Special Report: Do We Need a New F.D.R. to Save Us From Depression?

Filed Under Uncategorized

The New York Times stated today that “75 Years Later, A Nation Hopes for Another F.D.R.” The New York Times apparently believes that it is speaking for each of us. Indeed, most people’s impression of what happened during the great depression goes something like this: because of greedy businessmen and investors, and because of the free-market policies of President Hoover (Republican), the stock market crashed, and plunged us into a depression resulting in millions of people being out of work and suffering. It was then that Franklin Delano Roosevelt (Democrat) who came along with ingenious policies of social protection, wealth redistribution, and regulation that got us out of the depression. Believing this story is like believing that black is white or that up is down. Some of us know better; some of us know that both Hoover and F.D.R. kept us in the depression for ten years. Let’s quickly stroll through ten years of the great depression, and observe economic cause and effect[1]. It should be kept in mind that president-elect Obama has clearly indicated that he would like to emulate F.D.R. and his policies, and that many people and groups, including the New York Times, want to re-create these types of policies.

What Created the Onset of the Depression?

As is the case today, it was in fact the government’s central bank that started the economic problems of the 1930s. As we shall see in more detail later, when the central bank expands the money supply, not only does it cause inflation, but it distorts the nation’s production structure in a way that causes a large-scale misallocation of capital. The result of this misallocation is financial losses among companies in the capital goods and construction industries, which in turn results in bank losses and a contraction of the money supply. The central bank lowers interest rates by pumping money into the economy which did not previously exist. This money serves not only as new demand for products, but as funding for business projects which would otherwise not receive funding. When the central bank, for fear that the new money it is printing will cause prices to rise, raises interest rates near the end of the business cycle, the flow of new money is reduced, economy-wide demand falls off, and the availability of credit to businesses - credit which keeps unprofitable projects afloat - is no longer available. Reduced production, bankruptcies, layoffs, and increased unemployment ensue.

It is precisely this turn of events that caused not the depression itself, but only the initial economic downturn. The U. S. central bank, the Federal Reserve, expanded the money supply by about 60% between 1921 and 1929.[2] Official inflation rates were low, primarily due to extraordinary technology-based productivity increases. But the fact that price increases rose at all, instead of falling, during this time of high productivity, reveals that real inflation (i.e., increases in the money supply) was high. The large amounts of money being poured into the economy, along with, to a lesser degree, gold (real money at the time) flowing in from WWI debtor countries, caused a large economic boom that caused this period to be called the “roaring 20s.” But when the money valve was shut off (interest rates rose from 3.5% to 6% between 1938 and 1939), the boom came to a crashing halt.

The reduction in money supply, which fell by 30% over the next three years, and which was exacerbated by the Federal Reserve’s selling of government bonds, caused the economy to collapse and the stock market to fall. Up until that point in our nation’s history, recessions were largely left alone (some more than others) by government, and most lasted less than two years and never more than four. This too would have been an ordinary recession had it been left alone by government. The natural market forces would have corrected the economic imbalances: the price system would have moved labor and capital back to where they were most effective. But the market was not allowed to “clear” - as they are doing today, our politicians prevented the free market from working.

The Economy Under Hoover

Hoover engaged in unprecedented interference in the economy in order to try and help it. He was rightly accused by his 1932 presidential opponent Franklin Roosevelt of taxing and spending too much, boosting the national debt, choking off trade, putting millions on the dole, and for trying to centralize economic turmoil in Washington. John Nance Garner, Roosevelt’s running mate, stated that Hoover was “leading the country down the path of socialism.[3]” Hoover’s administration created 30 new government departments and hired 3,000 new bureaucrats.[4]

In 1930, Hoover, ignoring the pleas of many economists, signed the Smoot-Hawley Tariff, virtually preventing foreign goods from entering the country. The act increased rates on various goods of between 20% and 60%, on average. Production processes that used inputs imported from abroad were hit with higher costs, resulting in unemployment. For example, Most of the 60,000 employees of plants making cheap clothing from imported wool rags were unemployed after the tariff on wool rags rose by 14%.[5] Hoover and Congress thought that by raising trade barriers they would cause more citizens to buy American goods, thereby reducing unemployment. But they didn’t consider that besides raising costs to consumers, tariffs would cause unemployment in those sectors making goods to be exported to other countries.

