Toward The Great Cleansing
Chapter 1 (Part 2 of 4) of the book
The Discovery of First Principles, Volume 3
Edward J. Dodson
The Flirtation With Gold
Another issue facing the post-war leaders and their advisers was
whether the world's great trading nations ought to return to the use
of gold to settle currency account balances between nations.
Proponents argued this was just about the only means of imposing
discipline on the fiscal and monetary activities of governments.
During the war, the export of gold was generally prohibited given the
enormous risk of sending gold through submarine-infested waters. This
meant that even though governments were spending far beyond what they
took in from taxes and borrowings, the domestically-held supply of
gold remained relatively constant. Without cancellation of the debts
by foreign creditors, however, gold would be called upon to balance
accounts. Prices were already rising in virtually every country in
response to scarcity. Citizens of every country were also well aware
that the quantity of paper currency was increasing in terms of
existing gold reserves. The U.S. dollar, heavily in demand by European
debtor nations and backed by a large and growing gold reserve, quickly
escalated in value. Commodities and manufactured goods coming from
France, for example, became a bargain for holders of U.S. dollars,
while domestic prices to the French citizen paying in francs increased
eight-fold between 1914 and 1926. Prices then stabilized at this
level. After the war, the sale of exports for U.S. dollars, along with
the receipt of gold payments from Germany helped the French to also
accumulate a sizable storehouse of gold. This, in turn, helped to
control further erosion in the value of France's currency.
For most of the rest of Europe, the situation was much worse than
that experienced by the French. With public confidence eroded and
their governments in disarray, producers withheld their goods from the
market. Prices escalated, incrementally at first, then in runaway
fashion. The paper currency of Austria collapsed, followed soon
thereafter by the German currency. Their governments resorted to the
issuance of a replacement paper currency to pull the old notes out of
circulation. The new German
rentenmark was, in the manner of a corporate bond, secured not
by the full faith and credit of the government but by the assets
controlled by the Republic. One wonders by what mechanism these assets
would have been distributed to note holders in the event of
bankruptcy. Remarkably, confidence was restored, prices stabilized and
production resumed.
The first real effort by Europe's governments to impose monetary
discipline and come to agreement on trade issues between nations
occurred in 1922 at the International Economic Conference in Genoa.
Within a few years, the world's major trading nations returned to a
system of fixed exchange rates that on the surface looked a good deal
like the prewar gold exchange standard. The circulation of gold coins
was systematically curtailed in an effort to concentrate holdings in
the hands of government treasuries or the central banks. Also, as a
means of settling accounts with other central banks, reserve
currencies (primarily the British pound and U.S. dollar) were
accumulated for use when necessary. Under conditions of prolonged
peace and reasonably normal commerce between nations, these
arrangements might have moderated the coming economic storms. By 1924,
however, Germany's inability to maintain reparation payments became
clear to all. An agreement hammered out by U.S. banker Charles G.
Dawes dramatically restructured German payments and provided a loan
equal to the first year payment. U.S. loans would continue through
1930. As a result of these negotiations, all the major trading nations
except for Britain set the price of gold at the current value of their
paper currency. Britain's Chancellor of the Exchequer, Winston
Churchill, following the advice of conservative advisers committed to
imperialist policies, returned to gold at the prewar price in terms of
the pound. Three subsequent generations of economists have essentially
agreed with John Kenneth Galbraith, who describes this decision as "the
most dramatically disastrous error by a government in modern economic
history."[40] The prices of commodities and virtually all
domestically-produced goods were already higher in Britain than in
France or the United States. Churchill's decision had the effect of
making British goods even more expensive.
Had the Conservatives relieved domestic manufacturers and workers of
some of the their tax burden, collecting instead the full rental value
of locations and natural resource-laden lands, prices -- and the cost
of living for British citizens -- would have come down. Keynes,
ignoring the potential for a shift in tax policy to bring down prices
on domestic goods, criticized Churchill's move as devastating to
exports. "The Chancellor of the Exchequer has expressed the
opinion that the return to the gold standard is no more responsible
for the condition of affairs ... than is the Gulf Stream. These
statements," Keynes continued, "are of the
feather-brained order."[41] Keynes understood that businesses
cannot long operate at a loss and that increased unemployment is one
certain result of diminished purchasing power and disappearing profit
margins. If any of Britain's policies continued to have a positive
offsetting influence, adherence to relatively low tariffs must be
identified as the only policy protecting British consumers from an
additional loss in real wages. To be sure, even this lingering vestige
of a bygone era was under attack by Conservative and Labour leaders
alike. As noted above, the Conservatives won a decisive majority in
the elections of 1924, and Stanley Baldwin -- one of the Conservative
party's staunchest protectionists -- was asked to form a new
government. For the time being, however, Churchill's presence as
Chancellor of the Exchequer stood in the way of a wholesale return to
protectionism. In the very short run, protectionism would have opened
a window of opportunity for British producers in the domestic market.
The obvious problem was the potential for a wave of retaliatory
measures that would further jeopardize exports. The additional
consequence, of course, was that under existing conditions dwindling
exports meant rising unemployment and an aggregate loss in purchasing
power for the population. In 1926, British miners and many other
workers stopped working altogether. Most went back to work after a
week, but the miners refused to do so for seven months. Very little
was well in the British Isles.
