Benjamin M. Anderson: Economics and the Public Welfare: A financial and Economic History of the United States, 1914-1946. Indianapolis: Liberty Fund, 1979 [1949].
With exceptions too inconspicuous to remark, nobody loves a banker. Except other bankers. Sometime banker, sometime college professor Benjamin M. Anderson insists that “there is a great fraternity of bankers, both in the United States and in the world outside. They trust one another. They tell one another the truth about highly confidential matters. They go far out of their way to be of service to one another and to one another’s customers.” William Jennings Bryan, he isn’t.
Writing in the late 1940s, Anderson happily recalls the world prior to World War I. “There was a sense of security then which has never since existed. Progress was generally taken for granted,” since “the experience of the preceding century, so far as social and economic evolution was concerned,” consisted of “a prolonged period in which decade after decade had seen increasing political freedom, the progressive spread of democratic institutions, the steady lifting of the standard of life for the masses of men.” True, there had been “occasional sharp setbacks”—severe, short financial crises followed by severe, short economic depressions. “But they did not approach in length or depth the depression of 1929-39, or in depth the much less severe depression of 1921.” Even during the downturns, “it was axiomatic that revival would come again.” Overall, and not only in economic life, “it was an era of good faith,” when “men believed in promises,” including “the promises of governments”; “treaties were serious matters.” “No country took pride in debasing its currency as a clever financial expedient,” as for example in 1933, when the United States government suspended gold payments, reduced the dollar to some 59% of the old gold parity and repudiated the gold clause in its bonds. No politician “boasted of their achievements in unbalancing the budgets or termed the deficit ‘investments.'” As late as 1913, “men trusted the promises of government and governments trusted one another to a degree that is difficult to understand today”; indeed, “Japan and Mussolini would never have started on their careers of aggression if the great democratic nations had kept faith with one another.”
Anderson emphasizes trust, faith, because “industry, commerce, and finance depend on credit.” Credit depends upon a measurable way of gauging profit and loss, surplus and debt. The gold standard gave governments that way. “The whole world was…far safer financially when each of the main countries stood on its own feet and carried its own gold.” The United States’ Federal Reserve banking system, instituted in 1913, could have prevented even some of the bank ‘panics’ that did occur, had it been “wisely handled,” but it wasn’t. “There was no such thing in prewar days as the kind of international cooperation which we saw in the 1920s, under which a dangerous boom was prolonged and turned into an almost uncontrollable inflation through the cooperation of the Bank of England and the Federal Reserve System of the United States.”
The First World War thus was not only a calamity but an unanticipated one, foreshadowed by the gold hoarding of Germany in 1912-14 and, in reaction, that of England of France in 1914; the imperial and regime conflicts between an absolute monarchy and two commercial republics reminded a generation that the original term for ‘economics’ was ‘political economy.’ These actions were policy decisions.
For that reason, Anderson firmly rejects economic determinism: “Political, moral, cultural, and religious forces are coefficients with economic forces in the determination of historic events, and the influence of outstanding personalities in strategic positions is often far more significant than any economic determinist will concede.” When war hit, “the American financial system met the shock with no formal governmental aid, although there was good cooperation and good understanding between New York and Washington.” Stocks declined, but not drastically. “The investor was safer in the unregulated market of 1914 than when protected by the Security and Exchange Commission in 1937.” Except for the South, where cotton exports to Europe declined badly, the crisis ended in November 1914, righted by the warring Europeans’ need for goods and leading to American “war prosperity.” Although corporations used some of their profits to increase dividends to shareholders, they “prudently recognized that they were in an extraordinary situation, that war profits could not be expected to last, and that it was well to provide for contingencies.” Wages lagged behind wholesale prices, improving profits. By contrast, “in World War II wages rose far faster than wholesale prices, and corporate profits and additions to corporate surpluses were far more moderate in relation to the national income. In World War I the thing was left to the natural play of the markets. In World War II we had elaborate government policy”—beginning with the Renegotiation Act of 1942—designed “to hold down corporate profits and to encourage wage increases.”
