Thinking Things Over February 19, 2012
Volume II, Number 7: F.A. Seiberling, Goodyear, and How the Federal Reserve Can Wreak Havoc in Life
By John L. Chapman, Ph.D. Washington, D.C.
I am the last of the old men of rubber ….rich and poor again by turns…..I have seen life from the mountaintops and the valleys. I fear there will be hard times ahead for America….but what happiest of days were those former times [of building Goodyear]….my baby — my giant! — F.A. Seiberling, Goodyear Tire & Rubber Co. founder, looking back at age 88
Introduction: Though Not Well Understood, Stable Money is Critical for Economic Growth and Prosperity
Readers of our column, and indeed all output from the investment research team at Alhambra Partners, well know that we are fans of sound money — that is to say, money that is dependably-valued over time, such that it allows for proper calculation of profits and losses, for investment planning and entrepreneurial deployment of scarce capital resources in an uncertain future, and for the maintenance of its worth in exchange so that it continually encourages such forward-looking — and thus risky — investment. As stewards of other peoples’ money, in any “macro” or global assessment of investment choices where a paramount goal is preservation of purchasing power, this is the first consideration for us, in fact. Russia, for example, is a country teeming with natural resources, a well-educated and hungry populace, and improving mechanisms to safeguard property rights — but without assurance that the ruble will not again go the way of its valuation path in the 1990s, the country remains a question mark for foreign direct investment.
The fact that the Russian government and its central bank cannot seem to understand this — or choose to ignore it, in order to optimize political manipulation of the ruble for the internal domestic benefit of the (de facto) Putin-led ruling class, is of course a loss both for the world and for the Russian people at large: much in the way of mutual gains from trade and investment is lost. And indeed, this is the best way to size up any currency, and better understand the crucial function of money in civilized society. For only a well-functioning medium of exchange, one in which its users have strong and enduring confidence in its exchange value over time, permits the smooth trade and exchange of literally billions of different goods and services (both in the present, and across time, between present and future), via concomitantly permitting a deep division of labor and specialization in order to produce these billions of different goods. And in turn it is this specialization and division of labor that are themselves the primary driver of an ever-increasing productivity of labor, which is the root source of increase in output and real wealth. In other words, a well-functioning monetary unit is critical to improving standards of living and prosperity, along with the protection of property rights and an effective tax system that incites work, saving, and investment.
We take pains to mention this because at the moment we are deep into investigation of the short-term path of U.S. Dollar value both abroad and as it concerns latent domestic inflation, and hence its impact on global asset prices (and the U.S. stock market in particular). Sadly, this is now an ongoing project for us because we fear that the fundamental importance of sound money as a necessary condition for prosperity is lost on the modern political class in the United States, including the President, the Treasury Secretary, and the leadership at the Federal Reserve. Lip service is paid to promoting a “strong dollar”, but not since Rubin’s Treasury in the late 1990s has this been an overt policy concern in Washington (and as we showed in Chart IV last week, the trade-weighted value of the dollar has fallen sharply in the last decade as confirmation of this neglect, explaining more than anything the sclerotic growth of the U.S. economy — 1.9% per annum — since 2000, likely the worst stretch in U.S. history for growth). Republicans are hardly better on this issue; Mitt Romney never mentions monetary issues and ignores them completely in his published plans for economic revival, for example (though in this election season Messrs. Paul, Johnson, Cain, and now Gingrich have all talked about the importance of monetary stability as a key factor in restoring sustainable prosperity in the U.S.).
And again, stating the obvious, monetary instability in Germany in 1922-23, when the price level rose more than one billion times in the 15 months leading up to the November 1923 destruction of the German Papiermark (and not coincidentally, the Munich beer hall putsch that landed an obscure rabble-rouser named Hitler in jail, but portentously paved his future ignominious destiny), is understood by all to be an unambiguous example of bad monetary policy. Less obvious, however, are cases of milder monetary mismanagement that nonetheless sow seeds of disaster in future years — this, in fact, this “zero-interest rate policy” for three more years, is a dagger pointed at our future, if not repealed.