Across the Atlantic, producers in the United States deposited the
British currency they received in U.S. banks and were credited with
dollar balances at the new fixed exchange rate. When the time came for
periodic settlement of accounts, the Federal Reserve banks repatriated
excess sterling notes for gold based on Churchill's higher fixed
exchange rate. John Kenneth Galbraith explains what then occurred and
the reaction by British, French and German authorities:
By 1927, the loss of gold to the United States was
alarming. Accordingly, in that year, Montagu Norman, the head of the
Bank of England, in company with Hjalmar Schacht, the head of the
Reichsbank ..., sailed for New York to try and get it back. There,
in company with Charles Rist of the Banque de France, they asked the
Federal Reserve to lower its interest rate, expand its loans and
thus ease monetary policy. The lower interest rates would discourage
the flow of money to the United States. The easier money would mean
more loans, more money, higher American prices, less competition in
Britain and elsewhere from American goods and easier sales by
Europeans in the United States. The Americans obliged. This was the
action ... that is held to have helped trigger the great stock
market speculation of 1927-1929. The easier money went to finance
purchases of common stocks instead.[42]
The debate over the intervention by government in economic matters
was not yet a dominant or urgent matter of public concern in the
United States. An atmosphere of optimism prevailed and faith was
renewed in the potential of the American System to lift its
less fortunate members up and out of poverty. Those who had disposable
income - and those who could obtain credit from the banks -- were
taken over by the prospects of easy gains from investment in the stock
market and from land speculation in Florida and elsewhere. The Federal
Reserve System added fuel to these speculative fires early in 1927 by
reducing the rediscount rate from 4 to 3.5 percent, which had the
result of greatly increasing the availability of credit from the
nation's banks at a time when many borrowers were less than credit
worthy and their collateral overvalued. Mainstream economic policies
and the existing powers of government and the Federal Reserve System
were about to be severely tested.
IN THE EYE OF THE HURRICANE
As the twentieth century continued to unfold, the distance between
the promise of social democracy and the actual living conditions of
most people remained as a highly divisive social and political
framework. The technological developments underway seemed on the verge
of creating a very new and different material environment. And yet,
few societies had come close to solving long-standing socio-political
maladies. Only the most isolated tribal societies managed to yet
escape the grasp of the expansionist nation-states or multinational
corporations engaged in resource extraction and the exploitation of
indigenous peoples. Despite the efforts of transnationals and of some
socialists and progressives, conditions during the two decades
following Versailles exacerbated intense and longstanding hatreds, as
well as a resurgence of ethnic nationalism.
The territorial borders dividing the nation-states of Eurasia (and
their imperial holdings elsewhere) were drawn by virtue of conquest
and treaty. This dictated that control over the numerous tribal and
ethnically-homogeneous societies therein could be maintained only by
force or the threat of force. Most of these groups had fought one
another over territory for centuries and could scarcely be counted on
to develop a loyalty to any external government. Living in what
amounted to a permanent state of siege, their sense of loyalty
remained tied to their tribal or group identity and moved with them
from place to place. Yet, as pointed out by historian Hannah Arendt in
1951, the Pan-German and Pan-Slavic movements placed themselves
outside and above the rest of humanity:
The[y] ... preached the divine origin of their own
people as against the Jewish-Christian faith in the divine origin of
Man. According to them, man, belonging inevitably to some people,
received his divine origin only indirectly through membership in a
people. The individual, therefore, has his divine value only as long
as he belongs to the people singled out for divine origin. He
forfeits this whenever he decides to change his nationality, in
which case he severs all bonds through which he was endowed with
divine origin and falls, as it were, into metaphysical homelessness.
The political advantage of this concept was twofold. It made
nationality a permanent quality which no longer could be touched by
history, no matter what happened to a given people -- emigration,
conquest, dispersion. Of even more immediate impact, however, was
that in the absolute contrast between the divine origin of one's own
people and all other nondivine peoples all differences between the
individual members of the people disappeared, whether social or
economic or psychological. Divine origin changed the people into a
uniform "chosen" mass of arrogant robots.[43]
Myth combines with the history of ancient glories and conquests to
give to those who see themselves as chosen and superior the patience
to wait for their next opportunity. The dream of self-determination
and sovereignty, and of revenge, drive them on. This form of group
association emerged following the dissolution of the Austria-Hungarian
empire and has done so repeatedly to this day.
The larger tribal groups fought against the armies of Eurasia's
imperial nation-states with the view that the postwar decade presented
a real window of opportunity to formally recapture their sovereignty.
Ukrainians declared their independence from Russia and fought off the
Bolsheviks, while the Poles advanced, retreated and advanced again
into Russia. While the Bolsheviks were forced to give up territory to
the Poles, they gained control over Armenia and Georgia in a peace
settlement with the Ottoman Turks. And, as has already been mentioned,
the mixture of ethnic groups in Czechoslovakia, Yugoslavia and the
entire Balkan region guaranteed a future dominated by conflict and
violence. Ethnic nationalism also flourished in Turkey, where a new
republic was formed under General Mustafa Kemal. The Turks
successfully drove out an opportunistic Greek invasion force, whose
retreat was accompanied by the withdrawal of nearly a million settlers
of Greek heritage. In the east, the Turks attacked Armenian
settlements in a war of extermination and also drove the French out of
Cilicia in the south. In 1920, the Hungarian government was seized by
Admiral Miklos Horthy and a totalitarian regime established. Two years
later, in the midst of prolonged labor strife in Italy, the Fascist
leader Benito Mussolini was called upon by Victor Emmanuel III to form
a cabinet. After the elections of 1924 gave the Fascists a strong
majority, they moved to eliminate all opposition and create a police
state. And, in Ireland, after five years of violent guerilla warfare,
the nationalists wrestled independence from Britain for all but the
six northern counties. "The country was full of young men who
had learnt no trade but guerrilla warfare,"[44] wrote H.G.