When the United States entered the war in April 1917 (in large measure because Germany had been sinking U.S. merchant vessels, interfering with trade), the federal government didn’t take on many loans “for future generations to pay,” financing the war mostly with tax revenues and war bonds. The government didn’t borrow directly from the Federal Reserve. The government did fix prices but understood “that price fixing ought not to be pushed in advance of the development of machinery for commodity control,” such as rationing. “In World War I we knew these things very well. Proposals for the fixing of all prices met very little sympathy form President Wilson, who was a good economist. [1] “We established a pretty comprehensive system of commodity control of scarce essentials needed for war or for the life and health of the people.” Such price controls as were imposed affected wholesale prices; “we did very little about retail prices,” which were left to market forces within the framework of wholesale price controls. Unlike the New Dealers, the Progressives “did not look upon a great war as primarily an opportunity for accomplishing sweeping social reforms or for reconstituting the basic principles of economic life.” The newly-formed Federal Reserve Board worked well under these emergency conditions, enabling “a smoothness and simplicity in handling huge financial transactions that would have been incredible under the old system,” which depended on the friendly cooperation of the several major private banks.
Things began to go wrong in the aftermath of the war. Anderson begins his analysis with the basics: “Right prices are prices that move goods. Right prices cannot be foreseen in advance. They must be found out experimentally in the open market,” in the equation of supply and demand. Price controls therefore make sense in a major war, but continued interference with market equations will lead to serious crises when peace returns. In the United States, exports didn’t decline after the war because Europeans needed manufactured goods, given the wartime destruction of factories; the Europeans paid for these good with loans extended by American banks. “It is the duty of a lender to an embarrassed debtor to see to it that the debtor mends his ways and reorganizes his affairs so that the loan may be a good loan.” But the war’s loser, Germany, “was going to pieces financially” and American bankers “were lending to Europe overgenerously,” demanding inadequate reforms in exchange for their money. “Economic abnormalities” were bound to arise. “The heart of the business situation is the outlook for profits”; therefore “the heart of the credit situation”—the indispensable condition of good faith in economic, social, and political relations—is “the quality of credit and the quality of credits rests on the outlook for profits.”
There lay the danger. “Our great export trade was based, not on revival in Europe, but on the failure of Europe to revive.” That couldn’t last, even with the salutary end of wartime price controls. “Europe was buying goods in enormous quantity on credit from every part of the world, and building up throughout the world a fictitious prosperity similar to that which we had in the United States. Reaction and collapse were inevitable.”
Agriculture was the first sector to feel these effects. As observed, industry had used the wartime boom “as an opportunity to accumulate additional capital funds and to increase liquidity.” Even after the stock crash in 1920, United States Steel was stronger financially than it had been at the beginning of the war. But farmers had used their wartime earnings “as a foundation for rising prices of agricultural lands and increased mortgage debt” on those lands—quite understandably so, since “a wise investor will ordinarily buy the kind of thing that he knows and understands,” and ‘the farmers knew land.” Unfortunately, land is an illiquid investment, insusceptible to the tactic of quick sell-offs or immediate reductions in the labor force. The Great Depression began early for the farmers. The stockbrokers, by contrast, were able to arrange a well-timed mass purchase of a few key stocks, sparking a rise in market confidence which caused a rapid snap-back in stock prices. Unlike American agriculture, American finance and industry took off. Japanese bankers, industrialists, and government officials did the opposite, clamping down on “freedom of the markets” by holding prices high above the world level for years, resulting in industrial stagnation throughout the decade followed by a banking crisis in 1927. “It was a stupid policy”; it resembled the policy of the New Deal, a decade later. “In contrast, in 1920-21 we took our losses, we readjusted our financial structure, we endured our depression, and in August 1921 we started up again.” That rally “was not based on governmental policy designed to make business good,” and Americans did it “without outside help” from foreigners. “From the standpoint of New Deal economics,” this policy “was extremely benighted,” as “it was not regarded as the function of the government to provide money to make business activity.” Instead, the American economy saw “a great spurt in the application of new technology to industry,” which didn’t cause unemployment but “helped to generate an immense increase in employment” in the new industries that resulted. Output per wage earner increased, which was good, and, thanks to the Federal Reserve’s policy of purchasing government bonds, bank credit expanded, which proved to be very bad, by the end of the decade.
