Submitted by Sean Corrigan via True Sinews blog
,
With the Fed supposedly steeling itself at last to remove a
little of its emergency ‘accommodation’, it has suddenly become
fashionable to warn of the awful parallels with 1937, as the
highly-respected Ray Dalio of Bridgewater has notably
done.
That year, the story goes, the nation’s ascent from the
depths of the Great Depression was aborted because the Fed
‘tightened’ and the government ‘cut spending’: a sharp recession
was the immediate and highly avoidable result. Therefore, we are
told, we must not act today.
We strongly refute the analogy:Fed actions were marginal and
largely technical in nature while the real fiscal story was the
rise in taxes, not any slashing of regular outlays
Far more instrumental in the slump was the nature of those
taxes – being steep, ideologically motivated increases in levies on
wealth, profits, and capital.
Also to blame were the government’s tolerance of labour
militancy and its concerted campaign against ‘tax avoiders’,
‘economic royalists’ and the ‘top sixty families’ – all of which
frightened and discouraged the entrepreneurial classes. This fear
intensified greatly when the Supreme Court was neutered as means of
seeking relief from the state’s attacks.
It is in such displays of pitchfork populism by financially
and intellectually bankrupt governments that we – in the age of
Piketty, of the organized deprecation of the ‘1%’ and of the abuse
of the ‘Fair Share of Tax’ slogan – need to draw the most pertinent
comparisons
The real Ghost of ’37 takes the form of such mean-spirited
and, counter-productive politics: the spectre should not be
conjured up to excuse the central bank from further delaying its
overdue embarkation on the long road back to normality and policy
minimalism.
With his recent, detailed foray into the world of historical
comparisons, the renowned fund manager, Ray Dalio has given rise to
something of a journalistic cottage industry in which every
journeyman scribbler tries to ensure that references to 1937
feature as prominently in their submissions as can be, all the
better to frighten the horses with the catastrophe that they insist
must inevitably befall us should the Fed ever take that first,
tentative step away from extreme over-accommodation.
In some ways this is gratifying, if woefully belated, for this
is a theme that your author has been propounding all through our
seven long years of financial famine – though for almost exactly
the opposite use than that to which the analogy is being put
today.
For instance, a bare couple of months after the demise of Lehman
triggered the great convulsion, we wrote:-
‘…the sorry track record of both post-Bubble Japan and the
post-Tech Boom West amply demonstrates – the central banks will be
far too reluctant to remove their unparalleled degree of
accommodation for fear of provoking a new crisis, as fears of
1931-3 are essential replaced by those of 1937-8 – supposing, that
is, that with balance sheets now so horrendously compromised, they
would feel able even to make the attempt.’
‘Official rates probably have further to fall and will be
maintained at low nominal (and increasingly low real) yields for a
good while thereafter.
If Bernanke thinks he understands 1931-33, he surely has
also drawn (the equally wrong?) lessons from 1937-8, in
addition.’
Again in spring 2011, readers were reminded of the dangers we
foresaw:
‘As we never cease to underline… we lose our money and squander
our wealth, by making mistakes here, during the Boom: we merely
recognise these errors—and, ideally, realise them and rectify them
– during the travails of the Bust. The attempt to subvert this
cleansing process through the inflation of a new bubble of false
asset pricing on the ruins of the old—a development the Fed has
explicitly been trying to engineer—is not to break the cycle, but
to intensify it, as each intervention becomes more radical, less
well thought-out, more plagued with unwanted side-effects, and more
rapidly self-defeating than the last, the whole bringing about an
increasingly costly and accelerating hysteresis of ‘Stop-Go’
capital destruction.’
‘
Thus, if the Ghost of 1933 got us into this mess—i.e., the
mainstream’s fervent adherence to a largely mythical narrative of
the Great Depression, centred on Roosevelt as Messiah—the Spectre
of 1937—an alarmist rendering of the dire consequences of a
’premature’ interruption of gross market interference—has
guaranteed that the Fed will only make matters worse’
The following spring, the attack was renewed:-
‘…[policy makers] will again be tempted to re-open the
Keynesian spigots, issuing yet more billions of their doubtful
pledges with the implicit backing of their pliant central banks, so
as to take advantage of interest rates which have suppressed to
perilously low levels and which will continue to be capped for as
long as is humanly possible. That this is no fanciful prognosis can
be seen in the fact that, even within the very throne-room of the
kingdom of the blind, the partially sighted Richard Fisher at the
Dallas Fed has forthrightly accused his own institution of seeing
“every problem as a nail: its only tool a hammer.”’
‘If this is continued beyond the point where the current,
highly unusual willingness to hold on to a large fraction of the
superabundance of newly-created money – and thus dampen its worst
disruptions – begins to evaporate, what we have called the Spectre
of 1937 – that fear of tightening too early which will almost
guarantee the tightening comes too late – could well turn this
into… a flight to real values.’
Similarly, that autumn, we wrote:-
‘The State – helped by its willing patsies at the Central Bank
– all too frequently overplays its hand, not least because its
interference prevents the economy from properly ‘resetting’ itself
and so renders too much of what subsequently passes for growth both
weak and overly stimulus-dependent.
In turn, this almost guarantees that the timely adoption of
an ‘exit strategy’ is not to be expected: the Ghost of 1937
features no less large in the folklore of Depression than does the
Spectre of 1931.