A Case Study in Capricious Policy by the Federal Reserve That Greatly Damaged Lives
Indeed, monetary policy is often seen to be well-executed in the United States when measured solely by the yardstick of consumer prices — and as adjudged by members of the political class themselves — even as subterranean turmoil at the level of wholesale prices and errant investment decisions by entrepreneurs create economic havoc by causing distortions in capital allocation (i.e., waste of scarce resources), and subsequent losses and unemployment. To this day, for example, Alan Greenspan obfuscates matters by maintaining that he did nothing wrong to cause any of what became a global financial markets disaster and deep recession in 2007-2009, which confusion Messrs. Obama and Geithner ratify by blaming private sector greed and unscrupulousness that called for Dodd-Frank and a new, more intensive level of federal government oversight.
Perhaps then a concrete illustration of a real life example of Federal Reserve malfeasance that distorted entrepreneurial decision-making and led to malinvestment, job losses, and destroyed lives will best make the case that the Bernanke Fed is now playing with fire. For perhaps in showing the human toll can monetary manipulation be best seen for what it is — no better than a zero-sum game, and often one involving huge individual and collective losses.
The Founding of Goodyear Tire & Rubber Company
In the spring of 1898 Frank Augustus (F.A.) Seiberling was in Chicago on business when he quite by chance ran into a business executive from Piqua, Ohio, H.C. Nellis. Mr. Nellis’ firm owned an abandoned straw-board factory in Akron, Seiberling’s hometown, that had been shuttered for 4 years, in the midst of the 1893-96 recession (that was the most severe in history prior to the Great Depression — there had been massive labor strife and 10%+ unemployment for an extended period, and debate about expanding the money supply to include silver in order to relieve debtors had animated the 1896 election), and Nellis asked Seiberling if he knew of any buyers. $140,000 in capital had been sunk into the factory buildings and equipment, but Nellis would part with it for $50,000. Seiberling told Nellis he would be lucky to get $25,000 for it, and he himself would not pay more than half that.
Nellis then offered to sell it for $13,500, $3,500 down and the rest on a four-year note, and Seiberling agreed. That night he rode the train back to Akron, lying awake and thinking about what to actually do with the facility. By mid-morning the next day, as he talked to family and friends in order to raise the necessary $3,500, Seiberling had decided to go into the rubber business, focusing on bicycle tires, and other assorted products such as rubber bands. He also decided to name the firm after Charles Goodyear, the inventor who had discovered the vulcanization process. The firm was profitable almost immediately as the bicycle craze led to an exploding market, and by 1901 had also entered the burgeoning market for pneumatic tires made for “horseless carriages” — a nascent industry centered at the time in Cleveland and Detroit, where the big early producer was Henry Ford.
The Entrepreneurial Drive, Actualizable Only in a Free Market Economy, That is the Mainspring of Human Progress
Seiberling had shown by the instinctual gamble he took in acquiring the facility sight unseen, and even more so with no business plan in mind, that he had the classic tacit judgment capabilities common to the most successful entrepreneurs. That is to say, he literally “smelled” an opportunity in the form of an undervalued asset, and struck out in pursuit of exploiting it. “Promoter, inventor, risk-taker, and charismatic leader” (according to Maurice O’Reilly, Goodyear historian), Seiberling capitalized on the resources at his disposal, including knowledge and history of the rubber business, which had come to Akron as far back as 1870 with the arrival of B.F. Goodrich. Akron was uniquely positioned geographically to capture the rubber tire market, with transportation waterways, railroads to all major markets, and of course easy access to auto production (which within a decade was centered solely on Detroit).
Seiberling possessed other traits shared by Steve Jobs, Bill Gates, Andrew Carnegie, and other great American business legends: indefatigable energy and determined will to succeed. He worked seven days per week and took no vacations for some thirteen years after founding the company, while at the same time branching his investment activities into other transport-related businesses. Over the course of the next twenty years, Seiberling came to be thought of as a force of nature in the industry, acquiring the nickname of the “little Napoleon of rubber”, and growing Goodyear to become the largest tire company in the world. The firm became leading edge in marketing innovation (e.g., licensing patents, agency deals), capital investment (invention of new and revolutionary tire-making equipment), strategy (regional sales offices and eventually regional production), and human relations (good wages for workers and company-subsidized benefits, including housing and recreation).