Meanwhile, bankers understood that America’s wartime shift from a debtor to a creditor nation required “a liberal foreign trade policy,” without which exports would find no markets in devastated Europe. The Republican Party had long supported high tariffs, but they initially reversed this now-incorrect policy for a year or two after the war. But the 1920 elections brought younger, less experienced Republicans to office, including “a man little trained in economics, who looked at economic issues from the standpoint of political tradition and emotion, Warren G. Harding.” In 1922, tariffs were raised and “the seeds of death were planted into our industrial revival.” “The young student of economics, sociology, and history is easily impressed with the doctrine that history is made by impersonal social forces, irresistible in character,” but “when one sees history being made from the inside it is impossible to avoid the conclusion that a vast deal depends upon the strengths and weaknesses of the leading participants.” Harding was weak. Wilson was strong, favoring free trade against tariffs and attempting to keep the peace with the League of Nations.
Anderson deplores “our absence from the League of Nations” primarily because France then was left with too much influence in it. The peace treaties dismantled the Austro-Hungarian Empire, “which had been a great free trade area,” leaving behind a “Balkanized” Central and Eastern Europe with trade barriers everywhere. And Americans had insufficient leverage to moderate French revanchisme against Germany, whereby impossible-to-pay reparation exactions and the prevention of industrial revival contributed to the collapse of 1929 and to the rise of the Nazis. In the years 1918-24, Germany was “economically a hollow shell.” “Invaders could scarcely have done a more efficient job of denuding her of resources than her own war government,” which had loaded the Reichsbank with “government paper” in anticipation of easy repayment after (the Kaiser’s men assumed) Germany’s victory made her the master of Europe. When that didn’t happen and the debt came due, German bankers found themselves in a fix, one exacerbated by the “wholly fantastic” reparations demanded by the French. Germany attempted to inflate its currency as a means of maintaining its generous welfare payments and employment-making public works. With inflation, “thrift became folly,” the middle class “was pretty much wiped out,” and the republican regime itself fatally weakened. Continued “French insistence upon payment [of reparations] regardless of Germany’s ability to pay made the German situation pretty helpless.”
In its domestic policies, France went on a splurge of deficit spending, under the slogan, “The Boche will pay.” But the hated Boche was bankrupt. “The one difference between the policies followed in France in this period and the policies advocated by the New Deal spenders for the United States is to be found in the fact that the French were ashamed of” its deficit spending “and tried to conceal it and to find excuses for it, whereas the New Deal spenders would glorify it and call it ‘investment.'” Quickly seeing that the Boche couldn’t pay, the French occupied the Ruhr, Germany’s industrial hub, in 1923, substituting “military decisions” for “business contracts.” Both the Germans and the French would pay for that.
With that, the Americans did intervene with their wartime allies to assist Germany. “Great sums were not required to stabilize a country when internal financial reforms were insisted upon in connection with the loan”—as per the sound banking practices Anderson noted previously—and even in the democratic-republican regimes “it was not difficult for the finance minister of an embarrassed country to persuade his people to submit to the necessary reforms when the outside help could thereby be obtained.” The 1924 Dawes Plan provided a comprehensive settlement for Germany, and it worked, despite continued French exactions. It was foolishly abandoned in 1929; reparations were drastically reduced, but the banks called the German loans prematurely. Anderson holds this act of unsteadfastness “responsible for the collapse of Germany” two years later.
Back in the United States, the Republicans’ tariffs on foreign manufactures hurt American farmers because Europeans got such low revenues from sales of manufactured goods to the U.S. that they couldn’t pay for American farm produce. Protective tariffs on European farm produce didn’t help, inasmuch as “the protective tariff did no good to a commodity where an export surplus existed. The agricultural tariff “constitut[ed] one of the first of the many ingenious devices for spoiling markets and perverting the price mechanism in the interest of special classes, which we have later come to know at the New Deal.” In this sense, the New Deal began in the mid-1920s. At the same time, banks and other investors overreacted to the anticipated benefits of the Dawes Plan, buying German and other European bonds in too-large quantities relative to a realistic assessment of the ability to repay; as indicated earlier, the Federal Reserve bought large amounts of U.S. government securities, vastly expanding bank credit and thereby causing “the illusion of unlimited capital.” There is, alas, no such thing as unlimited capital. “Our tariffs would not allow the Europeans to earn dollars here in adequate amounts to buy our farm products and to meet service on the past debts, so we proceeded to lend them the dollars they needed for these purposes!” Anderson exclaims.