‘
Then, from May 2013:-
‘What is moot in all this is whether this activity is
well-founded or whether too much of it has been built on the shaky
sands of an impossibly loose monetary and far too undisciplined
fiscal mix… If only the Fed and the Administration could summon up
the courage to trust in American technical know-how,
entrepreneurial spirit, legal advantage, and natural endowment to
drive the recuperation, all might be well,
but what we must fret upon instead is that – as we wrote
almost five years ago – the Ghost of 1933 would impel policy
settings into a blind alley an exit from which the Spectre of 1937
would do its best to deter those in charge from
attempting.’
Once again, from this time last year:-
‘As we wrote way back, while the padlocks were still swinging
on their newly-imposed chains on the doors of the Lehman building,
it was one thing to accept that the Phantom of 1933 would
lead the central banks to react in fear to a crisis largely of
their own making – and so to prolong it unnecessarily – but it was
quite another to sit idly by while they used the Spectre of 1937 to
postpone any subsequent attempt to correct their
errors.Hopefully, the Chinese have finally screwed up the
courage to lay their version of this particular ghost.’
And finally from the True Sinews piece,
‘Money, Money, Money’, posted a week before Mr. Dalio’s
contribution to the debate appeared, we said that:-
‘…on our twitter account – where the compressed nature of the
communications means that a certain sloganeering is not only
permissible but almost de rigeur –we have adopted one or two
mottoes in the attempt to try to bind our monetary text-bites into
a more coherent narrative. One is simply,”Abenomics fail”–
shorthand for our disdain for a programme of pretending that an
ageing nation of import-reliant savers can get rich by devaluing
their currency and by promoting a speculative hunger for equities.
Another leitmotif is the “Ghost of ’37”– a reference to the
widely shared folk mythology that a combination of monetary and
fiscal tightening in 1937 prematurely put paid to America’s
burgeoning recovery from the earlier slump when in fact the
proximate cause was that a new front was opened that year in the
New Deal’s regulatory and ideological war on ‘Capital’ – i.e., on
entrepreneurship itself.’
It should by now be clear that when we raised this parallel it
was with a weary foreknowledge that the terror of being held
responsible for a cessation of the lunatic rise of asset pieces,
much less for a slackening of the pace of real economic activity,
is something that holds in its thrall a present crop of
policy-makers who utterly lack the fortitude of predecessors such
as Paul Volcker or Hans Tietmeyer.
Sure enough, now that the pundits and the promoters are all
worried about the imminence of a move from the Fed, the idea that
we are about to repeat some crushing mistake of history has gone
viral.The fact that it has done so highlights the
callowness of the mass of commentators who still think that it is
central bankers who create wealth and finance ministers who
‘manage’ the economy. It also reflects rather poorly on their faith
in the justification for the remarkable ascent of the stock prices
of those great corporations whose praises they otherwise fill their
days in singing.
What they should come to realize is that if the inflation
of equity values is just that – a monetary distortion which is
largely divorced from the underlying merits of business practice
and entrepreneurial genius – the sooner we are made to look at
things with a more dispassionate gaze, the better for our long term
well-being.If, on the other hand, prices really do deserve
to be daily setting new highs, they should ask themselves why they
are being so lily-livered at the prospect for a whole 25 basis
points hike in interest rates.
But what is it about 1937 that so compels its use as a lesson
for today? The answer, as Ray Dalio laid it out, is that there are
indeed sufficient similarities in the observable time series to
confirm in their prejudices anyone prone to the belief that all
economic events can be traced back to an identifiable change in the
trajectory of a small number of macro-variables and, by extension,
to the actions of those who may have set these in motion.
If you believe that recovery from a slump can only be brought
about by the determined application of Keynesian profligacy
and monetary crankdom – by some combination of fiscal and monetary
‘pump-priming’ – then , of course, it is all too easy to persuade
yourself that a callous government led astray by the hidebound
pursuit of ‘austerity’ and a central bank peopled with paranoid
inflation hawks could be foolish enough to nip a long-awaited
industrial and commercial renaissance prematurely in the bud – even
if it is truly hilarious that we could ever tar an administration
led by Roosevelt or a Fed chaired by Eccles with THAT particular
brush!
This interpretation even seems to bear up to a superficial
consideration of the facts – or at least of those ‘facts’ which
best lend themselves to quantification and to manipulation in a
spread sheet. For was it not indeed the case that, in little under
a year, the Fed
doubledreserve requirements? That federal government
outlays in the period to the May ’37 peak of industrial production
were much diminished once the boost occasioned by the hefty,
pre-election sop of the Veteran’s Bonus bond, granted the previous
June, had dropped out of the accounts? Or that tax receipts were
substantially boosted by the draconian Revenue Act of 1926, so
reducing the oxygen of deficit finance to an asphyxiating low?
Moreover, was it also not true that the Fed and the US treasury
were both fixated on sterilizing gold inflows – and so were somehow
both slavishly addicted to
andsimultaneously ‘cheating’ on a gold standard mechanism
which they had shamelessly abandoned just four years previously –
and this to a degree which impaired their ‘management’ of the
domestic economy?