With the ability of foreigners to sell in the American market drastically reduced, they could not afford to buy as many U.S. products. American agriculture was hit the hardest. Thanks to their politicians, farmers immediately lost a third of their market, causing (along with a declining money supply) agricultural prices to plummet, and tens of thousands of farmers went bankrupt (keep in mind that during this time, almost 30% of the population was involved in farming).

Losses from farming and other industries caused losses for banks, since they were not repaid loans. Over 9,000 banks went out of business between 1930 and 1933. The stock market, as measured by the Dow Jones, fell by almost 90% by summer 1932. It would take 25 years for the market to once again reach its 1929 peak (and 35-40 years when adjusting for inflation).

Since falling prices were hurting farmers the government attempted to raise farm prices by reducing agricultural production. Thus, the government, with public tax money, paid farmers not to work, not to grow food, and not to grow livestock, which also implicitly means it paid them not to hire farm workers. Not only were they directed not to produce, they were directed to destroy crops and animals. Federal agents sanctioned the plowing under of fields of cotton, wheat and corn (mules had to be retrained to walk on the crops, since they had previously been trained not to). Healthy sheep, pigs (including six million baby pigs), and cattle were slaughtered and buried in mass graves. While much of the rest of the country was desperate for food, the government was destroying it in order to attempt to benefit a single political group. Roosevelt, in his administration, not only continued these policies, but accelerated them.

The farmers also took matters into their own hand. One farm union, led by a preacher, tried to force all farmers, against their will, not to produce food. To ensure that independent farmers did not increase supply, the farm unions in multiple mid-west states created an embargo that prevented food from being exported from the states. The farm union threatened fellow farmers and the public with guns in order to enforce their blockade. The governor of Minnesota went so far as to assist the union by offering to use the state militia to prevent innocent citizens from engaging in trade of agriculture.

Farmers were also aided by the senate, which directed the FTC to investigate the too-low export prices being paid to grain farmers.[6] Congress, doing its part, helped farmers to threaten the meatpacking industry. Farmers had always complained that the meatpackers paid them too little for livestock (while consumers complained that the meatpackers charged too much at retail. Since meatpackers were not a big voting block, under the guise of a war emergency, congress threatened to authorize the president to take over and manage their operations. The meatpackers were eventually forced to curtail much of their harmless operations, and to be regulated by the Secretary of Agriculture. This allowed farmers to benefit at the expense of the meatpackers and the public.

With economy-wide consumer prices falling, wages rates needed to fall as well. But Hoover single-handedly came up with the idea to keep wages high. His notion was that high prices bring wealth, when in fact it’s the other way around. He though that by restoring wages to what they were, wealth would be restored (in reality low prices were brought about by previous government policies of inflation). He thus “encouraged” (government encouragement means that if you don’t do if voluntarily, you will eventually be forced to) to keep wages high. Shockingly, many business leaders were at first on board with this idea, because they too thought it would help the economy. Eventually, the plan became broader and mandatory. But as company revenues were falling, in order for businesses to be profitable, costs, including wages, needed to fall as well. During the period in which consumer prices (business selling prices) fell by 25% from 1929 through 1933, wages decreased by only 15%. This represented a relative increase in wage rates and thus business costs. The result was widespread unemployment. (Had wage rates been allowed to fall to the market price, production would have still been profitable for businesses, and they would have still needed the workers. There would still have been a demand for business products by either other businesses or by consumers (who would still have had jobs, and would have kept spending). The only difference in terms of business production, employment, and wages, would have been the change in prices of goods and labor (except that many people would have needed to switch jobs, since the change in the flow of money from the central bank had caused a change in the demand for consumer goods relative to capital goods industries)).

As often is the case, businesses were all too happy to cozy up to government in cases where they could benefit. Gerard Swope, the head of General Electric, called for the cartelization of American business. This regulation, where the Federal Government would “coordinate production and consumption” was welcomed by much of the business world, including the U.S. Chamber of Commerce.[7] Why? Because such socialist planning would result in restricting production in order to increase selling prices. Such a feat could not be accomplished without government regulation because, in free markets, companies that attempt to maintain a cartel inevitably cheat by not limiting production to the cartel-mandated levels. Thus, supply is not artificially restricted.

Because of widespread unemployment, Hoover dramatically increased government spending on subsidies and relief schemes. The government’s share of GNP increased from 16.4% to 21.5% over a single one-year period between 1930 and 1931. Since farmers were hurt by Hoover’s previous policies, he handed out to them hundreds of millions of dollars. Billions more were given out to other businesses and individuals suffering from prior government actions.

