Dear NY Times: Krugman's Deregulation Assertion Misleads

29 March 2010

Editor, The New York Times

620 Eighth Avenue

New York, NY 10018

To the Editor:

Paul Krugman writes that "we used to have a workable system for avoiding financial crises, resting on a combination of government guarantees and regulation. On one side, bank deposits were insured, preventing a recurrence of the immense bank runs that were a central cause of the Great Depression" ("Punks and Plutocrats," March 28). This claim is misleading.

Bank runs don't just happen; they have causes. In the 1930s those causes were serious missteps by the very institution - government - that Krugman wants to invest with even more power.

First, regulation limited branch banking and, hence, prevented banks from sufficiently diversifying their portfolio of deposits. Second, U.S. banks were prevented from issuing their own notes, and so could not easily satisfy customers' desire for higher currency-deposit ratios. Third, government declarations of "bank holidays" heightened depositors' worries and caused runs even on solvent banks by depositors who feared that the "holidays" would spread. And fourth, the Fed allowed the money supply to contract by thirty percent. (Canada, which had no central bank and did not restrict branching or prevent banks from issuing their own notes, suffered zero bank runs during the Depression according to George Selgin.)

Mr. Krugman's enthusiasm for more government control over the financial system would likely be muted if his history weren't so potted.

Sincerely,

Donald J. Boudreaux

Don Boudreaux is the Chairman of the Department of Economics at George Mason University and a Business & Media Institute adviser.

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