Wells. And, under the leadership of the radical Republican Eamon De
Valera, they kept up their violent attacks against the leaders of the
new Irish Free State. The Irish struggle was, as has been more
recently described, "the precursor of all the coups,
rebellions and civil wars which were to harass the British Empire"[45]
thereafter.
The British were already in deep over their heads in the Middle East,
having made promises to Zionist leaders pressing for creation of a
Jewish homeland in Palestine. At the same time, the British cultivated
the allegiance of various Arab leaders anxious to unite Egypt, Syria,
Iraq, Lebanon, Transjordan and Arabia following the withdrawal of the
Turks. These were not efforts to instill democratic values or
establish participatory governments in this part of the world. Some of
the British representatives were unapologetic imperialists; others
came because of oil. A few sincerely desired to improve the condition
of the people, despite the fact that a formal distance was rigidly
maintained. Experience in the Middle East and the added objectivity of
historical perspective brought Sarah Searight to conclude that "[f]amiliarity
does not necessarily breed contempt but it can lead to a certain
scepticism which often charactertised British social and political
attitudes towards a Middle East slowly finding its feet after the
dissolution of the Ottoman Empire and the establishment of national
boundaries."[46] The sons of ruling Arabs who received their
education in Britain (or at Victoria College in Alexandria) learned a
good deal about the British mentality and how to use this to their
advantage. The masses remained Arab and were exposed to virtually none
of the virtues and all of the oppressive influences of Western
civilization. Only by adoption of parliamentary democracy and the
introduction of Western systems of education, civil service, finance
and economic organization could these societies be drawn into the
Western hegemonic system. Ironically, the British had neither the will
nor the capacity to bring the people of the Middle East into their
empire in such a fashion. The strength of Britain's empire had long
rested on the migration of British citizens to new and
thinly-populated lands, bringing their institutions and value systems
with them. Britain's hold on the people of Canada, Australia and New
Zealand was no longer based on military presence but on a shared sense
of history and cultural attachment. Elsewhere, the cost of holding on
to empire was becoming more than Britain's treasury could absorb.
One immediate concern to British imperialists was the fact that their
hold on India was rapidly disintegrating in the face of protest,
resistance and a populist movement arising under the guidance of
Mahatma Gandhi. Almost everywhere, in fact, the ties between Britain
and her Dominions was becoming ceremonial and economic rather than
that of a colony to mother country. British investors searching for
political stability as well as high returns now poured large sums into
Australia, New Zealand, Canada and South Africa. Despite Britain's
deeply-rooted ties to its Dominions, the heavy burden of the national
debt (aggravated by Churchill's adoption of the prewar fixed exchange
rate for gold) drained domestic producers of sorely needed financial
reserves. Currency speculators were abandoning the pound sterling in
favor of the U.S. dollar. Investors liquidated holdings in
corporations operating mostly in the British Isles in favor of
investment opportunities elsewhere promising rather higher yields.
Fueled by loans from the United States and the equity participation
of British investors, German industry was rapidly recovering to once
again become a serious competitor in the world's markets. The
turnaround was impressive, indeed. Investment in new plant and
equipment soared after 1924 and was accompanied by an enormous rural
to urban migration. Heavy subsidies to the landowning Junkers
stimulated the introduction of modern technology into agriculture.
Smaller farmers took advantage of rising land prices and sold out, so
that the ownership of farms became even more concentrated than
previously. Unemployed agricultural workers had little choice but to
move into the cities in hope of finding work. Extractive industries
received similar forms of government subsidy and protection from
foreign competition. Germany was quickly returning to the policies of
laissez-faire protectionism, its laws and regulations
structured to benefit industrial and agrarian landlords at the expense
of consumers and workers. Land prices in Berlin and other industrial
centers skyrocketed, and enormous amounts of financial reserves were
diverted from productive investment into land speculation. Arthur W.
Madsen, editor of the London-based Georgist publication Land &
Liberty, documented the upward spiral in land prices and warned of
the inevitable collapse:
Prices and rents of land soared at once, and so, too,
rose the cost of building materials, with manufacturers protected
against foreign competition by high customs duties. The price of
iron was double that in England at the time, and cement was three
times as high. ...
Land speculators had a fantastic time, some doubling or trebling
their fortunes overnight. While the common people toiled feverishly
and proudly to build up the new Germany that should be the world's
most advanced community, money poured into the pockets of those who
gambled in land values. ...
The industrial boom lasted for about seven years. Again and again,
intelligent men stood up and warned against the inevitable
consequences of what was going on. ...[T]he only right conclusion
was to alter the whole structure of German economic life, an idea
however which was taboo. Thus, Germany's destiny took its fatal
course. From the very beginning we can trace how the boom in
industry was impelled and speeded and intensified as land values
rose and then how the further speculation in land values rendered it
definitely absurd.[47]
By the beginning of 1929, the cumulative effects of the German
government's privilege-based policies were pulling the nation back
into recession. The number of business failures during the first half
of 1929 was greater by twenty percent than the previous year, and
stock prices were falling. After handing over more and more of their
incomes to the nation's landlords, workers had precious little left to
spend on other goods or services. When demand for exports fell, German
producers were not able to find a sustainable domestic market.