Similar to the politicians of our crisis today, Hoover blamed the crisis on a lack of credit, without identifying what caused that lack of credit.[8] Also, Hoover wanted to loosen bankruptcy laws so as to make lender’s, instead of consumers, suffer from the lack of being able to pay debts (just as our politicians today want the same with consumer mortgages).

As though the previous policies of high tariffs, large subsidies, and a deflationary monetary policy were not enough, congress then passed and Hoover signed the Revenue Act of 1932, which resulted in the largest tax increase in peacetime history. This act doubled the income tax, raising the normal rate from a range of 1.5%-5%, to a range of 4%-8%. The top tax bracket increased to a marginal rate of 63%! Additionally, exemptions were lowered, corporate and estate taxes were raised, new gift, gasoline, and automobile taxes were imposed, and even the writing of checks became taxed (just as some in congress today want to tax each and every stock trade). Not only were people made poorer by these tax increases, but their savings, particularly those of the rich, were desperately needed in the private sector in order to produce goods and to pay wages. By 1933, the results of these policies resulted in one quarter of the population being unemployed. Some states saw as much as 40% unemployment and some cities reached 80%.

The Economy Under Roosevelt

Contrary to Hoover’s view, Roosevelt blamed the depression on “unscrupulous money changers” (just as our politicians today blame shifty lenders for the housing bust and speculators for high oil prices). And like Hoover, he placed no blame on the central bank or the previous government policies which brought about the problems at hand.

FDR won the 1932 election on the promise of a 25% reduction in federal spending, a balanced budget, a sound currency based on gold, to end the “extravagance” of Hoover’s farm programs, and to remove government from areas that “belonged more appropriately to private enterprise.”

But Roosevelt delivered on none of these promises. He used the very same economic manipulation tactics as Hoover, and magnified the intensity. As Murray Rothbard stated, Hoover and Roosevelt were ideological twins. Rexford Guy Tugwell, a great admirer of Stalin and socialist central planning, stated that “We didn’t admit it at the time, but practically the whole New Deal was extrapolated from programs Hoover started”[9]

During the first year of the New Deal, Roosevelt proposed spending $10 billion, though government revenues were only $3 billion. Federal expenditures would rise 83% in the three years between 1933 and 1936.

As is usually the case with government spending and government “help,” the actions taken were based more on politics than on truly helping those in need. Economists Couch and Shughart, upon statistically analyzing New Deal government spending, concluded that: “The Weight of this evidence thus points to a political explanation for New Deal spending patterns: other things being the same, more federal aid was allocated to states which had supported FDR most solidly in 1932 and which were crucial to the president’s 1936 Electoral College strategy”[10] They also assert that the more economically devastated south, which was already mostly democratic, received disproportionately little new deal spending since it did not need to be encouraged to vote for Roosevelt.

New Deal money intended for economic aid was misused in many areas in order to win votes. Republican government workers in Kentucky were told that they would have to change their party affiliation if they wanted to keep their jobs. Pennsylvania WPA workers were told the same, and many that refused were fired. Tennessee WPA workers were instructed to contribute 2% of their salaries to the Democratic Party as a condition of receiving their wages. In Cook county Illinois, 450 men were directed by the WPA to canvass for democratic votes in 1938. The men were all laid off the day after the election.[11]

As is the case with our crisis today, banking regulation in the 1920s not only caused the great depression, but made it worse. Almost all of the banks that went under during the great depression were those in states with unit banking laws - laws prohibiting branch banking that allows banks to diversify their assets and reduce their risks.[12] Canada, which allowed unit banking, had not one bank failure, while 9,000 banks failed in the U.S.[13] Further, Canada did not have a central bank “saving the economy” during the worst part of the great depression.[14]

Roosevelt, who promised during his elections to take care of the nation’s money, instead, stole it. Upon being given the power by congress, he seized citizen’s private gold holdings. Government took away the only REAL money citizens had, and instead forced them to hold only paper bills. After doing this, the government devalued the dollar by 40%, simultaneously causing the citizens to lose 40% of their wealth while allowing the government to gain by the same degree; it might as well have just gone door to door with a gun to take 40% of their property. It was one morning over breakfast that Roosevelt decided to change the ratio between gold and paper bills, arbitrarily settling on a 21-cent price hike, because it was a lucky number.

