In March of 1929 the economy started to weaken, which was a jolt because it had been sailing along through most of the 1920’s under the fiscally conservative President, Calvin Coolidge (1872–1933). During the Roaring 20’s, the stock market had been rising higher and higher. It seemed like such a sure thing that people from all walks of life were borrowing money to invest in the stock market, often buying stocks with only a 10% cash investment, the other 90% was a loan against the stock. Even banks were pouring their depositor’s money into the market. Back then there was no Securities and Exchange Commission or limits on stock market investments by U.S. banks. With absolutely no government regulation, big-money players were able to manipulate the stock prices of many corporations. It didn’t seem as though anybody was actually paying attention to the underlying value of stocks being purchased — they were all going up, up, up, so who cared? Well, they should have, because a market bubble was inadvertently being created and it was about to burst.
The market did collapse in October of 1929, partly due to the weakening economy and partly due to a huge new tariff bill being discussed in Congress. Wall Street suspected that this sweeping bill, affecting some 20,000 imported products, would incite a trade war, weakening U.S. corporations. Perhaps most importantly, the market was simply stretched to the breaking point. The prices of stocks became so out of line with profits that their underlying values could no longer justify new buyers, even under the Greater Fool Theory. Then, the Smoot-Hawley Tariff was passed on June 17 of 1930 and immediately deepened the recession. Thereafter, Congress passed the Revenue Act of 1932, which significantly raised taxes across the board. And finally, when it seemed that matters couldn’t get worse, the Federal Reserve reacted to the banking crisis by tightening the money supply.
Part of the Federal Reserve’s logic had nothing to do with the worsening economy. When Roosevelt took office, the United States was on the gold standard. This meant that a lowering of interest rates would create a greater demand for the cheaper dollars, leading to an increase in our nation’s money supply — which would require the treasury to purchase additional gold to cover the newly printed currency. Therefore, by raising interest rates, less money was printed. The Federal Reserve Board’s decision not only decreased the need to purchase gold, but the treasury could actually sell off some of the gold that was stored in Fort Knox. However, the decreased liquidity meant that the banks had no money to lend — especially after the “run” on banks by worried depositors who had lost faith in the banking system.
Let’s review this perfect storm of private and public-sector ineptitude.
· Investors foolishly assumed that the market would continue to rise forever, ignoring the underlying value of the stocks in the exchange.
· Banks were using depositor’s hard-earned money to also speculate in the Stock Market. After the stock market crashed, banks experienced a huge decrease in the value of their stock holdings, causing serious losses and decreased liquidity.
· Investors were using highly leveraged money to speculate in the Stock Market.
· The Federal Reserve tightened the money supply, exacerbating the liquidity crises: bank failures multiplied, customers panicked and demanded their money from banks, which further decreased bank liquidity and resulted in more bank failures.
There were almost 25,000 commercial banks in the summer of 1929, by early 1933 that number was down to about 15,000. During the same time period bank deposits shrank by over a third. (These statistics were taken from: Milton and Rose D. Friedman, Free to Choose, Harcourt Brace Jovanovich, Inc., New York, 1979, 1980)
· Because Congress was angry at European countries for not paying their World War I war debts and reparation payments, they passed the punitive Smoot-Hawley Tariff to force money from the welchers. This, of course, instigated retaliation and the ensuing trade war deepened the recession into the Great Depression.
· Five months before FDR took office, Congress passed the Revenue Act of 1932 which raised taxes across the board. The top tax rate went from 25% to 63%. The estate tax was doubled and corporate taxes were raised by 15%. These tax increases both hurt the economy and killed any chance at recovery.
Publicly traded corporations were no longer able to raise capital in the stock market. Then because of the liquidity crises, banks had no money to lend. To make matters worse, foreign trade dropped 70%, which meant that manufacturers faced supply shortages, and foreign markets dried-up causing exports to dwindle. People were losing their jobs in droves, banks didn’t have any money to lend, and corporations were suffering huge losses. What I have just described is the mess that FDR inherited!
It should be mentioned that not every investor was inept. Joseph Kennedy (1888–1969) made millions during the boom and then foreseeing the bust, took all his money out of the market. Another savvy investor, Jesse Livermore (1877–1940) made millions going “long” during the market’s rise and then switched to “short” positions at its peak; thus, making millions more during its massive decline.
