Lecture 9: FDR’s New Deal and the Great Depression Politics and the Law: Perverse Incentives and Unintended Consequences As you evaluate what takes place in the news media -- particularly regarding those things touching philosophy and politics -- I would advise you to maintain a healthy dose of skepticism before being persuaded.
It is human nature to want to solve problems. When we see problems out in society as a whole, many pursue political action to try to solve those problems and the end result of such political action is the expansion of law and a resulting reduction in individual liberty. Most everything comes at a cost including attempted political solutions.
First, they may not actually solve the problem and waste a lot of resources in the process that could have been put to better uses.
Second, even if they provided some measure of solution to the problem at hand, they might also cause perverse incentives and unintended side effects that impose societal costs which overwhelm whatever societal benefits might have been achieved.
The economic costs of the implementation of such political “solutions” usually fall predominately on business which makes it more difficult for them to succeed and, in turn, may negatively impact our economic prosperity. It is not enough to just have good political/social intentions–we must be concerned about the actual net societal results that come from trying to solve every problem, and right every wrong, through the force of law.
Herbert Spencer complained in 1884 about the political apathy in his native England, and this was at a time when there were no such competing diversions as television, video games, the internet, etc. Said he:
“‘Surely,’ rejoins some one, ‘facility in reading opens the way to political knowledge.’ Doubtless; but will the way be followed? Table-talk proves that nine out of ten people read what amuses them or interests them rather than what instructs them; and that the last thing they read is something which tells them disagreeable truths or dispels groundless hopes. That popular education results in an extensive reading of publications which foster pleasant illusions rather than those which insist on hard realities, is beyond question.”1
In other words, Spencer observed that even though people read lots of things, they were not willing to read the right things—things that would instruct and teach hard truths and realities. Instead, they were only willing to read things that would just entertain and tend to create groundless political hopes and pleasant illusions.
J. Reuben Clark, Jr., once observed: “there always comes a time when unpleasant truths must be retold, even though the retelling disturbs the ease and quiet of a luxurious error. Today seems to be such a time….”2 In that address, he lamented where the country had been taken as a result of FDR’s New Deal.
What “groundless hopes,” or “luxurious errors” surround our understanding of FDR’s New Deal policies and the effects they had on the Great Depression? What “disagreeable truths,” “unpleasant truths” or “hard realities” should we consider and understand about that chapter of American history?
Specifically, I would ask you how Franklin Delano Roosevelt was presented to you in school regarding how his New Deal policies affected the Great Depression. If you were taught as I was taught, you were led to believe that FDR saved us from the Great Depression.
Recently, I read some books that take serious issue with that conclusion and argue just the opposite–that the reason that particular economic depression was so long and so deep compared to prior national economic depressions, was because of the extremely negative impact his various political policies, regulatory policies, tax policies, and his personal, and very publicly expressed, revulsion for business, had on the country’s business and economic climate and the economic opportunities available to our citizens. As I hope you will be able to see from this discussion, his policies discouraged risk-taking, scared new investment out of the market place, and practically guaranteed that the depression would truly become “Great” compared to all previous economic depressions.
If the personal model you have constructed about how the world works includes a strong belief that FDR’s invasive micro-management of the free market saved us from the Great Depression and effectively improved the health of our economy, and consider that issue to be firmly settled in your mind, I doubt you will be willing to read or listen to the rest of this lecture. For people tend to become very invested in the various models they create in their minds and tend to be more willing to ignore or explain away inconvenient facts that tend to call into question the accuracy of their models, than to consider the need to adjust their models to better comport with reality.
In my introductory lecture I introduced J. Reuben Clark, Jr., as an honest seeker of truth. In his 1898 university commencement address at the University of Utah, he said that he and his fellow students had been “taught those two great lessons first, to seek truth for the love of it, and second, and equally important, to recognize truth when found.”3 As a humble seeker of truth, Clark recognized the possibility that he might not yet have fully discovered it. In a quick memorandum he prepared at the request of Judge Salmon O. Levinson on American foreign policy, Clark said: “I reserve the right to change any and all views therein expressed, after more mature reflection.”4 He emphasized that statement by putting it into italics.
In other words, he always kept an open mind sensitive to the possibility that he might be wrong concerning the various models he had constructed in his own mind to explain how the world works and may, from time to time, have to change his position on something or, in other words, adjust his models. That is a great mental frame of reference that we all would be wise to adopt if we are to accurately be described as honest seekers of truth.
