High tariffs and trade subsidies, state-dominated recovery and rearmament programs, and manipulated fiat currencies became universal after the London conference failed. In the months which followed, Sweden, Holland, and France were driven off the gold standard, leaving international financial markets demoralized and chaotic.
At the end of the day, it was only the outbreak of war in 1939–1940 which pulled the world out of the rut of economic nationalism and stagnation to which FDR’s quixotic action had condemned it. It also meant that the domestic economy had now been cut off from its vital export markets, condemning the nation to a halting recovery and to continuous and mostly ineffectual New Deal doctoring that succeeded primarily in planting the seeds of welfare state expansion and crony capitalism.
Roosevelt’s deplorable action from the deck of the Nourmahal tends to be dismissed by historians as a forgivable bad hair day early in the reign of the economic-savior president. In fact, it was the very opposite: FDR’s single-handed sabotage of the London conference was one bookend of a thirty-eight-year epoch. The other end was bounded by Richard Nixon’s equally impudent destruction of Bretton Woods in August 1971.
In each case the modus operandi was the same. Both Roosevelt and Nixon were aggressive politicians who lacked any enduring convictions about economic policy. Neither had any compunction at all, however, about using the taxing, spending, regulatory, and money-printing powers of the state to achieve their domestic political and electoral objectives. In the great scheme of modern financial history FDR and Tricky Dick were peas in a statist pod.
THE GREAT WAR AND THE ROARING TWENTIES:
CRADLE OF THE GREAT DEPRESSION
FDR’s mortal blow to international monetary stability and world trade is the pattern through which the New Deal was shaped. Once Roosevelt went for domestic autarky, the New Deal was destined to be a one-armed bandit. It capriciously pushed, pulled, and reshuffled the supply side of the domestic economy, but it could not regenerate the external markets upon which the post-1914 American prosperity had vitally depended.
Herbert Hoover had been correct: the US depression was rooted in the collapse of global trade, not in some flaw of capitalism or any of the other uniquely domestic afflictions on which the New Deal programs were predicated. Indeed, the American economy had been thoroughly internationalized after August 1914 and had grown by leaps and bounds as a great export machine and prodigious banker to the world.
While it lasted, the export boom of 1914–1929 generated strong gains in domestic incomes, which in turn fueled the postwar rise of new durables industries like autos and home appliances. The tremendous expansion of exports and durables output also triggered the greatest capital spending boom in history. Auto production capacity, for example, rose from under 2 million units in 1920 to nearly 6 million by 1929, while whole new industries like radios and washing machines were born almost overnight.
The fact that the American economy had become supersized for continuous expansion of exports and durables, however, was its Achilles heel. In the event of a slowdown in demand for these core manufactures, rapid capacity expansion would stop and the capital goods industries would plummet. Likewise, consumer goods factories would be saddled with vast idle capacity if the bubble-fueled demand of the late 1920s faltered. Then a general spiral of falling incomes, profits, employment, and consumption would ensue.
When the great stock market bubble reached its apex in September 1929, the handwriting was already on the wall. The temporary “wealth effect” of soaring stock prices, along with the huge expansion of consumer installment loans and home mortgage finance, had fostered booming sales of autos, appliances, radios, and other consumer durables. All of this came to an abrupt halt when stock prices came tumbling back to earth.
Yet the financial bubble was not just domestic. It began way back in 1914 when the “guns of August” suddenly transformed the United States into the arsenal and granary of the world and an instant, giant global creditor. This was not a natural or sustainable route to rapid growth but it powered the US economy to a scale and level of prosperity that was palpable.
After the deep but brief post-armistice slump (1920–1921), America resumed its role as a giant creditor and exporter. By contrast, the rest of the world struggled to restart domestic economies and regain financial and monetary normalcy after desperate wartime sprees of government borrowing and currency inflation.