It is interesting that progressive revisionists have used the Great Depression as proof that capitalism can never be a viable economic system, and that only a progressive government is truly capable of managing the economy; however, even with the mistakes made in the private sector, the Great Depression would have been a minor historical event if it wasn’t for the incredible blunders made by Congress, the Federal Reserve, and Presidents Hoover and Roosevelt.
There were some steps that could have been taken to correct these blunders: First, FDR could have put pressure on Congress to repeal Smoot-Hawley and then reduced tariffs below their previous levels. He then could have put pressure on our trading partners to reduce their tariffs. Next, he could have convinced the Federal Reserve to immediately increase the nation’s money supply. Then they could have infused money into the banking system. Many viable banks failed simply due to a lack of liquidity caused by the Federal Reserve. (Whether you are in favor of bank bailouts or not, it is critical that a nation’s banking system is stable and inspires domestic and international confidence.) Finally, FDR could have pushed Congress to completely repeal Hoover’s Revenue Act of 1932.
These steps would have dramatically shortened the Great Depression. By eliminating it’s causes what remained would have been a routine business cycle recession — FDR took none of these actions.
What FDR Did Right
FDR’s establishment of the Federal Deposit Insurance Corporation (FDIC), which insures depositors against the possibility of a bank failure, was a good step in reestablishing bank confidence. He then cleaned up investor fraud and separated the securities industry from commercial banking, which he accomplished with passage of the Securities and Exchange Act, establishing the Securities and Exchange Commission (SEC), and the Glass-Steagall Act which created a distinct separation between investment banking and commercial banking.
From a philosophical standpoint, the old system was justifiable. Before the FDIC, if a bank made bad investments, bad loans, or was poorly managed, the free-market would theoretically intervene. Disappointed investors would sell their stock, lowering the market value of the bank. Depositors would take their money elsewhere and the bank would be forced to improve or go out of business. In a worst-case scenario, those investors and depositors still hanging on would lose their money, which was a risk that they voluntarily took.
The problems with the old system, however, were transparency and sophistication. Banks that were privately owned did not have a responsibility to share the bank’s financial statements with the public, and even those financial statements made available by publicly traded banks were of little value to most depositors. This is because, to the average person, bank financial statements are practically unintelligible. Plus, they require time and research, something very few depositors would bother to do.
FDR wanted a system where anyone could walk into any bank in the country with absolute confidence that their deposits were 100% secure. To this end, he came up with an ingenious solution: mandate by law that all banks must pay premiums to a federally-backed insurance company, the FDIC. Therefore, the banking system itself paid, through insurance premiums, for its own stability. On the door of the bank, customers could look at a sign that said: “This Institution is Backed by the Full Faith and Credit of the United States.” No more runs on banks by angry and fearful customers, draining the vaults of much needed liquidity.
For the government to be willing to back the banking industry, however, there was needed a greater degree of scrutiny on banking activities. It was this concern that led to Glass-Steagall and the requirement that banks “stick to their own knitting,” so to speak.
My primary criticism is in regard to Roosevelt’s motives. As you will soon see, there is substantial evidence to suggest that FDR was more interested in enhancing his own power than returning the country to prosperity. In fact, it is possible that he learned a valuable lesson from Woodrow Wilson (1856–1924). During World War I. Wilson was granted almost authoritarian, emergency war time powers, however, after the war ended, those powers were removed by Congress, over his objections. In Roosevelt’s inaugural address he stated
I shall ask the Congress for the one remaining instrument to meet the crises — broad Executive power to wage a war against the emergency, as great as the power that would be given me if we were in fact invaded by a foreign foe…
I wouldn’t be surprised if FDR believed that the longer he kept the country in crisis, the longer he would be able to maintain the country’s dependence on him. Regardless of his intentions, however, his policies did lengthen the Depression. See the chart below:
Depression Era Unemployment Statistics
Year — — Percentage of Labor Force Unemployed
1929 — — 3.14%
1930 — — 8.67%
1931 — — 15.82%
1932 — — 23.53%
1933 — — 24.75%
1934 — — 21.60%
1935 — — 19.97%
1936 — — 16.80%
1937 — — 14.18%
1938 — — 18.91%
1939 — — 17.05%
1940 — — 14.45%
1941 — — 9.66%
Let’s give FDR the benefit of the doubt and assume that his New Deal needed a few years to take effect. So, if we just look at the unemployment rate for his second term, it still averages over 16%! By comparison, the unemployment rate during the Great Recession that began in 2008 topped out at 9.6%.