The largest of the many New Deal government agencies was the Works Progress Administration (WPA), which employed millions of Americans to build highways, bridges, public buildings, canals, dams, and sidewalks, as well as to engage in artistic projects such as the production of paintings, theatre performances, and musical performances (about 4,000 a month). It could be argued that the infrastructure projects that truly contributed to economic growth do have economic value. But most of the construction did not consist of work that directly benefitted the production of goods and services. The myriad projects such as bridges, canals, and roads that were seldom or never used were a complete waste not only of funds that paid worker’s wages, but also of physical resources that could have been used elsewhere to produce goods consumers needed more urgently.

Similarly, even those projects that were condusive to economic growth still mostly resulted in a decreased standard of living. This is because the labor, materials, and machines employed to, for example, pave a road, could have instead been used to produce, household goods or other capital goods which would have produced more household goods. The importance and the need of one type of investment (such as highways) relative to another type (such as bread and sugar) can only be determined by consumers and businesses through the price system. It is highly likely that had government allowed a free market, suffering consumers would have first chosen to have more food and clothing during the decade of the 1930s, and settled for having new sidewalks and public buildings long after more immediate needs were satisfied.

Perhaps the most dramatic regulation enacted under Roosevelt was the totalitarian-style National Industrial Recovery Act (NRA). Passed in 1933, the NRA suddenly forced most manufacturing industries into government-mandated cartels - and forced businesses to finance it with newly assessed taxes (throwing yet more workers on the street). The mammoth bureaucracy created under the act was given unprecedented powers that would have made Italian dictator Benito Mussolini proud. In fact, it was run by General Hugh “Iron Pants” Johnson, an admirer of Mussolini. Johnson proclaimed: “May Almighty God have mercy on anyone who attempts to interfere” with his agency. He personally threatened to publicly boycott or “punch in the nose” those who refused to comply with the NRA.

The NRA developed more than 500 codes that regulated prices and terms of sale of individual products, which transformed American industry into a fascist operation. The codes, which spanned a slew of manufacturing goods categories, covered more than 2 million employers and 22 million workers. As Lawrence W. Reed States:

“there were codes for the production of hair tonic, dog leashes, and even musical comedies. A New Jersey tailor named Jack Magid was arrested and sent to jail for the “crime of pressing a suit of clothes for 35 cents rather than the NRA-inspired “Tailor’s Code” of 40 cents.”

The NRA had its own enforcement police who would enter factories, send out the owner, line up the employees to interrogate them, and confiscate the owner’s books. These enforcers would storm through the clothing district at night knocking down doors with axes to look for those who were committing the terrible crime of sewing clothes. For NRA accomplishments such as these, Time Magazine named Hugh Johnson the New Dealer Man of the Year in 1933.[15]

In the five months prior to the act’s passage, the economy was showing some signs of recovery, with factory payrolls having increased by 35% and employment by 23%. But six months after the implementation of NRA rules that raised business costs, taxed production, limited the hours worked, and raised wage rates, industrial production fell by 25%. The Supreme Court outlawed the NRA in 1935.

Not only did Roosevelt raise minimum wage laws that threw an estimated 500,000 blacks out of work, but he further increased taxes, insuring that fewer jobs would be created, and likely more destroyed. Naturally, like today, he increased taxes on the evil rich, and introduced a five-percent withholding tax on corporate dividends. After several rounds o f tax hikes, he eventually achieved a top marginal tax rate of 90%. He was accused by Senator Arthur Vandenberg of Michigan of doing what virtually every politician does today, namely following the socialist notion that America could “lift the lower one-third up” by pulling “the upper two-thirds down.”[16] (today, however, we try to lift the bottom nine-tenths up by pulling the top one-tenth down). In 1941, he even attempted to have a 99.5% marginal tax rate imposed on incomes over $100,000. When an advisor asked why, Roosevelt replied “Why Not?” He also issued an executive order to tax all income over $25,000 at 100% - to take every bit of income anyone earned that was in excess of $25,000! Soon after, congress rescinded the order.

