One hundred years ago today the world was shook loose of its moorings. Every school boy knows that the assassination of the archduke of Austria at Sarajevo was the trigger that incited the bloody, destructive conflagration of the world’s nations known as the Great War. But this senseless eruption of unprecedented industrial state violence did not end with the armistice four years later.
In fact, 1914 is the fulcrum of modern history. It is the year the Fed opened-up for business just as the carnage in northern France closed-down the prior magnificent half-century era of liberal internationalism and honest gold-backed money. So it was the Great War’s terrible aftermath—–a century of drift toward statism, militarism and fiat money —-that was actually triggered by the events at Sarajevo.
Unfortunately, modern historiography wants to keep the Great War sequestered in a four-year span of archival curiosities about battles, mustard gas and monuments to the fallen. But the opposite historiography is more nearly the truth. The assassins at Sarajevo triggered the very warp and woof of the hundred years which followed.
The Great War was self-evidently an epochal calamity, especially for the 20 million combatants and civilians who perished for no reason that is discernible in any fair reading of history, or even unfair one. Yet the far greater calamity is that Europe’s senseless fratricide of 1914-1918 gave birth to all the great evils of the 20th century— the Great Depression, totalitarian genocides, Keynesian economics, permanent warfare states, rampaging central banks and the exceptionalist-rooted follies of America’s global imperialism.
Indeed, in Old Testament fashion, one begat the next and the next and still the next. This chain in the Great War’s destruction of sound money, that is, in the post-war demise of the pound sterling which previously had not experienced a peacetime change in its gold content for nearly two hundred years.
Not unreasonably, the world’s financial system had become anchored on the London money markets where the other currencies traded at fixed exchange rates to the rock steady pound sterling— which, in turn, meant that prices and wages throughout Europe were expressed in common money and tended toward transparency and equilibrium.
This liberal international economic order—that is, honest money, relatively free trade, rising international capital flows and rapidly growing global economic integration—-resulted in a 40-year span between 1870 and 1914 of rising living standards, stable prices, massive capital investment and prolific technological progress that was never equalled—either before or since.
During intervals of war, of course, 19th century governments had usually suspended gold convertibility and open trade in the heat of combat. But when the cannons fell silent, they had also endured the trauma of post-war depression until wartime debts had been liquidated and inflationary currency expedients had been wrung out of the circulation. This was called “resumption” and restoring convertibility at the peacetime parities was the great challenge of post-war normalizations.
The Great War, however, involved a scale of total industrial mobilization and financial mayhem that was unlike any that had gone before. In the case of Great Britain, for example, its national debt increased 14-fold, its price level doubled, its capital stock was depleted, most off-shore investments were liquidated and universal wartime conscription left it with a massive overhang of human and financial liabilities.
Yet England was the least devastated. In France, the price level inflated by 300 percent, its extensive Russian investments were confiscated by the Bolsheviks and its debts in New York and London catapulted to more than 100 percent of GDP.
Among the defeated powers, currencies emerged nearly worthless with the German mark at five cents on the pre- war dollar, while wartime debts— especially after the Carthaginian peace of Versailles—–soared to crushing, unrepayable heights.
In short, the bow-wave of debt, currency inflation and financial disorder from the Great War was so immense and unprecedented that the classical project of post-war liquidation and “resumption” of convertibility was destined to fail. In fact, the 1920s were a grinding, sometimes inspired but eventually failed struggle to resume the international gold standard, fixed parities, open world trade and unrestricted international capital flows.
Only in the final demise of these efforts after 1929 did the Great Depression, lurking all along in the post-war shadows, come bounding onto the stage of history.
America’s Needless Intervention In The Great War And The Ensuing Chain of 20th Century Calamities
The Great Depression’s tardy, thoroughly misunderstood and deeply traumatic arrival happened compliments of the United States. In the first place, America’s wholly unwarranted intervention in April 1917 prolonged the slaughter, doubled the financial due bill and generated a cockamamie peace, giving rise to totalitarianism among the defeated powers and Keynesianism among the victors. Choose your poison.
Even conventional historians like Niall Ferguson admit as much. Had Woodrow Wilson not misled America on a messianic crusade, the Great War would have ended in mutual exhaustion in 1917 and both sides would have gone home battered and bankrupt but no danger to the rest of mankind. Indeed, absent Wilson’s crusade there would have been no allied victory, no punitive peace, and no war reparations; nor would there have been a Leninist coup in Petrograd or Stalin’s barbaric regime.