The company’s rise paralleled the industry’s, and helped drive explosive growth of the city of Akron. In 1900, Akron had 42,000 residents, growing to 69,000 by 1910, and 208,000 by 1920; this matched the explosion of automobile registrations in the United States, which stood at 8,000 in 1900, 200,000 in 1908, and 7.5 million by 1920. As for F.A. Seiberling himself, he was the company’s largest single share-holder, and a near-billionaire (in current 2012 dollars) by the end of World War I. The company’s motto, “Protect Our Good Name,” was one flowing from his innermost core, an unquenchable drive-train to make Goodyear the world’s dominant rubber company.
The Federal Reserve Initiates a Century of Activism to Aid in Finance of World War I
When war broke out in Europe in 1914, all belligerent countries suspended their currencies’ links to gold. This allowed governments to inflate currency stocks through the banking system’s fractional reserves, and while it assured higher prices in the future, it also ceded to government more direct control over societal resources, as the government and its agents were able to spend the newly-created money before anyone else. The United States did not enter the war until 1917 as a belligerent, but suspended the gold standard in 1914 and again from 1917-19. Special currency printing through the Aldrich-Vreeland Act (the 1907 legislation that led to the creation of the Federal Reserve, and in this case allowed for printing of currency in an emergency, to be backed by bonds) was authorized, and again thanks to fractional reserves the money supply (M2) expanded dramatically during the war — doubling between 1915-20. This led to exploding commodity prices (as it had in all prior wars for the U.S., and would in later ones as well), shown in a few ways. First, Chart I shows the Producer Price Index (PPI) since 1913:
Chart I. Producer Price Index, 1913-Present, Log Scale
Note that the rise in producer prices was sharper between 1915 and 1920 than it has ever been at any other time in the last 100 years, rising by more than 150%. And indeed, the PPI increased by another 150% again — between 1920 and 1978 (albeit not before falling all the way back to 1915 levels by the end of the great deflation of 1933.
This commodity price explosion is so critical to the lesson to be learned here that we ask for reader indulgence in looking at the PPI again “up close” during the era in question, between 1913 and 1926:
Chart II. Producer Prices, 1913-26, Log Scale 
The enormous explosion in producer prices was matched by increases in consumer and inflation-sensitive farm prices as well; agricultural land and asset prices were up 80% between 1915 and 1921, for example. Reading these price signals, and not being aware of the Federal Reserve’s “looser” policies or the ramifications of decoupling the dollar from gold, Seiberling pushed Goodyear forward by committing to investments in a far-flung empire, including new factories or operations in Arizona, Brazil, California and Canada. Because he did not trust (and never had trusted) New York banking syndicates, to fund this growth Seiberling raised new equity capital through two subscription offerings directly aimed at friends, family, and employees. He also bought rubber and other industrial commodities on forward contracts at these vastly-inflated prices by 1920; this seemed to be a prudent thing to do, to both lock in prices before they were raised yet again, and to gear up for what had seemed to be the likelihood of a long war. Further, Seiberling reasoned, even if the war ended abruptly (which it subsequently did), demand would then shift back to civilian desires for more autos.
But the end of the war brought a big deflation, and as the graphs show above, rapidly declining prices. The government cancelled huge long term contracts, but there would be a lag to convert to civilian demand and production. A major recession began in early 1920 which was to carry over well into 1921 and Goodyear, which was so strong operationally and in terms of market share, was nonetheless caught in an extremely illiquid position.
Expectations of higher prices had led to expansion of inventories which now could not be liquidated due to the severe deflation fueling the 1920-21 depression and its steep drop-off in demand. In terms of magnitude, Goodyear’s net profit level totaled $51 million in 1920 on sales of $192 million, but in 1921 sales fell to $105 million as the firm lost $5 million net.