The French proved equally unwilling to take a hard, objective look at
their socio-political arrangements and institutions in the wake of the
postwar decline. Although direct taxation was extremely low and widely
circumvented, the French were overwhelmed by the need to service the
national debt taken on to finance the war. The combination of
continuous borrowing and the loss of the French currency's purchasing
power resulted in a nearly three-fold increase in the national debt
between 1918-1924. Many wealthy French citizens and foreign bond
holders lost enormous sums to inflation, which amounted to a de facto
repudiation of the war debt. Raymond Poincare, returned to the post of
Premier in 1926, embarked on a program of recovery based on fiscal
austerity. With Poincare's new coalition government formed, a sense of
confidence returned and the franc began to recover. An independent
agency was established to manage the national debt, its sources of
revenue kept separate from the Treasury. Poincare then introduced a
new tax on capital gains and increased existing taxes on wages, farm
income and business profits. Within six months the budget was balanced
and the franc had doubled in value. The exchange rate between the
French franc and the British pound was stabilized late in 1926 and set
by law in June of 1928. Even so, the savings of many French families
of modest means had been destroyed. Since 1914, the franc had lost
eighty percent of its purchasing power. Few expected to ever recover
this lost purchasing power; most simply hoped things would not get
worse.
In a move to take the incentives out of speculation in the franc and
prevent either inflation or deflation, the government prohibited the
Bank of France from including foreign currencies in the calculation of
its required reserves. At the same time, the liquidity needs of French
banks had to be met by conversion of foreign currencies obtained in
trade into francs and by the sale of gold to the Bank of France (which
announced it would no longer convert the U.S. dollar, pound sterling
or other currencies into francs). France thereafter joined Britain and
Germany in their dependence on export markets to sustain a modest
growth rate.
Whether the global economy would experience a mild period of
recession or something far more serious now depended, it seemed, on
the direction of policy and economic activity in the United States.
The U.S. was quickly becoming the world's industrial and consumption
giant. Despite the fact that the U.S. was also the world's largest
creditor, there was in the executive suites and legislative halls of
the U.S. little support for an open door policy for foreign goods.
Americans, generally, were becoming less and less interested in Old
World troubles. The U.S. economy was believed by many to be
self-contained. Domestic population was growing, automobile production
kept increasing and housing construction was hard-pressed to keep up
with demand. Little consideration was given to the question of what
might happen if producers in Germany or Britain were unable to sell
their goods in the United States. Once the governments of these and
other debtor nations were out of gold, the only means of debt
repayment was by taxing or borrowing U.S. dollars on deposit with the
banks. Restrict the flow of foreign goods into the U.S. and the
likelihood of default increased.
LIVING THROUGH THE GREAT CONTRACTION
In the United States, the Presidency passed in 1929 from Calvin
Coolidge to Herbert Hoover. Coolidge (and Harding before him) allowed
the nation to return in important respects to the era of
laissez-faire privilege -- to the protection of monopolistic
property rights and the use of civil authority against organized
labor. The family farm was also threatened by the combination of huge
debt and low commodity prices. Far too many farmers had used bank
loans to expand their acreage and production during the First World
War. Now that European farmers were once again meeting domestic
demand, many farmers were experiencing serious cash flow problems.
What the farmers clamored for was a reasonable system of price
guarantees (with government purchasing surplus production at the
guaranteed price and selling the products overseas at market prices).
The Republican Presidents were reluctant to intervene on their behalf.
Farmers would simply have to become more productive in order to
increase their incomes and more frugal in order to set aside reserves
for less prosperous times. As Walter Lippmann wrote in a 1924 letter:
"Coolidge abandoned all the agrarian West and is to run
frankly as an Easterner and representative of large property."[48]
Under Coolidge, Andrew Mellon significantly reduced direct taxation
on the wealth of Americans and introduced indirect taxation in the
form of protective tariffs. These tax policies shifted a large portion
of the cost of government onto households of modest incomes and placed
an enormous drain on the ability of millions of people to purchase
even basic goods. Even so, production in basic industries soared, and
the incomes of managerial and professional workers rose. The nation's
urban and industrial landlords ruled over a $70 billion economy in
1928 that included the production of over five million new
automobiles. A closer look at the distribution of purchasing power
would have provided a sobering picture of the future; however, few of
the nation's leaders and almost none of the professional economists
either recognized or were yet willing to suggest the need for real
structural reforms to improve the distribution of wealth and income.
During the 1928 Presidential campaign, Herbert Hoover told his fellow
citizens that the nation was closing in on the day when poverty would
disappear; and, in his inaugural address he affirmed his faith in "regulation
of private enterprise" rather than nationalized industry to
achieve "liberation from widespread poverty" and bring
about "a higher degree of individual freedom than ever before."[49]
Hoover totally failed to recognize the fragile network of
institutional arrangements that bound producers, consumers, financiers
and monopolists together. The U.S. economy was in the midst of a
debt-financed speculative surge driving up the cost of accessing
locations in the cities as well as the nation's agricultural and
natural resource-laden lands. The Federal Reserve system had been
facilitating stock trades on margin by maintaining a low rate of
interest charged to member banks, bolstered as well by an avalanche of
cash coming from outside the country. Foreign investors looking for a
safe harbor exchanged gold for U.S. dollars they then deposited with
the New York bankers or invested in the securities market. Few
individuals with cash to invest or the ability to borrow wanted to be
on the sidelines in a market where the average stock price climbed by
more than 100 percent during the first three quarters of 1929.