Likewise, Churchill’s starvation blockade would not have devastated post- Armistice Germany, nor would there have been the humiliating signing of the war guilt clause by German officials at Versailles. And the subsequent financial chaos of 1919-1923 would not have happened either—-meaning no “stab in the back” myth, no Hitler, no Nazi dystopia, no Munich, no Sudetenland and Danzig corridor crises, no British war to save Poland, no final solution and holocaust, no global war against Germany and Japan and no incineration of 200,000 civilians at Hiroshima and Nagasaki.
Nor would there have followed a Cold War with the Soviets or CIA sponsored coups and assassinations in Iran, Guatemala, Indonesia, Brazil, Chile and the Congo, to name a few. Surely there would have been no CIA plot to assassinate Castro, or Russian missiles in Cuba or a crisis that took the world to the brink of annihilation. There would have been no Dulles brothers, no domino theory and no Vietnam slaughter, either.
Nor would we have launched Charlie Wilson’s War to arouse the mujahedeen and train the future al Qaeda. Likewise, there would have been no shah and his Savak terror, no Khomeini-led Islamic counter-revolution, no US aid to enable Saddam’s gas attacks on Iranian boy soldiers in the 1980s.
Nor would there have been an American invasion of Arabia in 1991 to stop our erstwhile ally Hussein from looting the equally contemptible Emir of Kuwait’s ill-gotten oil plunder—or, alas, the horrific 9/11 blow-back a decade later.
Most surely, the axis-of-evil—-that is, the Washington-based Cheney-Rumsfeld-neocon axis—- would not have arisen, nor would it have foisted a $1 trillion Warfare State budget on 21st century America.
The 1914-1929 Boom Was An Artefact of War And Central Banking
A second crucial point is that the Great War enabled the already rising American economy to boom and bloat in an entirely artificial and unsustainable manner for the better part of 15 years. The exigencies of war finance also transformed the nascent Federal Reserve into an incipient central banking monster in a manner wholly opposite to the intentions of its great legislative architect —the incomparable Carter Glass of Virginia.
During the Great War America became the granary and arsenal to the European Allies—-triggering an eruption of domestic investment and production that transformed the nation into a massive global creditor and powerhouse exporter virtually overnight.
American farm exports quadrupled, farm income surged from $3 billion to $9 billion, land prices soared, country banks proliferated like locusts and the same was true of industry. Steel production, for example, rose from 30 million tons annually to nearly 50 million tons during the war.
Altogether, in six short years $40 billion of money GDP became $92 billion in 1920—a sizzling 15 percent annual rate of gain.
Needless to say, these fantastic figures reflected an inflationary, war-swollen economy—-a phenomena that prudent finance men of the age knew was wholly artificial and destined for a thumping post-war depression. This was especially so because America had loaned the Allies massive amounts of money to purchase grain, pork, wool, steel, munitions and ships. This transfer amounted to nearly 15 percent of GDP or $2 trillion equivalent in today’s economy, but it also amounted to a form of vendor finance that was destined to vanish at war’s end.
Carter Glass’ Bankers’ Bank: The Antithesis Of Monetary Central Planning
As it happened, the nation did experience a brief but deep recession in 1920, but this did not represent a thorough-going end-of-war “de-tox” of the historical variety. The reason is that America’s newly erected Warfare State had hijacked Carter Glass “banker’s bank” to finance Wilson’s crusade.
Here’s the crucial background: When Congress acted on Christmas Eve 1913, just six months before Archduke Ferdinand’s assassination, it had provided no legal authority whatsoever for the Fed to buy government bonds or undertake so-called “open market operations” to finance the public debt. In part this was due to the fact that there were precious few Federal bonds to buy. The public debt then stood at just $1.5 billion, which is the same figure that had pertained 51 years earlier at the battle of Gettysburg, and amounted to just 4 percent of GDP or $11 per capita.
Thus, in an age of balanced budgets and bipartisan fiscal rectitude, the Fed’s legislative architects had not even considered the possibility of central bank monetization of the public debt, and, in any event, had a totally different mission in mind.
The new Fed system was to operate decentralized “reserve banks” in 12 regions—most of them far from Wall Street in places like San Francisco, Dallas, Kansas City and Cleveland. Their job was to provide a passive “rediscount window” where national banks within each region could bring sound, self-liquidating commercial notes and receivables to post as collateral in return for cash to meet depositor withdrawals or to maintain an approximate 15 percent cash reserve.