All of these charges do, indeed, contain a kernel of the truth,
but to stop there is to try to judge the book, not so much from its
cover as from a glance at the tables laid out in the appendix in
the back. This very point was in fact raised by a director of the
NBER, Albert Hettinger, in his closing commentary in Friedman &
Schwartz’s seminal
‘Monetary History of the United States’– a work in which
they memorably sought to apportion all the blame for the ills of
the 1930s to the Fed’s stubborn refusal to inflate early enough,
energetically enough, or enduringly enough to a certain Mr. Ben
Bernanke’s enthusiastic agreement.
Gently questioning the authors’ almost exclusive reliance on the
effects of arithmetical changes in ‘high-powered’ money, Mr.
Hettinger – who had been active in business and finance throughout
that vexed decade – wisely noted that:-
‘To me, business is imply decision making and calculated risk
taking… It has been burned upon me that monetary policy, in the
final analysis, acts on men whose conduct is not predictable; it
neither operates in a vacuum nor in a world in which all other
factors can be taken as constant.’
With that insight kept firmly in mind and since it is the facet
of the problem to which appeal is being explicitly made today, let
us try to deal with this monetary issue first. Afterwards, we shall
move on to a consideration of the fiscal angle, a study which, we
will argue, will allow us to tease out the true explanation of what
went wrong and so allow us to derive the real lesson for the
circumstances of today.
From the depths of the initial collapse, early in 1933, money
supply – depending somewhat on which set of the available data one
uses – had expanded somewhere between 55-65% in the four years to
the cyclical highs of late spring 1937, or by an impressive 12-13%
a year compounded. Reserve growth followed an even steeper path by,
tripling over the period in question. This was an increment of such
magnitude that the count of
excessreserves contained within it swelled by a factor of
5.7 and so came to account for no less than half the total by
mid-1936. Gold holdings grew likewise, up 150% in the four years
since the devaluation at a 27% compound annual rate.
As the upswing approached its climax, domestic appetite was even
strong enough for imports to outpace exports, with both growing at
over 40% a year. That was enough to produce the largest trade gap
in a decade typically marked by the generation of surpluses, so one
might forgive the Fed for thinking that much of the recent inflow
of gold represented a form of hot money of which there was already
too much to hand. One could also imagine them to believe those
suspicions confirmed when they noted the then fashionable
Fairchild’s index of retail prices rising 9.2% in the space of a
twelvemonth, alongside wholesale prices which were up 10.1%, or
when they saw copper soaring 48%, rubber 35%, cotton goods 23% and
tin 20%. The fact that the stock market was up 20% in twelve months
and had doubled in twenty-four – over which latter horizon pre-tax
earnings had only managed a 40% gain – would also have given pause
for thought. Finally, as we shall see below, wages were also
charging ahead while the roll of the jobless had shrunk by almost
60%.
What was the Fed to do, we might ask today’s perfect hindsight
critics? Underwrite this burgeoning inflation by further monetizing
it? That, too, would have been a course fraught with peril.
Part of the gold ‘avalanche’- as it was then described – was due
to a surge in production to which the metal’s raised price and the
miners’ lower costs had so greatly contributed that global output
in 1937 was a full 75% greater than that of 1930, the last year
before the metallic exchange standard collapsed. Opportunistic
dishoarding at the new elevated parity in India added more to the
pot while the ongoing economic and political turmoil in Europe
provided one final source of bullion.
Rendered uncompetitive by Perfidious Albion’s defection from the
gold standard in 1931, then dealt a double blow by Roosevelt’s 1933
repudiation of it, the remaining members of the Continental gold
bloc had been jolted from one crisis to the next, each of which
gave rise to an increase of flight capital. Successive defections
by the Czechs in 1934 and the Belgians a year later only served to
increase the pressure on the Netherlands. For its part, Switzerland
had to suffer through the politicking associated with an ultimately
unsuccessful popular referendum which called for the Confederation
to adopt a package of American-style measures. Just as today,
however, the real problem lay with France.
Here successive, short-lived administrations had alternated
wildly between attempts to balance the books by cutting costs and
partial emulations of New Deal reflationism. The one constant was
that, whether spending was going up under one faction or revenues
were coming down under the other, the finances could not be
adequately controlled. Alas, the only means of bridging the
crippling gap between income and outgo was to have recourse to the
Banque de France– a policy guaranteed to see further gold
losses and so to frighten off whatever smattering of investment
remained.
Finally, in early 1936, the spin of the political wheel brought
to power Leon Blum at the head of a Popular Front coalition of
Socialists and Communists. Taking office, the incoming regime opted
to try to suspend the laws of economics and thus achieve the
Workers’ Paradise by decree. The results of such fatuous Utopianism
were entirely predictable. The programme, in whose failure lies the
first of the salutary lessons we might genuinely hope to draw from
our grandfathers’ tribulations, included such evergreen Jacobin
themes as a crack down on fraud, speculation, and tax evasion,
combined with state support for agriculture and an extension of
benefits to young and old alike. But the real killer was the move
to cut the working week from 48 hours to 40, while adding 2-3 weeks
of paid leave and simultaneously hiking wages by up to 15%.
Today’s cart-before-the-horse apostles of a higher minimum
wage as a means to increase ‘purchasing power’, please take note: a
30% effective jump in labour costs meant that joblessness was soon
mounting while the anxious attempt to pass on the rise in wage and
other input costs set off successive waves of distress for
businesses and consumers alike.Bowing to the inevitable,
Blum reneged on his election pledge to maintain the franc and
undertook a 25% devaluation of the currency. The Swiss, Dutch, and
Italians quickly followed, the Czechs took a second bite at the
cherry, while Greece, Turkey, and Latvia forsook their attachment
to the franc and joined the sterling bloc instead.