The maddening thing of it for Seiberling was the company’s fundamentally strong market position. By war’s end, for example, Goodyear supplied 60% of new inflatable and 35% of solid tires for trucks in the U.S.; 50% of the motorcycle market; and 60% of all carriage and buggy-maker needs. Goodyear was General Motors’ single biggest supplier, owing to Seiberling’s close relationship with W.C. Durant (at the same time, Firestone was Ford’s biggest supplier for decades). But the firm was reeling as the 1920 downturn turned into a mini-nightmare. Over 100,000 businesses went bankrupt that year, many over-leveraged or too-extended like Goodyear. Industrial production fell 21% between mid-1920 and mid-1921, and this was enough to ensure unemployment tripled, from 3% to over 10% in the U.S. in that same timeframe. By the spring of 1921 Goodyear’s capital stock was nearly wiped out.
Seiberling’s downfall came in May of 1921 when, due to his lack of support in the New York banking community, he struck out at getting support for working capital loans to bridge the firm until cash flow could again turn positive, as it surely would when longer term purchase contracts either ended or were re-worked, and the firm’s sales returned once the industry came back. Along with Seiberling, 26,000 Goodyear employees lost their jobs in 1920-21, as the Board voted to bring in Clarence Dillon of Dillon, Read & Co. to bridge the firm and also offer up support for new managerial talent.
Lessons Learned and Application to Today’ Federal Reserve
For F.A. Seiberling, to have his heart and soul — 23 years of his life — ripped out of his chest at age 61, the time was devastating. Further, because back in those days corporate finance practices were not formally developed, loans to the business were often made by the founder entrepreneurs in the form of full recourse — Seiberling had signed these loans opening his own net worth to exposure. By the time he was removed from Goodyear, he was allowed to keep his house, and little else. He was, in a financial sense, wiped out, having just a few years earlier had a 9-figure net worth statement.
In a very real sense, the Federal Reserve brought Seiberling — and many tens of thousands like him — to complete ruination. For had the Fed not intervened after 1915 to support the war effort with big increases in the money stock, prices would not have been distorted in relative terms. And thus entrepreneurs like Seiberling would not have mis-read the false signals from wholesale prices after 1915, leading to massive malinvestment of capital in projects that could not pay off. This is the Fed’s contemptible legacy that carries forward to the present day: policy activism that is in fact de-stabilizing in terms of prices, and the dollar’s value.
It’s never too late to do the right thing, however, and for the Federal Reserve, it is past time to “put a stake in the ground” and declare a value for the dollar (working with Treasury) that can be defended. Even in seeming mild inflations such as we are now experiencing (i.e., roughly 3% currently), a terrible bond market collapse is now a distinct possibility, and certainly entitlement disasters await, too, absent any policy changes. And there are in any case already many faceless names of people who have been unable to find work in the present economic torpor, or seen a decline in their standard of living because they were or are on the wrong side of the prior dollar-manipulation. In short, Mr. Bernanke cannot much longer (if at all) rely on global investors to bail him out due to them having slightly worse currency management skills than Fed and Treasury economists or Beltway politicians. Indeed the devastation caused for F.A. Seiberling and his employees all those years ago points to a canon law of classical political economy that must per force be resurrected: sound money is as much a moral issue as it is one of prosperity-inducing efficiency. And indeed, for this reason, the Fed and monetary policy ought to become a central campaign issue in 2012 once again, as it was in 1896 and again in 1980.
Epilogue
F. A. Seiberling was badly hurt by the events of May 1921 at Goodyear — his life was changed forever, losing nearly everything. But he went forward stoically, and by that November had raised enough capital to start a new firm. In time, Seiberling Rubber Company would rise to become the world’s 7th largest in this industry — nothing on the scale of Goodyear, but a comeback nonetheless, borne of sheer determination. Seiberling died at age 96 in 1955, never fully apprehending what had happened back in 1920-21, and why there had been such a massive “clustering” of entrepreneurial errors such that a hundred thousand businesses would all fail at the same time. Today, fortunately, the Fed’s errors are much easier to see.
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, John Chapman can be reached at john.chapman@4kb.d43.myftpupload.com. The views expressed here are solely those of the author, and do not necessarily reflect that of colleagues at Alhambra Partners or any of its affiliates.
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