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.


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.


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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