Beneath the upward surge in stock prices, however, an increasingly
vocal minority of economists warned of rising business failures and
defaulted loans. Export revenue was falling and the agricultural
sector -- unable to overcome the earlier effects of intense
speculation in farmland -- was in serious trouble. With Progressive
programs relegated to the backwaters of the political agenda and
optimism the watchword of the decade, both Republicans and Democrats
were largely content to allow the markets to operate and rely on the
price mechanism to establish the appropriate equilibrium. There was
also a practical reason for this reliance on markets to be
self-correcting. The collection of data on economic performance was
still in a rather primitive state. Economists, moreover, generally
wrote and spoke to one another in a language alien even to most public
officials. To many, they had yet to demonstrate a strong relevance in
their theoretical work to the formulation of public policy. John
Kenneth Galbraith suggests there were other reasons as well:
The regulation of economic activity is without doubt the
most inelegant and unrewarding of public endeavors. Almost everyone
is opposed to it in principle; its justification always relies on
the unprepossessing case for the lesser evil. Regulation originates
in raucous debate in Congress in which the naked interests of
pressure groups may at times involve an exposure bordering on the
obscene. Promulgation and enforcement of rules and regulations is by
grinding bureaucracies which are ceaselessly buffeted by criticism.
...[50]
The great economists, with a few exceptions, reacted to [the Great
Depression] with professional detachment and calm. Called on for
advice, as they were, most warned of the dangers of "untried
experiment," experiment usually being of such character. Or
they stressed the danger of inflation. ...
There was also, in these years, notable stress on the importance of
patience as a therapy -- a treatment that is believed to be easier
with academic tenure on a regular income. Especially powerful were
the warnings from Joseph Schumpeter of Harvard and Lionel Robbins of
the London School of Economics. They affirmed that depressions ended
only when they have corrected the maladjustments and extruded the
poisons by which they were caused. ...[51]
Galbraith added the observation that in these times there was a
strong tendency by political economists to echo the views of the
affluent and of business spokespersons. The economists generally
shunned controversy and remained content to enjoy the benefits of
tenure and micro-analytic scholarship. Meanwhile, the fabric of the
U.S. economy was becoming unraveled. There was no plan that could be
pulled from the shelves and put into action. All the work that Henry
George had done to examine and explain the causes of depression was
forgotten. Or, when reminded by a member of the Georgist remnant,
those in a position to influence policy rarely responded.
Not everyone in the United States succumbed to the speculative fevers
circulating on Wall Street or in the sandy beaches of Florida. Quietly
and gradually, the more prudent investors liquidated their holdings
and walked away with their winnings. While still Secretary of
Commerce, Herbert Hoover had been among those who warned that "previous
crises have arisen through the credit machinery," expressing
further his alarm over the fact that "the Federal Reserve
System should be so managed as to result in stimulation of speculation
and overexpansion..."[52] The Federal Reserve had been
created by government mandate but had long been run in a manner that
satisfied the interests of powerful bankers. This arrangement began to
change after the death of Benjamin Strong late in 1928. His
replacement as Governor of the Federal Reserve Board was Roy Young,
who came from the Minneapolis Federal Reserve Bank and is described by
Galbraith as "a more substantial figure" and "a
man of caution who sought no fame as a martyr to the broken boom."[53]
Encouraged and pressured by Hoover, Young issued a directive to
tighten credit and penalize lending institutions whose portfolios were
heavily collateralized by stocks. These measures and a general
nervousness about what the Federal Reserve Governor might do next
triggered the first massive sell-off late in March. Speculators were
subjected to margin calls and steep increases in interest fees charged
on borrowed funds. Only the timely (or untimely, depending upon one's
perspective) intervention of National City Bank (whose chairman,
Charles E. Mitchell, sat on the board of the New York Federal Reserve
Bank) stabilized the market and prevented a deeper correction. Senator
Carter Glass publicly called for Mitchell's resignation for this abuse
of power, but no action of consequence was taken by the government.
All through the summer months of 1929 the stock market resumed its
upward climb, with the major stocks increasing in price by almost
twenty-five percent. Most Wall Street professionals and even the
nation's premier economists expressed their confidence in further
growth, convinced that the new age of mass production and invention
were ushering in the anticipated new prosperity, accompanied by even
higher thresholds of corporate profits. Writers unimpressed by those
who practice the dismal science frequently repeat the ill-fated
forecast of Yale University's Irving Fisher, who was widely quoted in
the newspapers of October 17 with the statement that "[s]tock
prices have reached what looks like a permanently high plateau."
Although many other economists held a very different view, few felt
obligated to take an activist stance and press for new regulation or
other institutional changes. Thus, one should not be surprised that
little public attention was aroused by Harry Gunnison Brown's
expressed concerns over the troubled nature of the global markets for
land, labor, capital and credit -- or the influences of
socio-political externalities on the production and distribution of
wealth. The global economy would fall into deep and prolonged
depression before the neoclassical analysis of markets would come
under sustained criticism.
When the collapse finally and inevitably occurred, the neoclassical
economists scrambled to identify mistakes in management of the
monetary system as the culprit. Others began to suggest that in a
global economy increasingly dominated by multinational corporations,
markets would never again operate efficiently. The time had come for
government to take on a much more direct role in smoothing out the
boom-to-bust nature of the business cycle. Harry Gunnison Brown
carried on a lonely rear guard vigil against what he called "the
'new economics' and its 'prophets'."[54] The insight he
brought to modern economics was, of course, that highly speculative
periods of investment in locations, or natural resource-laden lands or
stocks were structural in origin. Absent a complete overhaul of tax
policy accompanied by the tearing down of barriers to trade and
commerce, the only means of economic management tool available to
government was the control of credit. Concern was expressed by
numerous business analysts and even the Harvard Economic Society that
the underlying strength of the economy was unstable. Despite the
risks, astronomical rates of return kept the stock market primed with
cash. Few investors who could afford to do otherwise were content with
returns from investment in corporate bonds or government securities.
Even corporate treasurers, charged with managing cash reserves, were
enticed by the appreciation in stock values and exposed their
companies to the loss of operating revenue as the market crashed.
