The View From 1776

I’ve touched upon the subject in a number of postings under the head of economics and Constitutional principles.

In brief, the money supply was greatly over-expanded in the 1920s by the newly created Federal Reserve System.  Partly it was an accommodation to American manufacturers and farmers filling the rebuilding needs of war-torn Europe.

The result was similar to our dot.com boom of the 1990s.  With the economy awash in excess credit, businessmen mistook those conditions for real consumer prosperity and over-expanded production facilities.

Then, with economic conditions deteriorating in Europe (England struggling to stay on the gold standard; Germany battling hyper-inflation, etc), the Fed too sharply curtailed the money supply, precipitating the Black Friday stock market crash of 1929.  This was the insight documented by Milton Friedman and Anna Schwartz.

At that point Hoover was President.  Liberal historians like Arthur Schlesinger, Jr. depict him as a do-nothing conservative.  That is the opposite of fact.  Hoover was both a trained mining engineer and a social engineer, a liberal Republican.  As Commerce Secretary before his term as President, Hoover had sponsored efforts to get industrial groups to form stronger associations to do what amounted to price-fixing.  As President, he called major industrial heads like G.E.’s Gerard Swope into meetings and jaw-boned them to keep wages up and not to fire employees, both being the opposite of the tried-and-true methods to end an economic recession quickly. 

Hoover also created the Reconstruction Finance Corporation (RFC) with power to borrow vast amounts of money that was to be employed to prop up troubled companies.

Had Hoover let matters run their course, the 1929 recession probably would have been over before the 1932 election.  Businesses would have quickly cut costs by laying off workers, curtailing production, and liquidating inventories to pay off bank debt and eliminate borrowing costs. 

Instead, Hoover preached a sort of social Gospel that businesses had a moral responsibility not to fire workers or to cut their wages.  If businesses can’t cut costs and reduce inventories, but instead keep workers on the payroll and continue producing, they are feeding on their seed corn, a process that will only make matters worse.

Employees in some big businesses kept their jobs and pay rates, but worked fewer hours.  Other workers, fearing the loss of jobs or already having lost jobs, began saving every penny possible.  Under the impetus of the RFC, various public works projects were started (Hoover Dam in Nevada being a big one).  These merely created spots of economic activity, but did nothing for the economy as a whole.

Roosevelt continued where Hoover left off, greatly expanding the extent and scope of Hoover’s actions.  The result was the New Deal, which scared the daylights out of business.

FDR tried a variety of different approaches, the first being so-called pump-priming: the Feds were to spend a lot of money to get business going, then the imparted momentum was to carry business forward on its own.  That failed, because businessmen aren’t stupid.  They don’t hire new workers or invest in new or expanded production if there isn’t solid evidence of consumer savings as the source of credit, savings that can support purchases of the expanded production long enough, at high enough volumes, to earn a targeted rate of return on investment.

Liberals commence, instead, with the false assumption that the economy is supported by government spending, which is presumed to create consumer spending.  The snag is that, unless taxes rise (and thereby choke spending and production), the Feds have to employ deficit spending, which creates inflation.  That scares the bankers, who recognize that their loans will be repaid, if at all, in dollars worth less than the dollars they lent.  Banks just stopped making new loans to most borrowers, once the impact of FDR’s policies became clear.  After three centuries of relative price stability in the United States, inflation took off in the New Deal and has never stopped since.

Liberals’ assumption also overlooks the expectations factor: how confident are consumers that the level of employment will continue long enough to pay off their debts (if they buy on credit cards) or, in the old days, will their rainy-day savings be adequate to tide them over if they dip into current earnings.  Businesses want to know the same things in order to gauge the market for expanded production that will create new jobs.

Ultimately FDR adopted J. M. Keynes’s thesis that the Depression had been caused by people saving too much money, which implied that the government had to spend as much as, or more than, business normally spent on expanding production and creating new jobs.  Moreover, New Deal planners in conjunction with the Fed, then in the hands of Marriner Eccles, a Keynesian true-believer, had swallowed whole the hubristic presumption that the Federal government could manage and run the whole economy in the same way businessmen ran corporations.

The result was a long-running disaster.  To get chapter and verse on the utter stupidities perpetrated by the New Deal, read Jim Powell’s FDR’s Folly.

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