Also, consider that the U.S. unemployment rate in 1938 (five years after taking office) compared to the rest of the world was also dismal. Of the sixteen countries surveyed by the League of Nations, we were in thirteenth place. Only three of the sixteen countries had higher unemployment rates. Ours was almost double that of the average world index. (As a side note, the reduction in unemployment from 1940 to 1941 was directly related to a huge increase in defense related contracts, as FDR ramped-up military spending from $2.2 billion in 1940 to a whopping $7.2 billion in 1941.)
Gold and Silver
As you may recall, when FDR took office the United States was on the Gold Standard, meaning that in addition to the “Full Faith and Credit of the United States,” our nation’s currency was backed by gold; and as a check against inflation, the price, for the past thirty years had been set at $20.67 an ounce. Roosevelt’s “Brain Trust” (mostly academics from Columbia University) incorrectly believed that if they raised the price of gold, inflation would occur. Farmers and businessmen would therefore be able to sell their products at higher prices.
In addition, FDR knew that his administration was going to be throwing around large amounts of money to pay for the New Deal and he also knew that the money would not be completely covered by revenues. He did not want the government to be forced to back all this new currency with gold, so he did two things: first, he took the country off the gold standard, and then he began hoarding gold. Anyone in possession of gold was required by law (and fear of fines and imprisonment) to exchange their gold for currency. He then canceled any government contracts that were to be paid in gold, and started buying gold from mining companies and foreigners. Through the Treasury Department, he was buying up gold from world markets at increasingly higher prices. Meanwhile, the mining companies were loving the increased production and high prices.
In 1934 Congress authorized the Gold Reserve Act which fixed the price of gold at $35 an ounce. The federal government now had in its possession 190 million ounces in gold, most of which was purchased at much cheaper prices. And none of it was needed to back the currency! FDR had made a nice profit for the treasury, but it was largely at the expense of his citizens who had been the primary holders of his gold.
The deflation that had occurred as a result of falling prices did not turn around. There was such a weak demand for currency as a result of the Great Depression that Roosevelt’s New Deal spending was not enough to compensate for weak private-sector demand. Further, he discovered that while increased gold purchases by the government raised the price of gold, it did nothing to benefit other commodity prices.
Silver miners wanted in on the action. So, at the behest of politicians from the seven “Silver Bloc” States, Roosevelt agreed to pay them 64.5 cents an ounce for all their production, even though the current price of silver was 40 to 45 cents an ounce. Congress then passed the Silver Purchase Act in 1934 which allowed for silver purchases up to one-third of the nation’s reserve, or the price limit of $1.29 an ounce. Silver production sky-rocketed. The boondoggle lasted for fifteen years and ultimately cost the taxpayers about $1.5 billion (almost $27.5 billion today) . With the signing of this act, Congress and the President had nationalized both the gold and silver industries. And as with gold, he forced his citizens to redeem all silver holdings in exchange for U.S. currency.
As previously mentioned, Roosevelt and his progressive advisors believed that the economic downturn was caused by Free-market Capitalism, which they believed to be a failed system. The capitalists were to blame for “overproduction”, a situation where too many goods and services are produced relative to their demand. Overproduction leads to deflation, or in other words, falling prices and falling wages. In their minds, the solution was to restrict production which would result in increased prices and wages, thus pulling the economy up and out of the economic depression. As we saw with gold, it was Roosevelt’s intention to use the government to control the nation’s output of commodities, agricultural, and industrial production, and to limit foreign imports to protect American workers. While Roosevelt may have believed in this flawed strategy; it appears that his personal ambitions trumped his desire to help a suffering nation. As a side note, it was never Roosevelt’s goal to infuse massive amounts of currency into the private sector as Keynes would have advised (more on Keynes later). Roosevelt was not trying to stimulate the private sector; he was trying to replace the private sector with government run programs, as Marx would have advised. But unlike Marx, he was not using government to represent the proletariat; instead he intended to use and control the bourgeoisie to further his own political ambitions.
(From the Book Greed, Power and Politics, the Dismal History of Economics and the Forgotten Path To Prosperity, by Daniel Cameron)