Accordingly, the assets of the 12 reserve banks were to consist entirely of short- term commercial paper arising out of the ebb and flow of commerce and trade on the free market, not the debt emissions of Washington. In this context, the humble task of the reserve banks was to don green eye-shades and examine the commercial collateral brought by member banks, not to grandly manage the macro economy through targets for interest rates, money growth or credit expansion —to say nothing of targeting jobs, GDP, housing starts or the Russell 2000, as per today’s fashion.
Even the rediscount rate charged to member banks for cash loans was to float at a penalty spread above money market rates set by supply and demand for funds on the free market.
The big point here is that Carter Glass’ “banker’s bank” was an instrument of the market, not an agency of state policy. The so-called economic aggregates of the later Keynesian models—-GDP, employment, consumption and investment—were to remain an unmanaged outcome on the free market, reflecting the interaction of millions of producers, consumers, savers, investors, entrepreneurs and even speculators.
In short, the Fed as “banker’s bank” had no dog in the GDP hunt. Its narrow banking system liquidity mission would not vary whether the aggregates were growing at 3 percent or contracting at 3 percent.
What would vary dramatically, however, was the free market interest rate in response to shifts in the demand for loans or supply of savings. In general this meant that investment booms and speculative bubbles were self-limiting: When the demand for credit sharply out- ran the community’s savings pool, interest rates would soar—thereby rationing demand and inducing higher cash savings out of current income.
This market clearing function of money market interest rates was especially crucial with respect to leveraged financial speculation—such as margin trading in the stock market. Indeed, the panic of 1907 had powerfully demonstrated that when speculative bubbles built up a powerful head of steam the free market had a ready cure.
In that pre-Fed episode, money market rates soared to 20, 30 and even 90 percent at the peak of the bubble. In short order, of course, speculators in copper, real estate, rail-roads, trust banks and all manner of over-hyped stock were carried out on their shields—-even as JP Morgan's men, who were gathered as a de facto central bank in his library on Madison Avenue, selectively rescued only the solvent banks with their own money at-risk.
Needless to say, these very same free market interest rates were a mortal enemy of deficit finance because they rationed the supply of savings to the highest bidder. Thus, the ancient republican moral verity of balanced budgets was powerfully reinforced by the visible hand of rising interest rates: deficit spending by the public sector automatically and quickly crowded out borrowing by private households and business.
How The Bankers’ Bank Got Hijacked To Fund War Bonds
And this brings us to the Rubicon of modern Warfare State finance. During World War I the US public debt rose from $1.5 billion to $27 billion—an eruption that would have been virtually impossible without wartime amendments which allowed the Fed to own or finance U.S. Treasury debt. These “emergency” amendments—it’s always an emergency in wartime—enabled a fiscal scheme that was ingenious, but turned the Fed’s modus operandi upside down and paved the way for today’s monetary central planning.
As is well known, the Wilson war crusaders conducted massive nationwide campaigns to sell Liberty Bonds to the patriotic masses. What is far less understood is that Uncle Sam’s bond drives were the original case of no savings? No credit? No problem!
What happened was that every national bank in America conducted a land office business advancing loans for virtually 100 percent of the war bond purchase price— with such loans collateralized by Uncle Sam’s guarantee. Accordingly, any patriotic American with enough pulse to sign the loan papers could buy some Liberty Bonds.
And where did the commercial banks obtain the billions they loaned out to patriotic citizens to buy Liberty Bonds? Why the Federal Reserve banks opened their discount loan windows to the now eligible collateral of war bonds.
Additionally, Washington pegged the rates on these loans below the rates on its treasury bonds, thereby providing a no-brainer arbitrage profit to bankers.
Through this back-door manoeuvre, the war debt was thus massively monetized. Washington learned that it could unplug the free market interest rate in favour of state administered prices for money, and that credit could be massively expanded without the inconvenience of higher savings out of deferred consumption.
The Mythical Banking Crisis and the Failure of the New Deal
The Great Depression thus did not represent the failure of capitalism or some inherent suicidal tendency of the free market to plunge into cyclical depression—absent the constant ministrations of the state through monetary, fiscal, tax and regulatory interventions. Instead, the Great Depression was a unique historical occurrence—the delayed consequence of the monumental folly of the Great War, abetted by the financial deformations spawned by modern central banking.