As we begin our discussion of the New Deal, I would like to share a couple of other quotes from J. Reuben Clark that are applicable. The first quote occurred near the end of FDR’s first hundred days in office as President where there had been a flurry Congressional activity passing lots of his New Deal programs. Clark said:
“But we must not forget that some men are still selfish, that they still love power and dominion, that they still use all the means necessary to secure their ends. Tyranny has been so long away from us, that our ears do not detect his tread, our eyes do not recognize his face and then he comes in so many guises. What our fathers knew of him instinctively, we do not now know even by inspection. We must not sleep, lest we shall be bound before we waken. And while we watch and examine to spy out him who comes to rob us of our heritage, let us remember no tyrant is so hard to discern, none is so hard to unmask, as he who comes in the garb of a hypocritical interest in the welfare of the common people.”5
After FDR’s death and the end of WWII, Clark similarly observed:
“Tyranny has never come to live with any people with a placard on his breast bearing his name. He always comes in deep disguise, sometimes proclaiming an endowment of freedom; sometimes promising to help the unfortunate and downtrodden, not by creating something for those who do not have, but by robbing those who have. But Tyranny is always a wolf in sheep’s clothing, and he always ends by devouring the whole flock, saving none. So it is today.”6
How the Law Affects the Success or Failure of Business If the law becomes too intrusive, it will discourage business risk taking and negatively affect the economy. Business risks will only voluntarily be undertaken, and the economy allowed to grow, when the prospects for financial gain exceed the perceived risks of loss in the minds of those with ideas.
Most businesses fail because their costs of operation exceed their revenues over time. While it is very easy to see taxes as a cost of doing business, many seem to ignore the fact that legal regulations also impose artificial costs on business that must be covered like every other cost of doing business, if a company is to survive.
Recently I scanned the table of contents of a forthcoming book to be published by the Utah State Bar that is designed to help entrepreneurs comply with all the various federal and state laws that will apply to them. The very distinct impression I got was that if a budding entrepreneur were to read that table of contents and see all the legal mine fields that lay ahead of him before he took the plunge into business, he would probably decide not to go forward with his new idea for a business; rather than produce a job for himself and perhaps others down the road, he would probably consider the potential legal risks and hassles to be too daunting and beg somebody else for a job. That is not the way to produce a growing and vibrant economy that expands the economic opportunities for everybody. Rather, it would tend to inhibit and impair an economy and make good jobs relatively scarce.
Our relative prosperity and opportunities are not accidental-- a key determinant is freedom and a legal system that supports it. If we are not careful, we can “kill the goose that laid the golden egg,” or in other words, we can destroy what has been our amazingly prosperous economy. We can inadvertently kill it by regulating it and taxing it to death, be it under the name of rights, social justice, fairness, equality, equity, or any other euphemism one could use to get people to buy into that destructive proposition.
Rather than the Great Depression being a failure of capitalism, many believe it was a “failure of government”7 as will be explained shortly.
Again, this conclusion goes entirely against what I was taught in school which was that FDR’s government policies saved us from the Great Depression. But when you see the various policies of FDR’s New Deal, try to imagine yourself in the shoes of business people and ask yourself if you would have been inclined to borrow money and/or risk your capital in a new business venture, or to expand an existing one, if you personally faced the various New Deal policies discussed below. Most likely, just like the many business people of that day, you probably would have taken your money off of the table, headed for your tornado cellar, and waited for the political tornado of the New Deal to blow over and for calmer and sunnier political skies to rise in Washington D.C. before venturing out to again be willing to take risks with your capital or with borrowed funds.
How Did the Federal Government Deal with the Various Economic Depressions Before the Great Depression? We have had several “depressions”8 in our history but they usually lasted only a few years before things turned around and economic growth resumed.9 In contrast to the Great Depression where the federal government tried to micro-manage our way through it, our prior depressions were relatively short-lived in duration because the federal government tried to get out of the way of the free market allowing it to make its necessary corrections without interference through regulation and taxation.10 Before the Great Depression, companies were able to adjust to declining economic conditions by laying off some of their workforce. While it is true that this caused great hardships on those thrown out of work, it had the benefit of keeping the company healthy and able to survive the downturn and be in a position to increase its workforce when the economy began to recover. To use a naval analogy, before the Great Depression, the prime objective was to save the ship (i.e. businesses and the economy) at the sacrifice of some of the sailors (i.e. workers), knowing that if the ship sunk all would be lost rather than just those few that had to be sacrificed to save the ship. And a sunk ship would be permanently lost to all potential future usage and benefit.
How was Herbert Hoover’s Approach to the Depression Different from Other Presidents in Dealing with Their Economic Depressions? But before talking about FDR, let us begin with Herbert Hoover. After the shock of the October 1929 stock market crash, on November 21st, President Hoover called the most prominent businessmen of the nation to White House for consultations. Amity Shlaes observed:
“After hearing their views, Hoover did something radical. He noted that ‘liquidation’ ([or in other words,]layoffs) had accompanied all previous American recessions and that the federal government had allowed those liquidations to take place. This time ‘his every instinct’ told him things must be different; wages must stay in place. Otherwise values would be ‘stepped down’; industry must help to ‘cushion down’ the situation. At the worst, businesses in trouble might reduce hours to share jobs. But the general push must be to keep high wages and keep up employment.