Sparing the world another cascade of disruption on the foreign
exchange market, this
volte facewas in fact conducted under the auspices of a
fuzzy concord between Britain, the US, and France which was
grandiloquently called the Tripartite Agreement. Though far from
binding, this did offer some vague assurance that now that each of
the signatories had in turn drunk deep from the poisoned well of
competitive devaluation, there would be no more deliberate recourse
to this hoary old tool of mutual beggary. Markets breathed a sigh
of collective relief and if some of France’s foreign holdings
headed temporarily for home, the promise of stability led many
private individuals in the other former adherents to the bloc to
cash in their windfall profits by adding to the monies chasing Wall
St.’s eye-catching rise.
Ironically, the abatement of distrust of their home currencies –
by revealing just what an embarrassment of gold there was in the
world – eventually led to a desire to be rid of the stuff and to
swap it for holdings of dollars above all else. Fearing yet another
revaluation loss on their reserves were the British and American
stabilization accounts to be swamped and the gold price reduced –
as was actively discussed at the Empire Conference of May 1937 –
many smaller central banks began to unload their remaining stocks
of metal and so came near to rendering the prophecy a
self-fulfilling one. It would take the gathering of the clouds of
total war and the fears of its effect on paper currencies during
the course of 1938 to finally arrest this impulse.
It is in this context of the rapid reversals in speculative
flows unleashed by the unanchoring of the system – a turbulence
further strengthened by the succession of policy shifts and broken
promises from on high – that the US Treasury undertook to dampen
the effect of an influx which, as 1936 turned to 1937, was
beginning to alarm both it and its counterparts at the central
bank.To the extent that such swings were not being driven
in the main by underlying conditions of trade, it hardly seems fair
to accuse the authorities of trying to subvert the working of the
classic specie-flow mechanism and so of failing to allow a domestic
inflation to ‘compensate’ for a deflation abroad. Given, too, that
the stabilization account worked so as to increase bank ‘inside’
moneys – i.e., the gold-sellers’ deposits – not ‘outside’ ones –
i.e., reserve balances at the Fed – and that there was an excess of
the latter to set against the former, any monetary tightening
occasioned can only have been of secondary importance.
Here we should pause to make one further thing clear: although
the Fed’s three stage doubling of reserve requirements (effective
August 1
st1936, March 1
stand May 1
st1937) seemed to coincide with the peak in monetary
growth, it is to be borne in mind that it was the
excess, not the
totalof reserves which was drastically scaled back, the
rationale being that these were so disproportionate that they not
only constituted a threat to future stability but that they made
the Fed’s ability to influence current events quite nugatory.
Notwithstanding the moves, overall reserve growth was still an
impressive 23% yoy in the interval to mid-37 and if the quota of
required reserves was double that of the previous summer,
so too was their provision.
The effect of all this on bond and money markets was, in any
case, moot. Yes, from the rates which prevailed before the first
increase, there was a reaction, but we must also bear in mind these
were rates so low and so beyond anyone’s experience that Benjamin
Anderson, Chase Manhattan’s eminent chief economist, was moved to
describe them as ‘fantastic’. From their 10-12bps starting point,
T-bill and BA yields rose almost 50bps to their peak (though a peak
actually attained
beforethe last reserve hike when the Fed started buying
modest amounts of paper), as banks made adjustments to their
balance sheets (and perhaps as working capital demands increased
for reasons we shall discuss below), but Treasury and
investment-grade corporate bonds only saw a modest 15-20bps
increase and high-yield actually slipped a few bps until the
recession hit home and subsequently pushed yields and spreads in
that sector up by 150bps or so in time-honoured fashion.
What we have to ask then, was whether the subsequent,
14-month long, dip in the nominal money supply (which we can
variously estimate at somewhere between 3.5 to 5.0% and of
something like 1.5% of GDP) was enough to crush the real side of
the economy, driving domestic production down by a third and
imports by a half, slicing 40% or more of the value of stocks, and
throwing seven million people out or work, especially when some
part of that ostensibly critical reduction would have been related
to a regulatory-arbitrage between higher reserve requirement demand
deposits and lower-requirement time and saving alternatives (these
latter rose 1.5% in the interval); and also when a further
undefined, but more typically more volatile fraction (of at least
10% by analogy with other, known figures) was interbank in nature
and so strictly not determinate.
We might also note that the Fed was swift to react once it
became aware of the change in the situation (in fact it had already
partly mitigated the reserve tightening even before the last raise
had become effective). In August 1937, it cut the discount rate by
50bps to 1% (though this still represented something of a penalty
rate in comparison with those prevalent in the market) and it
encouraged bankers to avail themselves of the Window in case of
need. It then invited the Treasury to ‘desterilize’ a sizeable $300
million in gold and authorized the Desk to buy securities when
necessary despite an earlier expressed reluctance to accumulate
further government paper. All this was to no avail – or at least it
was without any effect of that same suspicious immediacy with which
its tightening moves were to be much later credited. The following
spring, the final reserve hike was rescinded, but by then, the
bottom of the cycle had already been reached.
