4. Good Ideas Spread, Bad Ones Don’t
In colonial times we had a chaotic money supply. Britain forbade the export of British coins, so while American colonists kept their accounts in pounds, shillings, and pence, what circulated in day-to-day transactions was a hodgepodge of Spanish, French, Portuguese, and some British coins, warehouse certificates for tobacco and other products, paper money printed by the colonies—until the British government forbade that too—and even wampum, the form of money used by the Indians.
After the Revolution, the need to create a national money supply was an urgent task of the new nation. The question of what unit of account to adopt was a complex one because the colonists were accustomed to so many different, and often incommensurate, units. Robert Morris, who had done so much to keep the Revolution financially afloat, tried to bridge the differences by finding the lowest common divisor of the monetary units encountered in each state, calculating this to be 1/1,440th of a Spanish dollar. He proposed that this unit be multiplied by 1000, making the new American monetary unit equal to 25/36ths of a Spanish dollar. Thomas Jefferson—whose role in this process amounted to his one and only positive contribution to the financial system of the United States—argued instead for simply using the dollar.
Once the dollar was chosen, it would have been natural to adopt the British system of dividing the basic unit into twenty smaller units, and those into twelve still smaller units, the way American merchants kept their accounts. The Spanish system in use in the colonies—cutting dollars into halves, quarters, and eighths, called bits—would have been a natural idea as well. But Jefferson advocated making smaller units decimal fractions of the dollar, arguing that “in all cases where we are free to choose between easy and difficult modes of operation, it is most rational to choose the easy.”
That made Jefferson the first person in history to advocate a system of decimal coinage, and the United States the first country to adopt one. This was a very good idea, and, as good ideas always do, it quickly spread. Today every country on earth has a decimal currency system.
But if Jefferson’s decimal coinage concept was a good idea that quickly spread around the world, another idea that developed here at that time was lousy: the so-called American Rule, whereby each side in a civil legal case pays its own court costs regardless of outcome. This was different from the English system where the loser has to pay the court costs of both sides.
The American Rule came about as what might be called a deadbeat’s relief act. The Treaty of Paris (which ended the American Revolution) stipulated that British creditors could sue in American courts in order to collect debts owed them by people who were now American citizens. To make it less likely that they would do so, state legislatures passed the American Rule. With the British merchant stuck paying his own court costs, he had little incentive to go to court unless the debt was considerable.
The American Rule was a relatively minor anomaly in our legal system until the mid-20th century. But since then, as lawyers’ ethics changed and they became much more active in seeking cases, the American Rule has proved an engine of litigation. For every malpractice case filed in 1960, for instance, 300 are filed today. In practice, the American Rule has become an open invitation, frequently accepted, to legal extortion: “Pay us $25,000 to go away or spend $250,000 to defend yourself successfully in court. Your choice.”
Trial lawyers defend the American Rule fiercely. They also make more political contributions, mostly to Democrats, than any other set of donors except labor unions. One of their main arguments for the status quo is that the vast number of lawsuits from which they profit so handsomely force doctors, manufacturers, and others to be more careful than they otherwise might be. Private lawsuits, these lawyers maintain, police the public marketplace by going after bad guys so the government doesn’t have to—a curious assertion, given that policing the marketplace has long been considered a quintessential function of government.
The reason for this is that when policing has been in private hands, self-interest and the public interest inevitably conflicted. The private armies of the Middle Ages all too often turned into bands of brigands or rebels. The naval privateers who flourished in the 16th to 18th centuries were also private citizens pursuing private gain while performing a public service by raiding an enemy’s commerce during wartime. In the War of 1812, for instance, American privateers pushed British insurance rates up to 30 percent of the value of ship and cargo. But when a war ended, privateers had a bad habit of turning into pirates or, after the War of 1812, into slavers.
Predictably, the American Rule has spread exactly nowhere since its inception at the same time as the decimal coinage system. There is not another country in the common-law world that uses it. Indeed, the only other country on the planet that has a version of the American Rule is Japan, where a very different legal system makes it extremely difficult to get into court at all.
The United States has more lawyers and more lawsuits, per capita, than any other country. But lawsuits don’t create wealth, they only transfer it from one party to another, with lawyers taking a big cut along the way. Few things would help the American economy more than ending the American Rule. Texas reformed its tort law system a few years ago and the results have been dramatic. Doctors have been moving into the state, not out of it, and malpractice insurance costs have fallen 25 percent. And remember, good ideas always spread.
5. Markets Hate Uncertainty
The Great Depression that started in the fall of 1929 ended, at least technically, in early March 1933. The stock market, almost always a leading indicator, had bottomed out the previous June, down 90 percent from its high in September 1929. 1933 would be the second best year for the Dow Jones average in the entire 20th century, coming off, of course, a very low base.
But recovery was very slow in coming. Unemployment, over 25 percent in 1933, was still at 17 percent as late as 1939. Indeed, in 1937, when the economy suddenly turned south again, there was a problem: what to call the new downturn. Most people thought the country was still in a depression, so that word wouldn’t do. But economists, delighted to have a problem that they could actually solve, came up with the word “recession,” and that’s what we have been using ever since.
Usually, when there has been a steep decline in economic activity, recovery is equally steep. The valley is V-shaped. That is what happened in 1920, when there had been a severe post-war depression and then a strong recovery. So why was the recovery so slow in the 1930s? One reason, according to an increasing number of economic historians, is that Franklin Roosevelt had a bad habit of changing his mind. While highly intelligent, he was no student of economics and seldom read books as an adult. So much of his program was, essentially, seat-of-his-pants policy. First there was the National Recovery Administration, which amounted to a vast cartelization of the American economy. When the Supreme Court threw it out—by a unanimous vote—FDR moved on to other remedies, including big tax increases on the rich.
But markets, which can function even in disaster with ruthless efficiency, hate uncertainty. When uncertainty regarding the future is high, they tend to tread water. As a result, there was what is known as a “strike of capital.” While corporations often had large cash balances—General Motors made a profit in every year of the Great Depression—and banks had money to lend, there was little investment and few loans made. Both the banks and the corporations were too uncertain about what the government was going to do next.
That is precisely what is happening today. Banks and corporations have plenty of money. Apple alone is sitting on about $100 billion worth of corporate cash. And yet the recovery from the crash of 2008 has been tepid at best. The valley is U-shaped. Undoubtedly a big reason for that is the enormous uncertainty that has plagued the country since 2008. Will health care—one-sixth of the American economy—be taken over by the folks who run the post office? Will the Bush tax cuts be ended or continued? Will the corporate income tax go up or down? Will manufacturing get a special tax deal? Will so-called millionaires—who, when you listen carefully to what liberal politicians are saying, can earn as little as $200,000 a year—be forced suddenly to pay “their fair share”?
Who knows? So firms and banks are postponing investment decisions until the future is clearer. Perhaps the clearing will happen on November 6.
Copyright © 2012 Hillsdale College. The opinions expressed in Imprimis are not necessarily the views of Hillsdale College. Permission to reprint in whole or in part is hereby granted, provided the following credit line is used: “Reprinted by permission from Imprimis, a publication of Hillsdale College.” SUBSCRIPTION FREE UPON REQUEST. ISSN 0277-8432. Imprimis trademark registered in U.S. Patent and Trade Office #1563325.
Reprinted by permission of Hillsdale College
Truth to Ponder 