* * *
“Hoover’s wage ideas sounded good to some. And they were indeed the opposite of federal policies in the last downturn. But they did not really make sense: to force business to go on spending when it did not want to was to hurt business. And in some areas–wages, especially–the president’s policy was dramatically counterproductive. As the crash continued, profits began to drop. Yet businesses could not adjust: if they wanted to be good citizens, they had to keep their pledge to Hoover and sustain employment and wages. The president was, essentially, requiring that companies take the hit in profits instead of employment.
“...This was different from 1921, when companies had been able to cover their losses by cutting wages. But there was also, of course, an effect on employers. Their wage costs forced down the value of company shares, aggravating the downturn that Hoover had vowed to fight....
“...Albert Wiggin of the Chase bank argued that Hoover had his logic about wages backward. ‘It is not true that high wages make for prosperity,’ Wiggin would protest at one point. ‘Instead, prosperity makes high wages.’”11 So, to return to my prior analogy, Hoover’s plan was to try to save every sailor as the first priority rather than having that first priority be to save the ship (i.e. business). FDR later pursued the same policy but in a faster and more complete way.
We call the depression that happened in the 1930s the “Great Depression” because it lasted so long and was so deep. It started in 1929 and didn’t end until about 1942 when we entered WWII in full force.12 Jim Powell observed:
“From 1934 to 1940, the median annual unemployment rate was 17.2 percent.13 At no point during the 1930s did unemployment go below 14 percent. Even in 1941, amidst the military buildup for World War II, 9.9 percent of American workers were unemployed. Living standards remained depressed until after the war.”14
Things didn’t really get better until future presidents stopped the anti business rhetoric, lowered taxes, cut back on government regulation of business and moved us back towards the free market model. In addition to the foregoing, we had the good fortune of being isolated by two gigantic oceans from the war zones which largely destroyed the industrial capacities of our economic rivals but left ours intact to quickly re-convert to the production of consumer products after the war.
What Caused Me to Look at Things Differently about FDR’s Effect on the Great Depression? I have always puzzled over why the Great Depression lasted so long--we had abundant natural resources, factories, machinery, and people who wanted to work. I was always taught that FDR saved us from the Great Depression, through all of the government agencies he created and laws he passed and I simply believed what I was told by my teachers.
But a few years ago I saw some book titles that grabbed my attention: The Roosevelt Myth by John T. Flynn, and FDR’s Folly–How Roosevelt and His New Deal Prolonged the Great Depression by Jim Powell. I bought them and finally discovered what the legal policies of FDR’s New Deal consisted of and could see the answers to my prior question which I will summarize momentarily.
Before getting into the details, consider two supporting statements by two Nobel prize-winning economists in the forward to Powell’s book:
Milton Friedman: “Admirers of FDR credit his New Deal with restoring the American economy after the disastrous contraction of 1929-1933. Truth to tell–as Powell demonstrates without a shadow of doubt–the New Deal hampered recovery from the contraction, prolonged and added to unemployment, and set the stage for ever more intrusive and costly government. Powell’s analysis is thoroughly documented, relying upon an impressive variety of popular and academic literature, both contemporary and historical.”
James M. Buchanan: “The material laid out in this book desperately needs to be available to a much wider audience than the ranks of professional economists and economic historians, if policy confusion similar to the New Deal is to be avoided in the future.”
Presidents Wilson’s Contributions to the Great Depression Before we discuss what FDR did, let us stay true to chronology and briefly consider some other things that happened on Woodrow Wilson’s watch. The Federal Reserve (Fed) was created in 1914 under Woodrow Wilson “primarily to act as a ‘lender of last resort’ from which private banks could borrow money in times of crisis.”15 Before this time the commercial bank clearinghouses performed this function.16 Great Britain had gone off the gold standard during World War I in order to print more money to pay its various war expenses. This caused inflation and after the war, it wanted to get back onto the gold standard at its original rate. In order to do this it had to have help from other countries to support its currency. Interest rates in America were higher than in England so money and gold were flowing out of England and over to America. In July of 1927, Montagu Norman, the head of the Bank of England, asked Benjamin Strong, the governor of the Federal Reserve Bank of New York, to help. In response, Strong cut the discount rate, at which the Fed would lend money to member Federal Reserve banks, from 4 percent to 3 percent. In addition he directly supported the English currency by sending gold to the Bank of England to buy 12 million British pounds. This caused the American stock market to rise significantly for at least two reasons. First, it made bonds less attractive relative to stocks, and second, lowering the discount rate effectively expanded the money supply and spurred lending; much of the resulting easy money was invested in the stock market causing prices to rise.17 By the way, do you see any similarities to what is happening today with the Federal Reserve’s discount rate currently being zero? What has happened to the stock market?—it has recovered all of its staggering losses from 2007 forward and has even rocketed past its prior high set in 2007 by more than a thousand points. The Fed is currently creating new money to the tune of about $85 billion per month in lending money to the government to support its voracious spending habits. As old bonds are being retired and replaced by new bond issues, most of those new bonds are not being bought by private investors with their pre-existing funds, but rather, are being bought by the Fed with new money it made out of thin air. Much of those freed-up private funds are then finding their way into the stock market thus propping up stock prices.