Dramatic legislation supposedly intended to directly aid workers was also initiated during the depths of the depression. With the passing of the Wagner Act in 1935, not only were labor disputes taken out of courts and placed under the National Labor Relations Board, which was full of union sympathizers who distorted the law and shunned equality under the law, but most employer resistance to labor unions were crushed. Anything business did to defend themselves against unions that were destroying them were deemed to be an “unfair labor practice” punishable by the board. Board decisions ultimately made it illegal to resist the demands of labor union leaders, instead of “negotiating” with them. Naturally, with these kinds of laws, union membership more than doubled, and boycotts, strikes, seizures of plants, and violence increased strongly, causing sharp reductions in productivity and sharp increases in unemployment. Due to union coercion, wages increased by 14% in 1937 alone, meaning that fewer people could be employed.

Roosevelt was anti-business, which means he was anti economy, and therefore anti-prosperity. He claimed that it was businesses that were blocking the recovery. He blamed them for not hiring and not producing, even though it was he and congress that were preventing it. Instead of freeing the economy and allowing business to be more profitable, Roosevelt punished businesses further, therefore also punishing workers and consumers. He imposed new restrictions on the stock market and by assessed a new tax on corporate retained earnings (profits not paid out as dividends). He increased the capital gains tax from 12.5% in 1933 to 39% in 1937[17]. He tried is best to extract all possible wealth from investors responsible for providing capital for companies to operate with. The result was a depletion of capital, and investors who were too scared, for fear of confiscation, to fund business operations.

While very modest economic improvement had been occurring in the mid 1930s, these additional anti-business policies caused a second round of economic suffering. From spring 1937 to spring 1938, the stock market fell by almost 50%. Unemployment, at 17% in 1936, rose to almost 20% in 1938. Bad economic policies generated a recession within a recession.

Overall, the economy did not improve until World War II came along. For on the eve of the war in 1939, GNP per capita was lower than in 1929. Similarly, unemployment, which was 3.2% in 1929, was still over 17% in 1939.

But contrary to popular opinion, it was not the economic stimulus of the war which improved it, as production of bombs and tanks - instead of bread and houses - make an economy weaker, not stronger. As Figure 1 reveals, unemployment declined because the value of what workers could produce was no longer below the cost of employing those workers (there was increasingly less payment of wage rates above and beyond the value of what businesses were getting in return for those wage rates). This was primarily because of the wage and price controls government instituted at the start of the war. The wage controls prevented wage rates from increasing, while high inflation rates raised business selling prices (the value of what workers produced). This, however, is not a productive way to have full employment, as citizens were still relatively impoverished during WWII. They earned wages, but had few goods available to purchase. The unemployment rate received help from the fact that we sent 16 million of our youngest and least skilled workers off to war, thus reducing the number out of work.

Figure 1:

Just as the Hoover and F.D.R. caused the nation to suffer a great depression, so will Obama cause us to suffer tomorrow if he tries to replicate the types of “policies” that “saved” us in the 1930s. What America, and the world, needs are free markets, not government help. It is government help (government intervention in the markets) that caused the very problems we currently face. The markets will right themselves if we let them, and it would not take very long.

.

[2] Murray Rothbard, America’s Great Depression

[3] “FDR’s Disputed Legacy,” Time, February 1,1982, p. 23.

[4] Thomas J. DiLorenzo: http://mises.org/media.aspx?action=search&q=great%20depression

[5] Reed

[6] Murray Rothbard, America’s Great Depression

[7] Murray Rothbard, America’s Great Depression

[8] Today, our politicians blame the lack of credit on the housing market bust, without identifying what caused the housing bust (the central bank’s printing of money)

[9] Paul Johnson, A History of the American People (New York: HarperCollins Publishers, 1997), p.740.

[10] The Political Economy of the New Deal, Jim F. Couch and William F. Shughart II, Cheltenham, Eng., and Northampton, Mass.: Edward Elgar for the Locke Institute, 1998, (p. 190).

[11] These examples are based on a lecture given by Thomas J. DiLorenzo: http://mises.org/media.aspx?action=search&q=great%20depression

[12] Jim Powell, FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression (New York: Crown Forum, 2003), p. 32.

[13] Jim Powell, FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression (New York: Crown Forum, 2003), p. 32.

[14]http://macromarketmusings.blogspot.com/2008/03/what-many-of-great-depression.html

[15] http://en.wikipedia.org/wiki/Hugh_S._Johnson

[16] C. David Tompkins, Senator Arthur H.Vandenberg: The Evolution of a Modern Republican, 1884-1945 (East Lansing, MI: Michigan State University Press, 1970), p. 157.

[17] http://www.huppi.com/kangaroo/TaxTimeline.htm

Kel Kelly @ November 8, 2008