mania, generally localized, like the tulip mania in Holland many years ago or the common-stock mania years ago or the common-stock mania of a recent time in Wall Street. But a delusion affecting the mentality of the entire world at one time was hitherto unknown. All our experience with it is original."

According to Garrett, the general shape of this universal delusion may be indicated by three of its familiar features.

First, the idea that the panacea for debt is credit. Garrett lays the principle blame for the unprecedented expansion of credit in the 1920s with World War I. Initially, the war debt was only internal and represented debt that the U.S. owed to herself. But parallel to its own war exertions it loaned to its European associates more than ten billion dollars. Thus began America's earliest excursions into both foreign intervention as well as foreign lending. It also marked the beginning of America's extraordinary national debt. How ironic that American sought to cure her own—and the world's—economic wounds through credit (i.e., debt) expansion, the very cause of her problems to begin with!

Second, a social and political doctrine, now widely accepted, beginning with the premise that people are entitled to certain betterment of life. "If they cannot immediately afford them, that is, if out of their own resources these betterment cannot be provided, nevertheless people are entitled to them and credit must provide them," writes Garrett. Thus began America's long and treacherous love affair with a debt-financed lifestyle. This ideology leads to the acceptance of a second faulty premise, namely, that "if the standard of living be raised by credit, as of course it may be for a while, then people will be better creditors, better customers, better to live with and able at last to pay their debts willingly." This premise obviously has proven to be grossly fatal in the years since America's long, failure-ridden experiment with credit since more than 95% of all governments in the world are bankrupt, as are the vast majority of the world's inhabitants. It is only the illusion of solvency that gives the system a semblance of order and keeps the credit machine in motion.

Third, the argument that prosperity is a product of credit, whereas from the beginning of economic thought it had been supposed that prosperity was from the increase and exchange of wealth, and credit was its product. "This inverted way of thinking was fundamental," writes Garrett. "It rationalized the delusion as a whole. Its most astonishing imaginary success was in the field of international finance, where it became unorthodox to doubt that by use of credit in progressive magnitudes to inflate international trade the problem of international debt was solved. All debtor nations were going to meet their foreign obligations from a favorable balance of trade."

Continues Garrett, "A nation's favorable balance in foreign trade is from selling more than it buys. Was it possible for nations to sell to one another more than they bought from on another, so that every one should have a favorable trade balance? Certainly. But how? By selling on credit. By lending to one another the credit to buy one another's goods. All nations would not be able to lend equally, of course. Each should lend according to its means. In that case this country would be the principal lender. And it was." And of course, it still is.

As American credit was loaned to European nations in ever-increasing amounts, in the general name of expanding our foreign trade, the question was sometimes asked, "Where is the profit in trade for the sake of which you must lend your customers the money to buy your goods?" The answers were insufficient, yet this dubious practice of "foreign aid" and "free trade" continued unabated, and still continues today.

But something was happening to all of that money we were lending to Europe in the form of credit. The European nations to whom we were lending began building up their industrial capacities in order to compete with our goods on the international market. In other words, we were lending our economic rivals the money with which to buy the guns they would later use to fire at us with. Even now, American has still not learned her lesson. Only today, instead of lending to "friendly" nations in places like northern Europe, we extend credit to our bitterest enemies in communist China and the "formerly communist" Soviet Union. Small wonder, then, our trade deficit is expanding to unprecedented levels each and every year. And yet the cry for more international lending (not to mention debt relief) continues.

Accompanying the fallacious belief that the way to mend fragile international markets is through extending ever-more credit was the belief that American should shed her "isolationist" way of living and conducting business and step into the international economy. Writes Garrett, "It had long been the darling theme of a few world minds among us that as a people we should learn to 'think internationally.' We never had. Then suddenly we found ourselves in the leading international part, cast there by circumstances, with no experience, no policy rationally evolved, no way of thinking about it….In our anxiety to overtake this idea we overran it; international-mindedness became a way of thinking not of ourselves first but of the world first, of the other people in it, and of our responsibilities to them. No nation ever did think that way. If a nation did it would not long endure. To suppose this nation in its right mind could or would was the first sign of the oncoming delusion."