A crucial element of the postwar stabilization process, especially in central Europe and among commodity-producing nations in Latin America, was the $10 billion of foreign bonds underwritten by Wall Street. That was the equivalent of $1.5 trillion in today’s economy, and went to borrowers ranging from the Kingdom of Denmark and German industrialists to municipalities from Hamburg to Rio de Janeiro.
On the margin, the 1920s foreign bond market was just the peacetime extension of the US Treasury’s vast war loans of 1917–1919. It was these extensive borrowings which allowed many American export customers to finance their purchases, thereby catalyzing the booming domestic economy. Accordingly, during the fifteen years between 1914 and 1929, real GDP growth had averaged nearly 4 percent annually, a rate that has never again been matched over a comparable length of time.
The trouble was that this prosperity was neither organic nor sustainable. In addition to the debt-financed demand for American exports, stock market winnings and the explosion of consumer debt generated exuberant but unsustainable household purchases of big-ticket durables at home. So when the stock market finally broke, this financially fueled chain of economic expansion snapped and violently unwound.
The first victim was the foreign bond market, which was the subprime canary in the coal mine of its day. Within a few months of the crash, new issuance had dropped 95 percent from its peak 1928 levels, causing foreign demand for US exports to collapse. Worse still, the price of the nearly $10 billion of foreign bonds outstanding also soon plunged to less than ten cents on the dollar, meaning that the collapse was of the same magnitude and speed as the subprime mortgage collapse of 2008.
Foreign debtors had been borrowing to pay interest. When the Wall Street music stopped in October 1929, the house of cards underlying the American export bonanza collapsed. By 1933, US exports had dropped by nearly 70 percent.
The Wall Street meltdown also generated ripples of domestic contraction which compounded the export swoon. Stock market lottery winners, for example, had been buying new automobiles hand over fist. But after sales of autos and trucks peaked at 5.3 million units in 1929, they then dropped like a stone to only 1.4 million vehicles in 1932. Needless to say, this 75 percent shrinkage of auto sales cascaded through the auto supply chain, including metal working, steel, glass, rubber, and machine tools—with devastating impact.
The collapse of these “growth” industries also caused a withering cutback in business investment. Plant and equipment spending tumbled by nearly 80 percent between 1929 and 1933, while nearly half of all the production inventories extant in 1929 were liquidated over the next three years. This unprecedented liquidation of working inventories—from $38 billion to $22 billion—amounted to nearly a 20 percent hit to GDP before the cycle reached bottom.
Overall, nominal GDP had been $103 billion in 1929 but by 1933 had shrunk to only $56 billion. Yet the overwhelming portion of this unprecedented contraction was in exports, inventories, fixed plant and equipment, and consumer durables. These components declined by $33 billion during the four years after 1929 and accounted for fully 70 percent of the decline in nominal GDP.
The underlying story in these data refutes the postwar Keynesian narrative about the Great Depression. What happened during 1929–1932 was not a mysterious loss of domestic “demand” that was somehow recoverable through enlightened macroeconomic stimulus policies. Instead, what occurred was an inevitable shrinkage in the unsustainable levels of output that had been reached by exports, durables, and a once-in-a-lifetime capital investment boom, not unlike the massive China investmen
t cycle of 1994–2012.
It was not the depression bottom level of GDP during 1932–1933 that was avoidably too low; it was the debt and speculation bloated GDP peak of 1929 that had been unsustainably too high. Accordingly, the problem could not be solved by macroeconomic pump-priming at home. The Great Depression was therefore never a candidate for the Keynesian cure which was inherently inward looking and nationalistic.
The frenetic activity of the first hundred days of the New Deal, of course, is the stuff of historians’ legends. Yet when viewed in the context of this implosion of the nation’s vastly inflated export/auto/capital goods sector, it’s evident that the real cure for depression did not lie in the dozens of acronym-ridden programs springing up in Washington.
