The United States has always had a stellar scientific establishment. American researchers and scientists lead the world in Nobel Prizes, scientific discoveries and technological inventions. However, in the 1970s their patents gathered dust, while Japanese electronics companies ran a successful business buying rights to American innovations and implementing them commercially.
Not anymore. American inventors put their own patents to work, setting up startups and creating a highly competitive environment in which technological innovation thrives.
We hear a lot about lower taxes and the winner-take-all economic system which is responsible for fostering an entrepreneurial culture. But America has always had great entrepreneurs, going back long before Thomas Edison, and the founders of Apple and Microsoft created their companies under the bad old high-tax regime. The Beatles in the 1970s continued to write songs and sell records even though some of their earnings were taxed at rates approaching 100%.
What is different now is the financial system. In the final decades of the 20th century, deregulation and hands-off government supervision created a vast, diversified shadow banking system which, among other things, was able to fund generously all kinds of technological innovation.
As a result we have an extremely dynamic, robust economy with intense competition and rapid technological progress. On the other hand, this freewheeling financial system is prone to run amok and create bubbles, since finance—besides being the lifeblood of economic activity—tends to seek opportunities for speculation.
This system is inherently unstable, and rapid growth is punctuated by periodic crises when speculative bubbles deflate. This has happened twice over the past 15 years. Ironically, to counteract financial crises—and to make up for sluggish demand growth in an economy with widening income differentials—the monetary authorities are constrained to keep pumping liquidity into the financial system and to hold interest rates extremely low, thus funding ever faster technological progress and stoking additional speculative bubbles with cheap money.
But the alternative to this dynamic economy is a return to much stricter financial regulation, breaking up too-big-to-fail banks and introducing more controls over offshore capital movements. A regulated economy may be more stable, but it is also far less dynamic and flexible. In the postwar decades, the U.S. economy could not sustain strong growth and technological innovation. In the end, sluggish growth, lack of flexibility and excessive income redistribution led to inflation and stagnation, the main features of the second half of the 1970s.
Catalog of Errors
Both the Roaring Twenties and recent decades saw technological progress stoked by plentiful funding and the emergence of new companies and brands. In both periods, stocks rallied strongly and speculative bubbles emerged in various asset prices. Eventually, there came the Great Depression and, in our own times, the Great Recession, unleashed by the bursting of the U.S. housing bubble.
In his new book “Hall of Mirrors,” economist Barry Eichengreen, a student of international monetary systems and the Depression who teaches at the University of California, Berkeley, examines those parallels from the viewpoint of policy issues: why major crises were allowed to develop and how various actors responded to them. Although heavy on historical detail—and two-sentence Wikipedia-style portraits of major players, from Charles Ponzi to Bernie Madoff—its relevance to investors probably comes from an analysis of how policy-makers used lessons of history to prevent another Depression in 2008, and why they nevertheless failed to avoid another protracted slump.