The U.S. government was, belatedly, showing concern and was debating
the imposition of more stringent reserve requirements on
Federally-chartered lending institutions. In May of 1928, the Swedish
economist Gustav Cassel provided testimony before the U.S. House of
Representatives Committee on Banking and Currency that, in hindsight,
should have been taken more seriously:
[T]he aim of checking this speculation, from the point
of view of stabilizing the money of this country, is an outside
interest, involving the monetary policy in great difficulties. If
you had not that speculative tendency in the New York Exchange, the
Federal Reserve banks ... would be able to keep a 3.5 or 4 per cent
rate of discount. Now, there is this stock speculation, and to meet
that the Federal Reserve bank in New York feels it is obligated to
raise the rate of discount to 4.5 per cent. This is, I assume, not
at all done for monetary purposes; that is a measure entirely
outside of the normal province of the Federal Reserve system, which
is to regulate the currency of the country; but there seems to be a
popular demand that the Federal Reserve system should mend all
difficulties arising in the country and particularly fulfill the
function of keeping the speculators in New York within reasonable
limits. I think this is unsound.
It would be a great benefit to the country if some means could be
devised by which it would be possible to limit speculation on the
New York Stock Exchange without increasing the Federal Reserve
bank's rate, because such increases may be very unwelcome. They may
disturb the whole monetary policy, and it may have an effect on the
general level of prices that will result in a depression in
production in this country, followed by a decrease in employment,
all only for the purpose of combating some speculators in New
York.[55]
Throughout the Spring of 1928 a heavy volume of stock trades drove
the market upward. The core group of professional investors and
speculators were confident the economy was about to rebound and that
companies such as General Motors would be reporting record earnings.
History was repeating itself, but on an even grander scale than in
previous speculative bubbles. There were too many banks lending to too
many minimally-capitalized start-up firms. Investment activity
disregarded fundamental measurements of corporate performance and
looked solely to rapid, double-digit returns on the purchase and sale
of shares of stock. The market was fueled by a proliferation of
investment trusts and credit lines provided by banks to the Wall
Street brokerage houses. Participation by the nation's banks
significantly increased the quantity of financial reserves accessible
to the speculators; and, when stock prices collapsed, the massive
defaults on loan payments forced these banks into insolvency. In 1931,
Frederick Lewis Allen reported that in 1927 alone the "amount
of money loaned to brokers to carry margin accounts for traders had
risen during the year from [$2.8 billion] to [$3.6 billion]."[56]
On the eve of the October 1929 crash, the aggregate outstanding
balances on loans to brokers approached $6 billion. The total value of
all stocks listed on the New York Stock Exchange was reported at $90
billion.
No more than a small minority of U.S. and foreign citizens owned and
traded shares. This was still an era long before tax-exempt
foundations and pension funds appeared as major investors in stocks
and bonds. Wealth and income in the United States was so concentrated,
in fact, that fewer than two million individual investors dictated the
financial fortunes of the entire population of 120 million. These
investors initiated the first phase of the sell-off early in
September, although few suspected that the underlying health of the
economy was also in jeopardy. Estimates made in 1960 by the U.S.
Bureau of the Census showed continuous growth in the Gross National
Product (GNP) between 1923 and 1929, when the economy peaked at $104.4
billion (measured in 1957 prices). GNP fell in 1930 to $91.1
billion.[57] A word of caution is required, however, before taking
these figures at face value as a direct indication of an improvement
or decline in living conditions. GNP (even when adjusted against a
base year for changes in the purchasing power of a nation's currency)
is almost as poor an indicator of societal well-being as per capita
income. Yet, these two measurements have long been utilized as bench
marks. For those interested in the statistical aspects of economics, I
would suggest that a far more valuable measurement of economic health
would be the exchange (i.e., market) value of all capital and
consumption goods. Services, after all, are important to the extent
they relieve those directly engaged in wealth production from having
to divert time and energy from high to low output activities. A closer
look at the real indicators of national economic health would have
revealed the anomaly of an expanding storehouse of wealth accompanied
by a concentration of control over agricultural and industrial
production. Tens of thousands of highly leveraged farmers had sold out
to corporate agribusinesses. Small companies were acquired and
absorbed by large corporations. Expanded output was not generating a
need for additional workers. Conditions worsened after 1927, when
contracts for commercial and industrial development fell off
dramatically, as did residential construction. As inventories piled up
on the shelves of producers and wholesalers, prices began to fall,
unneeded production workers were released and production capacity
became idle. The Federal Reserve authorities were, as Arthur
Schlesinger, Jr. explains, caught between the proverbial rock and a
hard place:
[I]t was certainly true that reducing the interest rate
was a clumsy way of combatting the boom. So long as the stock market
offered the highest returns, it was bound to have first call on
funds. In the short run, a higher interest rate might thus slow down
real investment faster than speculation. And in the longer run, a
higher interest rate would tend, through the capitalization process,
to bring down the prices of all capital assets and thus to
discourage real investment even further.[58]
Somewhat surprisingly, Harry Gunnison Brown still thought, even at
this late date, that a sustained drop in the discount rate and bank
reserve requirements could sufficiently infuse the economy with
financial resources to diffuse the impact of a collapse in stock
prices. What concerned Brown most was a general drop in prices for
goods and services without a corresponding drop in rental charges for
access to land. When prices are rising, long-term contracts benefit
debtors and lessees who are obligated to make payments based on the
nominal values attached to currency. When prices are falling,
creditors and landlords benefit under long-term contracts. The ideal
deflation, where "all prices would immediately and adequately
fall,"[59] could not be achieved by Federal Reserve action
alone, however, because of the propensity of locations in cities and
natural resource-laden lands to be withdrawn from the market in
periods of either rapidly rising or falling prices. There are
exceptions, of course. Landowners who are highly leveraged and
acquired their holdings at or near the peak in market prices will be
under great pressure to sell off assets. Despite falling prices, they
still have to produce cash flow in order to service debt. When they
can no longer do so, the banks foreclose, acquiring the mortgaged
assets and attempting to recoup some of their loaned funds by
auctioning off properties. In most instances, unfortunately for the
banks, the auctions occur under conditions with few buyers and many
sellers. Investors with huge cash reserves and little debt step in to
pick up additional farmland, industrial sites, commercial properties
and downtown office buildings at rock-bottom prices. All of these
dynamics occurred after the 1929 stock market crash and during
1930-31. Included in the escalating number of bankruptcies were
thousands of banks forced into liquidation by heavy loan losses.