Hence, the U.S. shed her "America first!" mentality and exchanged it for a mantle of globalism with its rallying cry of "the world first!" But before this ideology could be embraced, it was first necessary to convince the American people that it was in their collective best interest to follow this delusional way of thinking. Tradesmen were told of the extraordinary profit potential that existed overseas in all those immense, untapped markets. "Why," some blathering politician or banker would pronounce, "think of all the opportunity that trade with Europe will bring you, with their teeming multitudes, all longing to open wide their purses to buy your goods." What he didn't mention was that the U.S. taxpayer would be the one to fill those wide-open purses with the substance of their own hard-earned labor. Today, China has replaced Europe as the panacea to all our economic woes; its vast and over-crowded population is constantly pointed to as being a tremendous reserve of untapped trade potential. It's funny to recall how, only a few short years ago, a common refrain heard in American households was that the children had better eat all the food on their plate and be thankful: "Why," the mother would say, "just think of all those poor starving people in China!" The question should logically be asked, "If the people in China are poor and starving, how in the world will they ever be able to afford our goods and services?" Easily, of course, when you consider that we are the ones who will pay for it.

"Neither agriculture nor industry cared how it was bought," writes Garrett, "only so long as some one else seemed to be paying for it. In the end everybody paid for it. The loss that fell upon the private investor fell also upon the whole country. Those foreign outlets for the surplus we were so anxious to get rid of turned out to be very costly."

And not only that, but one of the assurances American gave herself to bolster her decision to plunge headlong into the role of international creditor was that by extending credit liberally to nations in need of it we were storing it up for own benefit in time of need. But the best way to store up for time of need, as Garrett says, "would be to pay off the public debt so that to meet any emergency thereafter the government should have a free, tremendous borrowing power, with no worry about its budget. But all the time it was easier to let it run away in happy torrents."

Garrett brings up an interesting point that we would do well to ask ourselves today: "Given again that inebriate demand on the part of the American investor which obliged the merchant banker to search the world for foreign borrowers, why then was it necessary for the bankers to adopt the intensive merchandising methods of industry in order to dispose of their merchandise? One would suppose it had sold itself, even faster than it could be originated. Why were foreign bonds [which were principally the means by which foreign governments "paid" us for extending loans to them] so expensively advertised? Why were they pressed upon the investor through costly, he-type selling organizations, by house-to-house canvass, even in some cases by radio ballyhoo?" Indeed, why today are we barraged with propaganda to extend to China (the modern-day equivalent of Europe in the 1920s and '30s) "Permanent Normal Trade Relations"? Why have we deceived ourselves into believing that China somehow represents the "goose that laid the golden egg" when, in reality, they can do nothing without our economic assistance? The answer to both questions—then and now—is that the U.S. had an ulterior motive not necessarily in the best interests of her citizens, namely, that of global economic and political integration (i.e., "New World Order").

The chief catalyst for the drive of the post-World War I era to integrate the U.S. with Europe was Germany. At that time, Germany was under a tremendous financial strain in having lost the war to the Allied powers and was paying heavy reparations under the Treaty of Versailles. Though she was American's enemy in the way, a remarkable turn in our foreign policy turned our eyes away from seeing her as an enemy, and instead tried to influence the American people to see Germany as their friend. Germany's war debts, they were told, were simply crushing and were ensuring that Germany's youth would feel the strain of it for years to come. It was our sworn duty as citizens of the world, America was told, to come to Germany's economic rescue.

"The bankers themselves," wrote Garrett, "became assertively sentimental about Germany." In much the same way, American bankers today have become sentimental—even to the point of becoming maudlin—about China. Their fate and ours, they contend, rests solely on our decision to extend them credit. "This," as Garret points out, "is not a policy. It is an idea only, largely fallacious as such….American credit is loaned on the obscure presumption that trade will somehow follow; the borrowers, having got the credit, may do with it what they like."

"Loans to Europe, especially to Germany," he continues "to rationalize industry, stimulate trade, and to introduce American methods of mass production could benefit American industry in foreign trade only if you argued that what American industry needed for its own good was more competition." In essence, what it all boils down to, according to Garrett, was this: "We were paying ourselves."

Garrett concludes, "That debt need never be paid, that it may be infinitely postponed, that a creditor nation may pay itself by progressively increasing the debts of its debtors—such was the logic of this credit delusion."

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including most recently “2014: America’s Date With Destiny.” For more information visit www.clifdroke.com.

The first use of gold as money occurred around 700 B.C., when Lydian merchants (western Turkey) produced the first coins