Contrary to the long-standing Keynesian narrative, therefore, the New Deal contributed virtually nothing to the mild recovery which did materialize during the six-year run-up to war in 1939. In fact, the modest seesaw expansion which unfolded during that period had been already set in motion during the summer of 1932, well before FDR’s election.
THE HOOVER RECOVERY INTERRUPTED
The New Deal hagiographers never mention that 50 percent of the huge collapse of industrial production, that is, the heart of the Great Depression, had already been recovered under Hoover by September 1932. The catalyst for the Hoover recovery was not Washington-based policy machinations but the natural bottoming of the severe cycle of fixed-asset and inventory liquidation after 1929.
By mid-1932, the liquidation had finally run its course because inventories were virtually gone, and capital goods and durables production could hardly go lower. Accordingly, nearly every statistic of economic activity turned upward in July 1932. From then until the end of September, the Federal Reserve Board index of industrial production rose by 21 percent, while rail freight loadings jumped by 20 percent and construction contract awards rose by 30 percent.
Likewise, the American Federation of Labor’s published count of industrial unemployment dropped by nearly three-quarters of a million persons between July 1 and October 1. Retail sales and electrical power output also rose smartly in the months after July, and some core industry which had been nearly prostrate began to spring back to life.
Cotton textile mill manufacturing, for example, surged from 56 percent of capacity in July to 97 percent in October, and mill consumption of wool nearly tripled during the same period. Likewise, the giant US Steel Corporation, which then stood at the center of the nation’s industrial economy, recorded its first increase in sixteen months in its order backlog.
Related indicators also confirmed a broad and vigorous recovery. Wholesale prices rose by nearly 20 percent from their early 1932 bottom, marking the first sustained uptick since September 1929. The stock market quickly grasped the picture and rebounded from its depression low on the Dow Jones Index of 41 on July 7, 1932, to 80 in early September, before fears of a Roosevelt victory set it back.
The most important sign of economic rebound, however, was in the beleaguered banking sector. After having experienced nearly three hundred bank closings per month for much of the post-1929 period, bank failures dropped sharply to only seventy to eighty closings a month after June.
Indeed, for the period of July through October 1932, deposits held by banks which were reopened during that interval exceeded those of newly failed banks, a complete break with the month-after-month deposit losses that had occurred until then. In a similar vein, the United States experienced five straight months of gold inflows after July, indicating that the panicked gold flight that had commenced after the British default of September 1931 had decisively reversed.
As one careful journalistic reconstruction of events published during this period noted, “With the defeat of all threatening inflationary legislation in June … [and] the complete restoration of foreign confidence in the American gold position—the breath of recovery began to be felt over the land.”
No less an authority on the national mood than Walter Lippmann, then at the peak of his game and influence, later summarized, “There is very good statistical evidence … that as a purely economic phenomena the world depression reached its low point in mid-summer 1932 and that in all the leading countries a very slow but nevertheless real recovery began.”
By election time, however, the rebound had cooled. Subsequently, all the indicators of economic and financial activity weakened sharply during the long interregnum between Election Day and the March 4, 1933, inauguration.
As outlined below, there is powerful evidence that this setback can be attributed to a “Roosevelt panic” in the gold and banking markets that was avoidable and the result of FDR’s numerous errors and provocations during the presidential interregnum. The fact is, every other major industrial country in the world also began to recover in July 1932, but none had a relapse back into depression during the winter of 1932–1933.
THE BANKING CRISIS THAT FDR MADE
The Hoover recovery has largely been omitted from the history books, fostering the impression that the American economy had continuously plunged after October 1929 until it reached a desperate bottom on exactly March 4, 1933. That rendition of events was far from accurate, but it did mightily burnish the Roosevelt miracle legend; namely, that FDR decisively reopened the frozen banking system, restarted the wheels of commerce, and restored a heartbeat to capitalism through the swarm of acronyms which flew out of New Deal Washington during the Hundred Days.