Corporate treasurers and the majority of banks outside of New York
City withdrew from the market during the last week of October. Broker
loans were essentially rolled over by the New York bankers. Various
business leaders and public officials urged the public not to panic,
declaring the economy to be essentially sound and that a market
correction had been expected. The market held and even recovered.
Then, as October became November, the bottom dropped out of the market
for the common stock of investment trusts (precursors of today's
mutual funds). Individual investors in these trusts began to liquidate
their holdings of even blue chip stocks in order to raise cash, and
the market fell even more. The stock market's collapse then spread
into the commodities market as well, where prices for steel, cotton,
wheat and corn had already fallen steeply. Stabilization finally came
in mid-November, but the stock market had lost roughly half of its $90
billion peak value.
President Hoover began a series of meetings with industrial, utility,
agricultural and labor leaders to obtain their insights into the state
of the economy. John Kenneth Galbraith suggests these meetings were
held primarily for public consumption, inasmuch as Hoover "was
clearly averse to any large-scale government action to counter the
developing depression."[60] One gains from Hoover a much
different impression of his willingness to use the powers of
government:
To our minds, the prime needs were to prevent bank panics
such as had marked the earlier slumps, to mitigate the privation
among the unemployed and the farmers which would certainly ensue.
Panic had always left a trail of unnecessary bankruptcies which
injured the productive forces of the country. But, even more
important, the damage from a panic would include huge losses by
innocent people, in their honestly invested savings, their
businesses, their homes, and their farms.[61]
The President ordered a step-up in the scheduling of Federal
construction projects and secured from the Congress a reduction in the
Federal income tax. He obtained from labor leaders a commitment to
hold the line on wages and refrain from strikes. For their part, the
nation's industrial landlords agreed in principle to spread reductions
in work across-the-board in order to minimize unemployment. As
important as these measures were, a large portion of the nation's
population remained outside of these protective agreements. As the
size of the economic pie contracted, the U.S. government reacted to
rising unemployment by closing the borders to immigration.
Agricultural price support measures were introduced to mitigate the
effects of declining global demand and offer some protection to
farmers subjected to the drought that hit the Midwest and South during
the 1930 growing season. Price supports were most needed when
production exceeded demand. Drought meant that for many farmers they
had precious little product to bring to market. Oregon Representative
Willis Hawley and Utah Senator Reed Smoot authored a new tariff bill
that, although publicly opposed by more than a thousand members of the
American Economic Association, was signed into law by President
Hoover. "The measure which eventually passed was not only
much more extensive than had first been envisaged, but it also seemed
[to European producers] essentially arbitrary in character,"[62]
writes historian Roy Douglas. The United States had taken a major step
forward in the direction of protectionism, and its trading partners
were quick to assess the damage to their export trade and adopt
countermeasures. None of the governments bothered to calculate the
number of jobs that would be lost when ships stopped leaving and
arriving at port cities filled with goods from around the globe.
Although aggressive when compared to the inaction of his immediate
predecessors, Hoover's efforts to stimulate recovery attacked the
symptoms rather than the disease and did so with rather meager
financial resources. Equally important, neither Hoover nor any of his
key advisers acknowledged the depth of privilege upon which the
foundation of American landlordism had been built and which was now
pulling the nation into depression. While on the campaign trail
against Franklin Roosevelt in 1932, Hoover naively asked his fellow
citizens to be patient and to have faith in the American System:
Before the storm broke we were steadily gaining in
prosperity. Our wounds from the war were rapidly healing. Advances
in science and invention had opened vast vistas of new progress.
Being prosperous, we became optimistic -- all of us. From optimism
some of us went to overexpansion in anticipation of the future, and
from overexpansion to reckless speculation. In the soil poisoned by
speculation grew those ugly weeds of waste, exploitation, and abuse
of financial power. In this overproduction and speculative mania we
marched with the rest of the world. Then three years ago came
retribution by the inevitable world-wide slump in consumption of
goods, in prices, and employment. At that juncture it was the normal
penalty for a reckless boom such as we have witnessed a score of
times in our history. Through such depressions we have always passed
safely after a relatively short period of losses, of hardship and
adjustment. We adopted policies in the Government which were fitting
to the situation. Gradually the country began to right itself.
Eighteen months ago there was a solid basis for hope that recovery
was in sight.
Then there came to us a new calamity, a blow from abroad of such
dangerous character as to strike at the very safety of the Republic.