Now lets get back to our story about the conditions preceding the stock market crash of 1929. By 1928 a number of Federal Reserve officials became concerned about the rampant stock market speculation. In response they turned off the liquidity tap by raising the discount rate to 5 percent. In August of 1929, following Strong’s death, it was further raised to 6 percent. This discouraged lending, constricted the money supply, and exerted deflationary pressures throughout the economy—including the stock market.18 Milton Friedman, who won the Nobel Prize in economics for his book The Monetary History of the United States, 1867-1960, said that the Fed’s action caused the money supply to shrink by about a third which was the main cause of the depression.19 Mismanagement of the money supply obviously is a failure of government, not business.20 Ivan Progracic said:
“In 2002 Ben Bernanke... [now (in 2013) the Fed Chairman] , made this startling admission in a speech given in honor of Friedman’s 90th birthday: ‘I would like to say to Milton [Friedman]...: Regarding the Great Depression, you’re right. We [the Fed] did it. We’re very sorry.’”21
In 1929 there were about 25,000 banks in the United States. By mid-1933 that number had dropped to about 15,000. People’s savings were wiped out so their natural response was to save and cut back on their spending causing the economy to falter. The Gross Domestic Product (GDP) was 29 percent lower in 1933 than in 1929. And the unemployment rate hit its historic high of 25 percent in 1933.22 “Friedman and Schwartz argued that all this was due to the Fed’s failure to carry out its assigned role as the lender of last resort. Rather than providing liquidity through loans, the Fed just watched as banks dropped like flies, seemingly oblivious to the [reducing] effect this would have on the money supply. The Fed could have offset the decrease created by bank failures by engaging in bond purchases, but it did not. As Milton and Rose Friedman wrote in Free to Choose:
“‘The [Federal Reserve] System could have provided a far better solution by engaging in large-scale open market purchases of government bonds. That would have provided banks with additional cash to meet the demands of their depositors. That would have ended–or at least sharply reduced–the stream of bank failures and have prevented the public’s attempted conversion of deposits into currency from reducing the quantity of money....’”23
Actual cash became so scarce that many communities, including Cedar City, created their own money substitutes to facilitate commerce. For example, J. David Leigh who had a store in Cedar City, had metal tokens made in various increments from five cents to a dollar that could be redeemed in purchases at his store. These were used in the our area as equivalents of real nickels, dimes, etc. and helped facilitate the continuance of business in our area rather than having to resort to wholesale bartering as our only means of transacting sales and purchases.
“The obvious question is: Why didn’t the Fed act? We don’t know for sure, but Friedman and Schwartz proposed several possible explanations: 1) the Fed officials did not fully understand the disastrous consequences of letting so many banks go under....; 2) Fed officials may have been acting out of their own self-interest since many of them were affiliated with large Northeastern banks. Bank failures, at least in the early stages, ‘were concentrated among smaller banks and since the most influential figures in the system were big-city bankers who deplored the existence of smaller banks, their disappearance may have been viewed with complacency’; 3) The inactivity may have been caused by political infighting between the Federal Reserve Board in Washington D.C., and regional Fed banks, in particular the New York district bank, which was the most important part of the system at that time.”24
“...Friedman and Schwartz claimed that the depression would not have been a Great Depression if there had been no Federal Reserve in the first place: ‘[I]f the pre-1914 banking system rather than the Federal Reserve System had been in existence in 1929, the money stock almost certainly would not have undergone a decline comparable to the one that occurred.’”25
Lawrence H. White further explains:
“Friedman understood...that the Fed, having nationalized the roles of the clearinghouse associations [CHAs], particularly the lender-of-last-resort role, did less to mitigate the panic than the CHAs had done in earlier panics like 1907 and 1893. In that sense, the economy would have been better off if the Fed had not been created.”26
The mismanagement of the money supply by the Fed was the first government failure which pushed us into the depression. But that depression became “Great” because of an accumulation of many other sequential government failures as explained below. While what the Fed did was not done for the sake of promoting social justice, the things that follow were.