But the received version of the March 1933 banking crisis is an invention of Arthur Schlesinger Jr. and other postwar commentators who postulated FDR’s “bank holiday” as the dividing line between Hooverian darkness and the Roosevelt miracles. By contrast, the most savvy and erudite financial observers at the time saw it far differently, and for a very good reason: on the Friday evening before Roosevelt’s inauguration most of the US banking system was still solvent, including the great money center banks of New York: the Chase National Bank, First National City Bank, the Morgan Bank, and many more.
Indeed, the latter had to be practically coerced into agreeing to the New York State banking holiday signed into effect by Governor Lehman at 4:30 A.M. in the wee hours before FDR’s inauguration. As it happened, the governor was a scion of the banking house bearing his name, but the circumstances of 1933 were the opposite of those which accompanied its demise in 2008.
Back then there had been no bank runs in the canyons of Wall Street because the great banks had largely observed time-tested standards; that is, they had been fully and adequately collateralized on their stock loans and were sitting on cash reserves up to 20 percent of deposits. The stock market crash of 1929–1930 had been brutal, of course, but in those purportedly benighted times officialdom had the good sense to allow Mr. Market to make his appointed rounds.
Accordingly, stock market punters by the thousands had been felled quickly and cleanly when upward of $9 billion of margin loans were called after Black Thursday. Indeed, the banks and brokerages liquidated in a matter of months the massive margin loan bubble—$1 trillion in today’s economy—that had built up under the stock averages in the final years of the mania.
The fact that none of the great New York money center banks closed their doors during the four years between the crash and FDR’s inauguration points to the real story; namely, that the bank insolvency problem had been in the provinces and countryside, not the nation’s money center.
In fact, the run of bank failures was largely contained within the borders of the oversized 1914–1929 agricultural and industrial export economy. As the latter collapsed, overloaned banks in industrial boom towns like Chicago, Detroit, Toledo, Youngstown, Cleveland, and Pittsburgh had taken heavy hits.
In the case of the agricultural hinterlands, the Great Depression had started to roll in a decade before the crash, owing to the unique farm country boom and bust which had accompanied the Great War. The unprecedented total industrial-state warfare of 1914–1918 had drastically disrupted European agricultural production
and markets, inducing an explosion of export demand, high prices, and soaring output in the American farm belt. There soon followed an orgy of speculation in land and real estate that exceeded in relative terms even the sand-state housing boom of 2002–2007.
Once the agricultural lands of Europe came back into production, however, the great American granary lost much of its artificial war-loan export market, causing farm prices to abruptly plunge in 1920–1921 and then to continue sinking for the next decade. Not surprisingly, thousands of one-horse banks dotting the countryside had been caught up in the wartime frenzy and then suffered massive, unrelenting losses during the long postwar deflation of the farm bubble.
Overall, about 12,000 banks failed during 1920–1933, but 10,000 of these were tiny rural banks located in places of less than 2,500 population. Their failure rate of more than 1,000 per year throughout the 1920s makes for eye-catching historical statistics, but they were largely irrelevant to the nation’s overall GDP. Losses at failed US banks during the entire twelve-year period through 1932, in fact, accumulated to only 2–3 percent of deposits.
This extended wave of failures was an indictment of the short-sighted anti-branch banking laws that rural legislators had forced upon the states, as well as a reminder that wartime inflation and disruption had cast a long shadow on the future. The crucial point, however, is that these thousands of failed banks were insolvent and should have been closed. They were not evidence of some fundamental breakdown of the banking system, or failure of the Fed to supply adequate liquidity, or a systemic crisis of capitalism.
Even after the 1929 crash, when the failure rate accelerated to about 2,400 in the twelve months ending in mid-1932, the periodic spurts of bank closures were not national in scope. Instead, they struck with distinct regional incidence in the agricultural and industrial interior. And almost without exception, these regional bank failure breakouts were centered on cities or banking chains which had indulged heavily in speculative real estate lending and other unsound practices.
The Great Deformation Page 21