But ironically, the “failure of capitalism” explanation of the Great Depression is exactly what enabled the Warfare State to thrive and dominate the rest of the 20th century because it gave birth to what have become its twin handmaidens—- Keynesian economics and monetary central planning. Together, these two doctrines eroded and eventually destroyed the great policy barrier—- that is, the old-time religion of balanced budgets— that had kept America a relatively peaceful Republic until 1914.
To be sure, under Mellon’s tutelage, Harding, Coolidge and Hoover strove mightily, and on paper successfully, to restore the pre-1914 status quo ante on the fiscal front. But it was a pyrrhic victory—since Mellon’s surpluses rested on an artificially booming, bubbling economy that was destined to hit the wall.
The Hoover Recovery of 1932
Worse still, Hoover’s bitter-end budget of June 1932, got blamed for prolonging the depression. Yet, as I have demonstrated in the chapter of my book called “New Deal Myths of Recovery”, the Great Depression was already over by early summer 1932.
At that point, powerful natural forces of capitalist regeneration had come to the fore. Thus, during the six month leading up to the November 1932 election, freight loadings rose by 20 percent, industrial production by 21 percent, construction contract awards gained 30 percent, unemployment dropped by nearly one million, wholesale prices rebounded by 20 percent and the battered stock market was up by 40 percent.
So Hoover’s fiscal policies were blackened not by the facts of the day, but by the subsequent ukase of the Keynesian professoriat. Indeed, the “Hoover recovery” would be celebrated in the history books even today if it had not been interrupted in the winter of 1932-1933 by a faux “banking crisis” which was entirely the doing of President-elect Roosevelt and the loose-talking economic statist at the core of his transition team, especially Columbia professors Moley and Tugwell.
The Pre-1933 Banking Failures Were Caused By Insolvency
The truth of the so-called banking crisis is that the artificial economic boom of 1914-1929 had generated a drastic proliferation of banks in the farm country and in the booming new industrial centres like Chicago, Detroit, Youngtown and Toledo, along with vast amounts of poorly underwritten debt on real estate and businesses.
When the bubble burst in 1929, the financial system experienced the time-honored capitalist cure—-a sweeping liquidation of bad debts and under-capitalized banks. Not only was this an unavoidable and healthy purge of economic rot, but also reflected the fact that the legions of banks which failed were flat-out insolvent and should have been closed.
Indeed, 10,000 of the 12,000 banks shuttered during the years before 1933 were tiny rural banks located in communities of less than 2,500. Most had been chartered with trivial amounts of capital under lax state banking laws, and amounted to get- rich-quick schemes which proliferated during the export boom.
Indeed, a single startling statistic puts paid to the whole New Deal mythology that FDR rescued the banking system after a veritable heart attack: to wit, losses at failed US banks during the entire 12-year period ending in 1932 amounted to only 2-3 percent of deposits. There never was a sweeping contagion of failure in the banking system.
Milton Friedman’s Huge Error: The Fed Did Not Cause the Bank Runs of 1930-1933
Nor did the Fed’s alleged failure to undertake a massive bond-buying program in 1930-1932 to pump cash into the banking system constitute the monumental monetary policy error that Milton Friedman so dogmatically claimed, and which has become the raison d’etre of contemporary central banking.
In fact, fifty years after the fact, Bubbles Ben 2.0 essentially Xeroxed the errors in Friedman’s treatise and got awarded a PhD for this tommyrot by Professor Stanley Fischer of MIT, who Obama has now seen fit to make Vice-Chairman of the Fed. Bernanke then passed himself off as a scholar of the Great Depression and a Friedman disciple, thereby bamboozling the ever gullible Bush White House into appointing a rank money-printer and Keynesian to head the Fed.
Bernanke then proceeded to follow Friedman’s bad advice about 1932 and flooded the banking system with money during the so-called financial crisis, and thereby bailed out the rot on Wall Street instead of purging it as the Board of Governors had the good sense to do in the early 1930s.
But...I digress—slightly!
In fact, it is important to refute the scary bedtime stories that have been handed down about the pre-New Deal banking crisis because they are the predicate for the Fed’s current lunacy of QE, ZIRP and massive monetization of the public debt, which, in turn, enables the perpetual deficit finance on which the Warfare State vitally depends.