His patience with such things temporarily exhausted, Anderson pauses to offer another brief lesson in elementary political economy. “Capital” consists of producers’ goods, not consumers’ goods, such “instruments to be used in further production” as machinery, bridges, and railroads, not hats, shoes, and ice cream. There are five main sources for capital: building (whether by raising a barn, letting fruit trees grow, or improving a tool); consumer savings, business (using profits to add to one’s surplus instead of paying dividends); taxation for capital purposes (that is, paying down public debt); and new bank credit. The latter can be dangerous, if unrestrained, since “credit and debt are merely different uses for the same thing”; the growth of bank credit “should be held in proper relation to the growth of the industrial activity of the country” and diversity of collateral must be maintained, since one kind of collateral may have little value at a given time. Since “a bank must always be prepared to pay its depositors on demand,” carefully “protect[ing] its cash” for that purpose, these precautions are indispensable. “Quantity of money and credit are less important than quality of money and credit.”
During the First World War, bank expansion of credit was necessary to raise, equip, and transport a four-million-man army to Europe and sustain them for the duration of the conflict, in the process “transform[ing] our industries from a peacetime to a wartime basis.” We also needed to finance shipments to our allies. But in the 1920s, without any such crisis, “without justification, lightheartedly, irresponsibly, we expanded bank credit by more than twice as much, and in the years which followed we paid a terrible price for this.” The Federal Reserve System “was not created for the purpose of financing a boom, least of all for financing a stock market boom.” Moreover, in the United States, commercial banks’ reserve requirements are legally fixed, giving our bankers less room for “judgment and experience in deciding how much reserve” to hold. In foreign countries, “a banker, foreseeing a crisis, would try to increase his reserves before the crisis came,” but American bankers “accustomed for two generations to having their minimum reserves fixed by law…had no such grasp of the theory of bank reserves as the best foreign bankers had.” As a result, they kept the legal minimum cash reserve on hand. “When the reserve requirements were lowered by the wartime legislation of 1917, a dangerous situation was thus created.” The Federal Reserve System increased that danger in its policy of easy money and credit expansion throughout the 1920s. In the United States, France, England, and indeed anywhere, “a high degree of banking concentration is incompatible with the exercise of free banking judgment, and the substitution of government policy in credit matters for the free exercise of banking judgment is one of the most dangerous things that can come to a country…. We should preserve competitive banking. Banks should be under pressure all the time to meet their engagements at the clearinghouse every day, so that the banker may be compelled to keep his bank liquid, to hold slow paper to a minimum, and to limit bank credit to proper bankable transactions. When, however, five hundred to a thousand banking offices are under the jurisdiction of a single central office, there is no such pressure on the individual offices; and if there can be a concerted policy among a few great central offices, the competitive pressure is so greatly lessened that unsound policies can be carried very far.”
Since the expansion of bank credit in the 1920s wasn’t needed for commerce, it was used for capital purchases but also for speculation, particularly speculation in real estate mortgage loans—an “ominous increase in illiquid assets,” in lands and buildings. This caused a ‘bubble’ in real estate prices in the United States, “an unwholesome and a precarious” position. “Speculation in real estate and securities was growing rapidly, and a very considerable part of the supposed income of the people which was sustaining our retail and other markets was coming, not from wages and salaries, rents and royalties, interest and dividends, but from capital gains on stocks, bonds, and real estate, which men were treating as ordinary income and spending in increasing degree in luxurious consumption.” Anderson criticizes Federal Reserve System chairman Benjamin Strong, President Coolidge, and Treasury Secretary Andrew Mellon for encouraging stock market investment under these circumstances. “The more intense the craze, the higher the type of intellect that succumbs to it.” Money flowed out of Europe to invest in the American stock market, further weakening Germany’s already dubious financial condition.