Given all this, it is well worth asking whether we might in fact
have the causality back to front; that rather than postulating that
a change in money retarded production, considering that a fall in
prices and output might have occasioned a minor, but noticeable
contraction of a few percentage points in money and loan balances.
Remember the sagacity of Mr. Hettinger: we are dealing here with
the hearts and minds of men, not with some tightly-jointed
mechanical linkage.
If we can bring ourselves to entertain this possibility for just
a moment, we must then to try to imagine what could have caused
such a sudden, violent departure from the preceding, upward path.
Firstly, let us recall that in order to have the means to buy the
product of others, people must first turn out their own.
Furthermore, those whose great societal talent lies in that they
can organize such production must themselves feel they have a
fighting chance of doing it sufficiently well that there will be
something left over not only to reward them and their backers and
to pay their dues to their creditors, but also to have something
left over to spend in the quest for a way of doing it better the
next time around. In other words, they must believe they have a
reasonable chance of making – and keeping at their disposal – a
profit.
Once we come to that realization, we might just begin to
see that some of the factors we have already discussed might have
been instrumental in triggering the recession: input prices were
rising and government receipts were greatly elevated.If we
add the fact that the price of a far less amenable labour force was
also shooting higher – average weekly wages in the six months to
June ’37 were 16% above those of the previous year and a third
higher than in the year before that – an extra piece of the puzzle
might seem to have been slotted into place.
Even then, the sterile time series alone can barely afford us a
glimpse of what was in truth a seething hotbed of class warfare, of
cynical and often casually destructive political manoeuvring, of
legal and regulatory uncertainty and of the swingeing, almost
vindictive taxation of gain. In short, we need to take a quick tour
of Roosevelt’s disastrous second term to put some flesh on the dry,
numerical bones of the data.
Two years earlier, in May of 1935, all had not been well in the
New Dealers’ City on the Hill. Industrial production had still not
moved beyond the peak set in mid-1933 in the first flush of
enthusiastic rebound. Unemployment rates were still in excess of
22%, representing a miserable total of 11 million souls without
work. The stock market, at the wrong end of a year-long, 20% slide,
was back to the levels of early 1933 – and before that to those of
late 1931 and even of spring 1922.
Then came the moment when the logjam was broken and the upward
momentum was regained, once more. The roll of the jobless would
then fall for two years to a seven-year low of 4 ½ million;
industrial production would rise by almost a half; the stock market
would double. And what wonder would achieve this miraculous
transformation? Some bold new stroke by the Federal Reserve? Some
vast new proto-Keynesian push to spend money borrowed into
existence by the state? Neither of these.
Instead we can attribute much of the turnaround to the landmark
judgement of that last bastion of constitutionalism, the Supreme
Court and its ‘Four Horsemen’, in which their Justices used the
opportunity provided by the appeal of a pair of kosher poultry
butchers, the Schechter brothers, to throw out Roosevelt’s
Byzantine centrepiece of legalized cartelization and bureaucratic
meddling, the National Industrial Recovery Act.
The NRA agency, with its infamous Blue Eagle emblem, represented
Roosevelt at his Corporatist worst, being a misguided attempt to
control all aspects of business; prices, wages, hours, and even –
as the Schechter case showed to the hilarity of the courtroom – the
customer’s ability to choose one particular chicken over another.
Not for nothing did an eminent counsel to the brothers highlight
the dreadful similarity with practices in Mussolini’s Italy. Not
for nothing did men and women everywhere relish the thought that
the verdict of the Court might allow them once more to go about
their business in a manner which they clearly knew far better than
did some busybody with a clipboard, newly descended upon them from
Washington.
Nor did the Court stop there. Several other key agencies and
programmatic innovations of the New Deal were deemed unlawful –
among them the pig-slaughtering, crop-ploughing under abomination
of the Agricultural Adjustment Act. Some measure of commercial and
industrial freedom, it seemed, was to be restored to the initiative
of the people and the long period of legal inconstancy they had
suffered might be thought to be drawing to its end.
Being both ignorant of economics and acutely sensitive to
any personal setback, Roosevelt failed to draw the obvious
conclusions from this reinvigoration of enterprise.The
rosy dawn of the revival which was launched by this liberation was
sadly obscured by the glowering thunder of his pique. Instead, he
turned to the task of securing his re-election by means of an
appeal to the worst instincts of his fellow citizens, one he framed
in a divisive populist invective about ‘economic royalists’ and
later, about the ‘sixty families’ who were sabotaging the move to
the Promised Land. Thomas Piketty and today’s disparagers of the
‘1%’ would have been in raptures.
The labyrinthine jockeying for position of the
influence-peddlers around the Great Man and his own vacillation
between one proposal and another out of those they set before him–
indeed, his frequent willingness to sanction two seemingly
contradictory approaches at once – need not detain us too long here
except to identify two main strands to his actions which, taken
together with his ill-advised thirst for vengeance upon those
members of the Supreme Court who had opposed him, would rapidly
undermine the nation’s burst of growth in a far more comprehensive
manner than did any tinkering with reserve ratios on the part of
the Fed.
The first was his tolerance for – indeed, his government’s
promotion of – that particularly belligerent strain of union
activism
which came to be conducted under the accommodating aegis of the
Wagner Act’s National Labour Relations Board and which was
championed by the pugilistic and intensely ambitious John L.
Lewis.