The countries of Europe proved unable to withstand the stress of the
depression.[63]
And so, in the mind of Herbert Hoover the United States was much more
the victim than a causal agent. What he and others failed to come to
terms with were the flawed systems of land tenure and taxation,
combined with shortsighted protectionism and a monetary system
permitting government to self-create credit. Yet, even Keynes looked
upon the deepening depression as an anomaly of flawed public policy,
to be learned from and forgotten as the great ascent continued. "We
are suffering, not from the rheumatics of old age, but from the
growing-pains of over-rapid changes, from the painfulness of
readjustment between one economic period to another,"[64] he
wrote in 1930. And what of the injustices inherent in existing
socio-political arrangements? Would the societies of the globe finally
rid themselves of the effects of monopolistic privilege? Keynes
anticipated only that in a world no longer plagued by scarcity,
individuals would become far less acquisitive:
When the accumulation of wealth is no longer of high
social importance, there will be great changes in the code of
morals. ...The love of money as a possession -- as distinguished
from the love of money as a means to the enjoyments and realities of
life -- will be recognised for what it is, a somewhat disgusting
morbidity, one of those semi-criminal, semi-pathological
propensities which one hands over with a shudder to the specialists
in mental disease. All kinds of social customs and economic
practices, affecting the distribution of wealth and of economic
rewards and penalties, which we now maintain at all costs, however
distasteful and unjust they may be in themselves, because they are
tremendously useful in promoting the accumulation of capital, we
shall then be free, at last, to discard.[65]
Keynes thought the great conversion in attitudes might take another
century to blossom. To this time frame he added the conditions of
general peace between nations, a stable population base, adherence to
principles of incremental change and a confidence in the capacity of
technologists to utilize scientific knowledge to the benefit of the
general population. The conditions set down by Keynes are still far
from being realized. His generation of leaders went on in the
subsequent fifteen years to orchestrate the global destruction of
wealth on a scale unprecedented in all of previous history, followed
by an arms race that continues to divert a huge percentage of
potential productive capacity into the manufacture, storage,
maintenance and too-frequent use of armaments. With the collapse of
the Soviet Union's system of State Socialism, we perceive the
opportunity for a sizable reduction in these expenditures; however,
the very real danger of terrorists, revolutionary groups and dictators
constructing or acquiring nuclear weapons -- as well as the upsurge in
conflicts generated by ethnic nationalism - dictates continued
military preparedness on the part of other nations. Despite these
negative influences, our productivity, even our ability to meet all
reasonable demands for the goods characteristic of a decent human
existence in an environmentally-sensitive manner, is more than
adequate to raise the well-being of all people everywhere by a
considerable degree. Yet, despite the parallel acceptance
transnational values and a rising advocacy on behalf of human rights,
roadblocks remain. Ethnic nationalism has triggered a new era of
conflict over geo-political sovereignty. Pluralism is under attack
even in many of the Social Democracies, with the historic majority
populations increasingly fearful of immigrant groups. Elsewhere,
ethnic minorities struggle to reclaim control over a portion of the
earth based on past occupancy. Keynes gave us another generation to
work out these problems, but he offered no guidance other than to act
rationally, have faith in the experts and welcome the future.
Hoover's immediate challenge was to gain the cooperation of fifty
separate state governments, coordinate their efforts and do all this
within the framework of a government ill-equipped to manage a
nationwide undertaking. The government's statistics indicated that by
the end of 1930 around 2.3 million households were without income and
that the total number of unemployed passed 6 million. Relief measures
inadequately met even a bare minimum of the need during the winter of
1930-31. Hundreds of thousands of people suffered from hunger and
malnutrition. Just how many thousands died of starvation and the
diseases caused by lack of food is unknown. One person in three
belonged to a household in which the primary income earner was
unemployed. Hundreds of thousands lost their savings, then their homes
to foreclosure, or were evicted from apartments for nonpayment of
rent. Two million people had become homeless drifters. Hoover
continued to look to the state and local governments, supported by
volunteer organizations and philanthropy, to relieve the intensity of
suffering.
More pressing in the mind of the U.S. President was what to do about
the collapse of the international monetary system. The inevitable
point had been reached in Germany and elsewhere when the upward surge
in land prices could no longer be sustained by those who actually
needed access to land for production purposes or for housing. New
buildings remained empty of tenants, and developers were forced to
default on construction loans made by the banks. European bankers
were, in turn, forced to liquidate their investments in the securities
of U.S. corporations, with the foreseeable result that the U.S. stock
market experienced another wave of sell-offs. Depositors lined up to
withdraw their funds from U.S. banks, and nearly 500 banks failed
during the months of August and September 1931 alone. One bank in five
-- more than 5,000 -- would fail during 1930, 1931 and 1932. Most of
those that failed were local banks without ability to draw deposits
from a wide area or diversify their lending risks. Hoover finally
responded by urging the Congress to charter a new Reconstruction
Finance Corporation empowered to provide loans to banks and other
businesses unable to raise needed cash. A system of Federal Home Loan
Banks was also created as a secondary market for residential mortgage
loans. None of these measures was sufficient to save Hoover and the
Republicans from the growing desperation spreading among his fellow
citizens. Even Calvin Coolidge, the former President, had become
totally despondent over the course of events. "In other
periods of depression it has always been possible to see some things
which were solid and upon which you could base hope," said
Coolidge at the beginning of 1933. Adding, "[b]ut as I look
about, I now see nothing to give ground for hope, nothing of man."[66]
President Hoover was now receiving distressing signals from labor
leaders, who warned of impending societal unrest and challenges to the
existing political order. The danger of a worker revolt seemed very
real to the defenders of the American System. For many
intellectuals and a small group of economists, the only safety valve
they believed was available to the nation was to make government a far
more significant active agent in a managed economy.
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