By 1928, the Federal Reserve was mindful of the problem, sort of. Its governors wanted “to restrain the use of credit for stock market speculation,” avoid tightening money in foreign countries, and not “let money grow tight in business uses at home.” It wasn’t possible to fine-tune credit and investment to that extent; these “efforts at restraint were handicapped and inconclusive,” and “the wild speculation ran on for a year and nine months after the restraining efforts began.” The catastrophic stock market plunge in September 1929 “demonstrated that fundamentally wrong policies had been pursued”: “cheap money and rapid expansion of credit”; high tariffs interfering with the movement of goods and preventing our European debtors from paying their debts with goods.” But to have reversed the policies in time “would have meant humiliation” for the Republican Party in a presidential election year.
Nonetheless, had we “taken our medicine in 1929 and early 1930,” although we would still “have had a severe depression,” the federal government could have ended it by undergoing “an orderly liquidation and readjustment”—lowering our tariffs, to enable foreign debtors to pay with goods. But with “the Hoover New Deal,” Washington instead turned “to frantic economic planning,” which Anderson calls “back seat driving by a man who doesn’t know how to drive and who, except in wartime, doesn’t know where he wants to go.” “Those who condemn the New Deal for its agricultural follies in 1933 and succeeding years, and above all, for loans to farmers which held back cotton which otherwise would have gone into the export trade, should not credit Roosevelt’s New Deal with originality on this point.” In the aftermath of the stock market debacle, the Republicans nonetheless sustained their policy of “artificially cheap money” and, in a “crowning folly,” raised tariffs instead of lowering them with the Hawley-Smoot Tariff Act of 1930. This spurred protectionism all “over the world,” cutting off markets, limiting trades, and boosting both unemployment in export industries and the prices of export commodities unemployed and employed persons alike needed to buy. Not coincidentally, in Anderson’s judgment, the Nazis became the second-largest party in the Reichstag in 1930. Even so, “If the governments had acted” to lift tariffs in the winter of 1931-32, “Hitler never would have come into power, and we should have saved the democratic regime in Germany.”
The Americans weren’t the only culprits. French revanchisme continued to play its part; England, with its strong labor unions, which wanted no reduction in wages, even in the face of the downturn, along with too-heavy investment in illiquid assets by the Bank of England, took the damaging step of going off the gold standard in order to devalue its currency, a serious “breaking of faith with the world” which inspired fears about every currency. Given that credit or faith sustains financial transactions, now “governments could no longer trust governments in financial matters” and “the confidence of central banks in one another was gravely shaken.” The value of gold rose sharply, since “gold’s greatest competitor is the confidence men have in the paper promises of governments and central banks to pay gold.” This didn’t faze the Americans, who “were very strong in gold.” “Our whole financial tradition rested on the principle that we would pay gold. Grover Cleveland in the middle 1890s had defended our currency with gold payments under very much more adverse conditions,” and it worked. In 1907, the bank runs had prompted bankers to restrict cash payments by banks but to continue to allow depositors to write checks to pay debts. Only “absolutely necessary cash was provided by the banks.” But in 1933, banks were obliged to pay five percent of their deposits in cash; five percent doesn’t sound like much, but banks never keep much more than that on hand for withdrawal by depositors. The banks’ cash reserves were rapidly depleted by terrified depositors.
Why? Because “men’s memories are short. Men come into positions of great responsibility fairly late in life, and the interval between 1907 and 1933 was too great an interval”; “there was no man left of the heads of great New York banks in the panic of 1907 who was still in that position in 1933,” and “the same thing was generally true over the country.” When the New Dealers came to power in 1933 “with virtually every bank in the country closed, control of the banking situation passed both from the banks and from the Federal Reserve banks to Washington,” which under the new administration pursued a policy of “deliberately shutting out the banking community from its councils,” having decided the bankers had caused the Depression. In one way they were right. The 1920s credit expansion, masking “the scarcity of real capital” with speculative loans and investments which boosted the stock market beyond the value of the overall economy, had “misled governments and induced them to place debt payment schedules higher than they should have been.” But of course the governments had done their part, with punitive reparations, high tariffs, and (in the United States) the misuse of Federal Reserve powers.