The second took shape in a damaging assault on the wealthy
and the powerful
– conducted not just with stage-managed vituperation and the
whipped-up ‘name-and shame’ witch-finding of the kind with which
today’s headlines resound, but with a barrage of punitive tax laws
which were aimed not just at exacting a few extra quarts from the
milk-cow, but at imposing a toll on her byre, as well as at
claiming a large share of her hide when she died. Worse, the regime
was not content to restrict its redistributionism to the personal
sphere, but was determined to do the same for corporates, too, lest
those afflicted by the former onslaught sought a ready refuge in
the latter.
Together, these were to act to raise the costs of doing business
as well as to reduce drastically the rewards for doing it.
Emerging from the relative backwater of the Union of Mineworkers
to direct the mighty river of the CIO for which he himself largely
dug the channel, Lewis was, by his own lights, one of the most
successful labour organizers of the era, if we can judge
success by the scale of disruption and intimidation – both of
bosses and workers – which he effected, or by the deep pot of
captive political funds he was soon able to deploy in order to buy
both legislative and executive support for his doings. Sheltered by
the Wagner Act and far more militant than any of the old guard of
labour leaders, Lewis was to sow dissent and ill-feeling all along
the commanding heights of the industrial economy – principally in
steel, coal, and autos. As he led a push which saw the unionized
proportion of the workforce double to 25% in four, short years, the
tide of strikes, stoppages, and sit-ins mounted and mounted until
the toll of workdays lost in June 1937 – just as recovery rolled
over into relapse, you will note – was an all-time record of 5
million.
Once you recognise the scale of the unrest thus created,
might it lead you to suppose that it was not entirely the Fed’s
fault that the economy stalled so suddenly and so
disastrously?
With the law coming down largely on the side of the strikers,
management everywhere had little choice but to succumb to their
blackmailers after whatever period of costly resistance it was it
chose to put up. Pay rates rose rapidly as a result to the point
that one unnamed but ‘high-up’ government official impressed Chase
Manhattan’s Anderson with a chart showing that the trend of real
wages in the US was only being exceeded by those in Blum’s
basket-case France. It would not be very long before our man’s
diagnosis would prove all too painfully accurate. GM – less than a
year after being forced to bow the knee to Lewis’s generals – would
sack 30,000 of its conquerors’ foot-soldiers and put the rest on a
three-day week. Lewis himself would be forced to play the
supplicant at the court of King Franklin in a vain attempt to
secure some extra relief for his now redundant vassals.
A particularly disheartening moment came in April of that
blighted year when the Supreme Court, that last great beacon of
hope, flickered and faltered badly. Patently acting with an eye at
defusing Roosevelt’s ultimately fruitless but, to contemporaries
even of his own party, blatantly dictatorial attempt at arrogating
to himself the powers needed both to purge that august body of its
recalcitrant old Solons and to pack it instead with his hand-picked
Yes-men, Their Justices shocked every businessman who had come to
rely upon the Court’s routine rejection of whole swathes of New
Deal interventionism by upholding the validity of that same eristic
Wagner Act, by allowing a new version of the Farm Mortgage Act to
pass along with the then-contentious Social Security Ac
(deliciously characterised by Garet Garret as a
‘fraud’in which people could only receive
‘their own money back less the cost of government’), and
by completing the somersault when they reversed their previous
disapprobation of several other of the Brain Trust’s wheezes
including a far-reaching one regarding the setting of minimum wage
rates.
With one dissenter. Judge Roberts, turning apostate and another,
Judge Van Devanter, about to take advantage of a knowingly crafted
rule allowing those over 75 years of age to retire on full pay, the
President may well have had to swallow the bitter ignominy of a
rare defeat in the Senate that July on the issue of the Court’s
composition, but it was clear that the final victory was soon to be
his. There was to be no further relief for the business community,
it seemed.
While all this had been going on, Roosevelt’s team had been
eroding the nation’s foundation of prosperity in other ways as it
set about attacking those best placed to contribute to a general
recovery for little better reason than the New Dealers’ ideology of
envy –a poisonous broth which was spiced up with more than a dash
of their boss’s characteristic malice and spleen.
Early in the slump, Hoover had enacted one of the largest tax
rises on record – a misstep for which he has rightly since been
excoriated. But Hoover – the Great Engineer of Things – was a tyro
by comparison with Roosevelt, the Great Manipulator of Men. While
Keynes (whose Shade we can surely picture chuckling from the
Stygian gloom at today’s central bankers), was fantasizing about
what his artificially low interest rates would do to the poor saver
– or the
‘rentier’to use his own sneering pejorative – the New
Dealers were actually enacting a similar pursuit of the
‘euthanasia’ of the entrepreneur and the capitalist who financed
him.
Worried at being outflanked to his left by the rabble-rousing
Senator Huey Long of Louisiana, Roosevelt had had his team cook up
what they called the ‘soak the rich’ Revenue Act of 1935.
Though somewhat watered down during its passage through Congress –
a sharply ‘progressive’ (i.e. progressively rapacious) tax was
imposed on incomes and inheritances, taking top rates up 14 points
to 83% on income in a single bound and levying a world-beating 72%
top rate on the man’s estate. Bad enough for its demoralization –
not to mention its despoliation – of those whose money might well
have been made in (and was frequently re-utilised for) the
provision of jobs for some and of valued goods and services for the
many, worse was yet to follow.