Roosevelt and his colleagues doubled down on government control of the economy; in their minds, the Republicans had done some good things, but not nearly enough. They failed to see that “a liberal foreign trade policy is contradictory to governmental economic planning, and the movement toward governmental economic planning grows rapidly when foreign trade is cut off. This was recognized a long time ago. One of the original economic planners was the German philosopher Fichte, a follower of Kant and precursor of Hegel,” who urged that governments adjust, “in proper proportion,” the several producing classes in each country by means of fixing the prices of commodities and manufactures while “render[ing] impossible direct trade between citizens and the foreign world,” reserving such trade to the state. So it was with the New Dealers. They “did not want either foreign trade or gold. They wanted internal regimentation.” For them, it wasn’t enough to take the role of backseat drivers; they aimed at putting themselves “in the driver’s seat.” If they “lacked economic understanding…it cannot be denied that they had a good deal of imagination regarding economic matters.” In Germany the matter went to its extreme, as the country in effect “substitute[d] the tyranny of Hitler for the tyranny” (as the bank-haters called it) “of gold.” Hitlerite venom spat at Jewish bankers gave his tyranny its genocidal edge, even as Leninist venom against the “harmful insects” of capitalism gave such an edge to that tyranny. This combination of bad economics and bad ideologies led to the military and political crises that prevailed for the six decades between 1930 and 1990.
An interesting economic experiment ensued. The widespread use of automobiles in the previous decades had “largely destroyed the usefulness of the small village” in American life, as “people did their business and sought their social life in the county seat and other nearby larger cities.” This weakened the small banks. But now, under the New Deal, the cities suffered and villages well removed from city centers survived. By accident, they found themselves out of the way of FDR’s policies, which included “blanket authority…to do pretty much as he saw fit regarding money and banking,” authority to seize the people’s gold and gold-backed certificates, preparatory to abandoning the gold standard. This again violated the public trust. “There is no need in human life so great as that men should trust one another and should trust their government, should believe in promises, and should keep promises in order that future promises may be believed in and in order that confident cooperation may be possible. Good faith—personal, national, and international—is the first prerequisite of decent living, of the steady going on of industry, of governmental financial strength, and of international strength.” Having promised to maintain the gold standard in his party’s platform, FDR committed “an act of absolute bad faith.” Since first England and then the United States broke faith with their citizens and with governments around the world, we now see “a world full of hot money, jumping about nervously from place to place, seeing no safety anywhere, but going from places that seemed unsafe to places that seemed less unsafe,” preventing men from making long-range plans of investment.
“By 1937 the gold standard in its old form had ceased to exist. There remained no important country in the world where paper currencies would be automatically and regularly redeemed either in gold or in gold bars.” This put peoples at the mercy of their governments, since “the recipient of gold does not have to trust the government stamp upon it, if he does not trust the government that stamped it.” Pieces of paper stamped by the government “will be accepted on faith if the government or the bank which has issued the paper has proved itself worthy of confidence by a satisfactory record of redeeming the paper in gold on demand”; “gold is an unimaginative taskmaster,” demanding only issuers of paper currency “keep their promises on demand or at maturity,” which in turn requires that “they create no debts without seeing clearly how these debts can be paid.”
A major complaint about banking practices seen in the 1920s current in the 1930s was “the alleged excess of savings over investment in the period 1924-29.” Supposedly, hoarding money in banks retarded investment. But “all of the real savings of this period” was in fact invested; the critics were really complaining that the bankers refused to invest “all of the rapidly expanding bank credit” afforded by Federal Reserve policies. On the contrary, Anderson argues, “far too much new bank credit” was invested. The banks weren’t too ‘conservative’ but too ‘liberal,’ and that contributed to the stock crash. “Men must be induced to save for the future by a reward, and that reward is interest”; banks can offer interest because they invest depositors’ savings by offering loans which, in aggregate, profit the banks after they’ve paid the interest due to depositors. The rate of interest the banks offer provides “the equilibrating factor which brings savings and consumption into balance.” Derange it and you violate the indispensable ‘credit’ or trust that makes ‘the economy’ prosper.