For, in the Revenue Act of 1936, the pernicious device of the
undistributed profits tax was conceived. Worried that the potential
victims of the previous year’s legal larceny were avoiding the
worst of its depredations by shielding their gains within a
corporate structure, Morgenthau and the New Dealers decided that
all a company’s
retainedearnings were henceforth to be taxed. In fact, at
the scale of the original proposals, any company with a pay-out
ratio of less than 50% would have faced a tax on the original
income of up to 42.5% and thus would have seen nearly
three-quarters of the balance it wished to hold back confiscated by
the state!
It is hard to imagine anything more counterproductive than
a tax on self-generated capital, whether in respect of the
soundness of the firm’s finances; of its ability to adapt to a
changing environment; or of its capacity to invest in its own
advancement and thus in the greater satisfaction of its
customers.If material progress – as well as the
spiritual and cultural edification to which the more easily assured
satisfaction of our bodily needs is so evidently conducive – is not
based on channelling the necessary capital means to those who have
proven they know how best to use it; if the generation of a surplus
in one’s own line of business is not the best proof of such an
ability; and if its retention at its place of its origin is not the
simplest way of assuring its delivery to the right place, then we
are at a loss to suggest alternatives.
But, in their zeal to root out tax avoiders and also in
their susceptibility to the false if ineradicable superstition that
if we are to avoid depression then money earned must be money spent
exhaustively (i.e., on end-consumption), whether by its direct
recipients or by the beneficiaries of the government’s
fauxlargesse, Roosevelt’s team were utterly blind to its
malign consequences.
As Ogden Mills, sometime Secretary to the Treasury, pointedly
asked: did anyone suppose that Ford Motor Co. would have gone
beyond its humble, back street garage stage if Henry had sat down
at the end of every month and shared out all his proceeds among
himself and his workers? Answer came there none.
Again, even though Congress managed to take some of the sting
out of the tax by reducing the top rate to just over one quarter
rather than nearly
three-quarters of the retention, the immediate results of
sowing this wind were entirely foreseeable: dividend payments
jumped in each of the next two years, weakening balance sheets and
threatening banking covenants in a manner which would reap the
whirlwind in the coming recession. In order to make up the
shortfall, security issuance also shook off some of its long
maintained lethargy though this should hardly be taken as a sign of
renewed capital appetite, merely of an expensive, if necessary,
regulatory arbitrage.
Not content with this triumph, the New Dealers came back to take
another swing at the Golden Goose in 1937. This time, the bill was
all about closing ‘loopholes'; at eliminating certain forms of
incorporation; at hindering or banning the use of trusts or foreign
holding companies, while also setting up a fiscal Inquisition in
the form of the Joint Committee on Tax Evasion & Avoidance.
Warming to the task, Roosevelt bade Treasury Secretary Morgenthau
set his operatives to sift through the tax audits of wealthy
individuals, looking for those who had minimized their
liabilities.
Then, as today, the essential distinction between legal
avoidance and illicit evasion was conveniently blurred so as to
round up more victims for the fiscal
auto-da-fé.With even less propriety, the Chief
told his tax commissioner to publicise the names of 67 such
‘offenders’, men whose only crime was to take shrewd advantage of
the existing law but whose fate was to be held before the Mob as
examples of people whose actions were frankly acknowledged to be
legal but nonetheless subject to condemnation for not being
‘conscientious’. On the back of the ensuing ballyhoo, a compliant
Congress meekly passed the tax bill in its entirety.
It must now be apparent that, by the summer of 1937,
businessmen small and large must have been feeling the
squeeze.On one side of the vice was the rise in costs –
especially, but not exclusively, that associated with the payroll –
and on the other was the knowledge that even if their efforts were
rewarded with a gain, a good part of that would be wrested from
them and that, were they to have the temerity to protest, they
would be hounded and harassed in the press as well as the courts.
Is it any wonder that many of them came to feel they would not or
could not go on as before?
Lost amid the silent aggregates with which the
macroeconomist likes to work is also the critical fact that such
profits as were being earned were highly concentrated – as in truth
they still are today when 40+% of corporates, representing 25-30%
of all sales make no money from their activities, even in a good
year.
Of the 2 million or so registered business in 1937, around half
a million took corporate form. Of these, those who actually managed
to generate a positive net income were members of a highly-skewed
distribution in which the largest 5% of companies were responsible
for 85% of all profits; where the next 20% accounted for another
12% of the gains; and where the long trail of the laggardly
residuum of 75% were left to scrabble over crumbs which represented
no more than 3% of the cake as a whole.
Even this bleak vision does not convey the true nature of the
challenge facing the small entrepreneur in trying to keep his head
above the lapping waters of viability for it ignores the many who
are already submerged in loss. Leonard Ayres of the Cleveland Trust
estimated that, in the prosperous year of 1936, as many as
two-thirds of all firms were beneath the waves. Performing a
separate calculation, E. D. Kennedy noted that once you removed the
960 companies quoted on the New York Stock Exchange from the total,
you had already accounted for the entirety of 1935’s profits. Just
42 of those listed corporations alone took three-fifths of the
entire pot and, of them, the biggest 6 swallowed up almost a
quarter.