The New Dealers’ fondness for labor unions further complicated matters. “The idea that the purchasing power of labor is the mainspring of business activity seems to be incredibly naïve,” inasmuch as the “the prospects of profit or losses” determine “industrial decisions.” Sure enough, when the National Industrial Recovery Act came into effect, production dropped. “The theory that shortening hours and raising wages would increase business activity was conclusively exploded in this six-month period of actual test,” and the Act additionally imposed a further burden, administratively-imposed regulations “subject to change without notice.” Minimum-wage regulations alone forced an estimated half-million black Americans onto relief in 1934. Finally, in raising the price of manufactured goods, the Act frustrated the New Dealers’ agricultural policy, which aimed at bringing farm products “the same purchasing power in relation to manufactured goods that they had in the base period 1909-14.”
During the 1932 campaign, FDR had promised a 25% reduction in government spending. A conversation with John Maynard Keynes in 1933 persuaded him that “government control of investment” was needed, which included economic stimulus at the cost of government deficits. [2] This failed. By contrast, in 1921, during the previous depression, “the government did not know about the new wisdom of Keynes.” It acted “to protect its own solvency, to protect the currency, to reduce public expenditure as rapidly as possible from the wartime levels, and to cut taxes”; “business recovery was for the people to bring about and not for the government to engineer.” The depression ended in a matter of months. In 1934, with the government bureaus multiplying, there was no one in Washington “who knew all the new bureaus that had been created and could see the government as a whole.” This suggests that a modern economy is too large and complicated for coherent rule ‘from above,’ except in one way: “The New Deal tax policy from the beginning has been more concerned with the redistribution of wealth than with raising revenue.”
Such redistribution damages investment. To invest in a new business with sufficient capital backing, the bank account of the small businessman won’t do. He needs a loan. since “the mortality among new ventures is high,” especially among firms founded upon “a real innovation,” bankers fund such enterprises reluctantly, unless the innovator has a record of success. “In American economic history such new ventures have often been financed by men of fortunes sufficiently large so that they could scatter their risks.” But if the government raises income taxes to the heights implemented by the New Dealers, why risk your money? Confiscatory inheritance taxes, intended to counter the formation of an oligarchic class, remove yet another motive for risking capital. Anderson agrees that “there is good ground for the belief that vast fortunes involve undesirable political and social potentialities, and that public policy should be direct: (a) toward making sure that such fortunes cannot be accumulated in antisocial ways, and (b) toward holding down the growth and the transmission of vast fortunes to the extent that this can be done without checking the accumulation of capital and the spirit of enterprise.” To do this without inhibiting the spirit of enterprise, legislators should impose inheritance taxes that allow “a great fortune…to reach grandchildren and great-grandchildren” only if the each new generation “add[s] very substantially to it by productive activity”—a tax rate not to exceed 50%.
All of these policies contributed throughout the 1930s to a real instance of the imagined problem of the 1920s: “unused capital and unused technological knowledge.” “The war set them to work, but it took the war to do it,” war being the one government program that does stimulate economic activity, especially if your side wins. Technological progress doesn’t lead to net unemployment, although it does make many jobs obsolete when the manufactures they supported become unnecessary. “Where did the workers go” when automobiles and other technological innovations displaced buggies, whips, and smithies? “The answer is to be found in many things, and first in the great increase in the service industries” and also into design work for newer and more elegantly styled cars. “It manifested itself also in an immense demand for education, and one of the major places to which our people went from factory labor and farm labor was to school.” Women moved from agricultural and factory work to “lighter, more interesting, and better paid occupations” in offices and hospitals.
The Second World War brought a lot of women back to the factories. Otherwise, the Roosevelt administration reorganized the American political economy not only to win the war, as Wilson had done, but “as a means of pushing further the New Deal program of the redistribution of wealth” via “a tremendous increase in taxes,” “borrowing from the people instead of borrowing from the banks” (i.e. deficit spending), restriction of bank expansion, and price fixing along with commodity controls. “If you have enough regimentation, if you have control of all commodities and all prices, if you have control of every man’s pocketbook and every man’s bank balance, if you have control of the farmer’s consumption of his own productions, and if you have a sufficiently powerful and efficient Gestapo, you can take great liberties with money and credit.”
In the event, businesses adjusted to the New Deal state, which was indeed something new and lasting. Between 1930 and 1940, the federal government saw a 73% increase in federal civilian employees, not counting the 2.9 million men and women who worked on federal relief projects. In the same period, the federal budget rose from $3.44 billion to $9.06 billion and, as the saying goes, never looked back. As the economic historian Robert M. Collins observes, although Keynes’s General Theory wasn’t published until 1936, FDR got a running start on the kinds of policies it recommended, and 1938 marked “Roosevelt’s first acceptance of fiscal policy as a legitimate tool for economic stabilization,” as he advanced a plan “to pump approximately $7 billion into the economy”—an “important turning point for the New Deal.” This, along with low interest rates determined by “central control” (the Federal Reserve) and “redistribution of wealth through taxation to increase the propensity to consume” were the trademarks of Keynesian ‘demand-side’ economic policy, which held that the way out of an economic depression was to spend your way out of it. World War II “provid[ed] striking evidence of the effectiveness of government expenditure on a huge scale,” in the minds not only of professional economists but of many business owners. The latter accommodated themselves “to the fiscal revolution and successfully turned aside the thrusts of those who sought to limit seriously [their] dominion” over American economic life. “The dynamism of American business illuminates an important trend in the relationship between state and society in modern America—the conscious effort to build a corporatist sociopolitical order that would avoid the dangers of both statist regimentation and laissez-faire waste and social tension.” (3) By the time Collins wrote this, however, this Keynesianism ‘of the right’ had more than begun to outlive the usefulness ‘pragmatists’ attributed to it.
Notes
- Anderson lavishes praise on Wilson, “the greatest man, the most upright man, and the most far-seeing man who has held great public office anywhere in the world within the memory of men now living.” One might demur, but Anderson’s assessment makes his book interesting because it means that he is sympathetic to the Progressives but bitterly critical of the New Dealers, who in so many ways continued the Progressives’ preference for administrative statism and ideological historicism.
- “Keynes was a dangerously unsound thinker” whose “influence on the Roosevelt administration was very great.” Keynes held the principle that “purchasing power must be kept above production of production is to expand.” According to him, “supply creates its own demand.” Earlier modern economists, notably John Stuart Mill, stipulated rather that “purchasing power grows out of production”—that, for example, “supply of wheat gives rise to demand for automobiles, silk, shoe, cotton goods, and other things that the wheat producer wants.” That is, “aggregate supply and aggregate demand grow together” and that economic prosperity occurs when these are in equilibrium. “The doctrine expects competition and free markets” bring about such equilibrium. “When there is an excess of bank credit used as a substitute for savings, when bank credit goes in undue amounts into capital uses and speculative uses, impairing the liquidity of bank assets, or when the total volume of money and credit is expanded far beyond the growth of production and trade, disequilibria arise, and, above all, the quality of credit is impaired. Confidence may suddenly be shaken and a countermovement may set in.” This, as Anderson has explained, is what happened in the years before the Great Depression. Only “free prices, telling the truth about supply and demand,” can serve as the information necessary for making rational investment.
- Robert M. Collins: The Business Response to Keynes, 1929-1964 (New York: Columbia University Press, 1984. As Collins goes on to say, the group that suffered the most from New Deal policies, especially during the war, were not “big business, big agriculture, and big labor,” which prospered from government contracts and other programs, but the small businesses. As a result, the Chamber of Commerce, whose leaders came to accept New Deal economics, lost membership, having drifted away not only from the sentiments but from the interests of its constituents. But by the 1950s, the Republican Party itself, under the presidency of Dwight D. Eisenhower, had more or less surrendered to the ‘welfare state,’ and the economics propounded by Ludwig von Mises and defended by Anderson became peripheral for a generation, until the combined effects of economic stagflation and inflation in the 1970s brought its warnings back into currency.
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