So now try to imagine how those companies were faring in 1937,
mired in a newly-tangled web of rules and regulations (to help keep
up with the breaking tsunami of these, the government helpfully
published the first Federal Register, a catalogue of impediments
whose inaugural edition stretched to 2,620 pages before leaping by
a third to 3,450 in 1937 itself), painfully aware of the
authorities’ antipathy to their leaders and owners as a class,
confronted by the aggression of professional union provocateurs,
having to pay a higher price for their inputs, and now unable to
plough as much of anything they
didmanage to make back into the business without rendering
a portion of their precious capital unto Caesar.
Do you not suppose that an extra 10, 20 – even 100 – basis
points on interest rates would have been among the least of their
worries in the circumstances?
Certainly there was little evidence that anyone at the time
thought so.
No less a worthy than Joseph Schumpeter remarked of the business
community’s plight that its members
‘…realize they are on trial before judges who have the verdict
in their pocket beforehand.’
Another contemporary observer, David Lawrence, wrote in 1938
that the President
‘… has aroused in the financial and business communities a fear
almost amounting to terror and a distrust which has broken down the
morale of the whole economic machinery …[and] the spirit and
faith…in the actual safety of a citizen’s property and his
savings.’
The ever perspicacious Garet Garrett declared in the March 5
edition of the
Saturday Evening Post, in an article entitled
‘The Fifth Anniversary’whose diagnosis of the ills
besetting his country should be compulsory reading for all
concerned with framing or executing policy today:
‘…the New Deal has crippled the free competitive system that
was working I this country…with all its faults better than any
other system that was ever known. In these ways it has been
destroying what was unique in the American system…What we have been
watching is the experiment of trying to make captive capitalism
work, conducted by a government that only half believes in it and
yet has not the daring to destroy it.’
In 1936, Howard E. Kershner came closer to the truth when he
wrote that
: ‘ Roosevelt took charge of our government when it was
comparatively simple, and for the most part confined to the
essential functions of government, and transformed it into a highly
complex, bungling agency for throttling business and bedevilling
the private lives of free people. It is no exaggeration to say that
he took the government when it was a small racket and made a large
racket out of it.’
Even Lammot du Pont, the eponymous head of that mighty
industrial concern – one of the six that earned a quarter of the
nation’s profits – expressed his bewilderment in the same year,
when he said:
‘Uncertainty rules the tax situation, the labour situation, the
monetary situation, and practically every legal condition under
which industry must operate. Are taxes to go higher, lower or stay
where they are? We don’t know. Is labour to be union or non-union?
. . . Are we to have inflation or deflation, more government
spending or less? . . . Are new restrictions to be placed on
capital, new limits on profits? . . . It is impossible to even
guess at the answers.’
If a powerful man such as he – privy to the information which
flowed through two of the world’s mightiest business concerns, Du
Pont itself and GM in which the family was a major
stakeholder – was at a loss as to how to proceed, can you
imagine the state of mind of the owner of the local machine shop or
the manager of an upstate paper mill?
Even from within the sanctum of the temple doubts were being
expressed. Brain Trust founder Raymond Moley wrote in his private
diary in May 1936 after a frustrating meeting with the President.
‘I was impressed as never before by the utter lack of logic of
the man, the scantiness of his precise knowledge of things that he
was talking about, by the gross inaccuracies in his statements, by
the almost pathological lack of sequence in his discussion. . . .
In other words, the political habits of his mind were working full
steam with the added influence of a swollen ego.’
Perhaps most damningly for the many worshippers of their joint
cult, even Keynes was perplexed by his twin deity’s approach. In
his open letter to the President of 1938, the Bloomsbury sage told
him:
‘There seems to be a deadlock. Neither your policy nor anybody
else’s is able to take effect…. Personally I think there is a great
deal to be said for the ownership of all the utilities by publicly
owned boards. But if public opinion is not yet ripe for this, what
is the object of chasing the utilities around the lot every other
week? …It is a mistake to think that they [businessmen] are
more immoral than politicians. If you work them into the surly,
obstinate, terrified mood, of which domestic animals, wrongly
handled, are so capable, the nation’s burdens will not get carried
to market; and in the end public opinion will veer their way.’
Given all of this, can we say have any truck with the
simplistic narrative which insists that it was the fact that ‘FDR
cut spending’ that contributed to the collapse and that, ergo, no
government today should ever dare to rein in on its deluge of doles
and entitlements? Not when it was not spending that was cut
in 1937 (not once we abstract the Veteran’s bonus effect, at least)
but that taxes were raised, raised hard, and moreover that they
were taxes of the most harmful kind, imposed in the most hateful of
manners?
Given all of this, can we really be so superficial as to
say it was all the fault of the Federal Reserve and that, by
extension, today’s Fed must never ever take the risk of starting
out on a slow re-normalization of policy?
For that, let us leave the last word with Benjamin Anderson, a
man we have already cited above. Dismissing the charge monetary
factors were responsible for the setback, he insisted that:-
‘It is very important that we clear up misunderstandings
regarding these points lest excessive timidity regarding future
money market control be generated by them’
Quite. I hope we have persuaded you, Mr. Dalio, of the merits of
Anderson’s prescription and that we should not
on any accountseek to dissuade the central banks from
trying to paint their way back out of the corner into which they
have forced themselves, lest their lack of moral courage occasions
us a far greater harm in the future.
Let us lay the Ghost of ’37 once and for all, by better
understanding the true nature of this grisly apparition, and not
allow the spectre to imperil us all over again while we cower in
terror before an entirely phantom danger.