The Unnecessary February 1933 Bank Panic: FDR’s 10-Day Fumble
In truth, the banking liquidation was over by Election Day, failures and losses had virtually disappeared, and as late as the first week of February 1933, according the Fed’s daily currency reports, there were no unusual demands for cash.
The legendary “bank runs” occurred almost entirely during the last two weeks before FDR’s inauguration. The trigger was Henry Ford’s vicious spat with his former partner and then Michigan Senator, James Couzens, over responsibility for the failure of a go-go banking group in Detroit that had been started by his son Edsel and Goldman Sachs. Always Goldman!
The hapless Herbert Hoover secretly wrote FDR begging him to cooperate in resolving the Michigan banking crisis. Instead, Roosevelt failed to answer the President’s letter for two weeks; lost Carter Glass as his Treasury Secretary because the President-elect refused to affirm his commitment to the sound money platform on which he had campaigned; and allowed Tugwell to leak to the press a radical plan to reflate the economy by reneging on the dollar’s 100-year old linkage to one-twentieth ounce of gold.
Within days there was a massive run on gold at the New York Fed and a scramble for cash at teller windows across the land. Unlike historians today, citizens back then knew that the Fed could not legally issue more currency unless it had 40 percent gold-backing—hence the sudden outbreak of currency hoarding.
In this context, the daily figures for currency outstanding give ringing evidence of FDR’s culpability for the midnight-hour run on the banks. After rising by a trivial $8 million per day in early in the month, cash outstanding rose by $200 million per day by late February and by a staggering half billion dollars on the day before the FDR’s inauguration. All told, 80 percent of the increase in currency outstanding—from $5.6 billion to $7.5 billion—occurred in the last ten days before FDR took office.
Then, even more fantastically, nearly all of the hoarded cash flowed back into the banking system on its own when 95 percent of the banks were re-opened in an “as is, where is” condition during the three weeks after FDR’s inauguration. Moreover, the mass re-opening scheme was actually drafted and executed by Hoover hold-overs at the Treasury, and had been completely accomplished before the heralded banking reforms of the New Deal and deposit insurance had even had Congressional hearings.
In short, the banking system never did really collapse and the true problem was bad debt and insolvency —not Fed errors or an existential crisis of capitalism.
New Deal: Political Gong Show
Beyond that, the New Deal was a political gong show that amounted to a grab-bag of statist gimcrack. The mild fascism of the NRA and AAA caused the economy to further contract, not recover. The legendary WPA cycled violently between 1 million make-work jobs in the off- years and 3 million make-vote jobs in the election years—-before even a Democratic Congress was compelled to shut it down in a torrent of corruption in 1939.
Likewise, the TVA was a senseless boondoggle and environmental curse; the Wagner Act paved the way for the kind of coercive, monopolistic industrial unionism that resulted in “Rust Bucket America” five decades later; and the legacy of New Deal housing stimulants like Fannie Mae speaks for itself.
Finally, universal social insurance enacted in 1935 was actually a fiscal doomsday machine. When in the context of modern political democracy the state offers universal transfer payments to its citizenry without proof of need it thereby offers to bankrupt itself—eventually.
To be sure, during the middle 1930s, the natural rebound of the nation’s capitalist economy continued where the Hoover Recovery left off— notwithstanding the New Deal headwinds. Yet the evidence that FDR’s policies retarded recovery screams out of the last year of pre- war data for 1939: GDP at $90 billion was still 12 percent below 1929, while manufacturing value added was off by 20 percent and business investment by 40 percent.
Most telling of all was private non- farm man-hours worked: the 1939 level was still 15 percent lower than what the BLS recorded in 1929.
How FDR Torpedoed Recovery and Sowed the Seeds of Autarky, Rearmament, Revanchism and War
So the New Deal did nothing to help the domestic economy. But FDR did personally torpedo world recovery and paved the way toward WWII with his so-called “bombshell” message to the London Economic Conference in July 1933. The latter had been the world’s last best hope for rescue of the failed task of post-war resumption. Specifically, the conferees had shaped a plan for restoring convertibility by means of pegging the pound sterling at a lower exchange rate to the dollar and gold, thereby alleviating the beggar-thy- neighbor pressure on the remaining gold standard countries like France, the Netherlands and Sweden.
In turn, monetary stabilization would pave the way for reduction of Smoot- Hawley instigated tariff barriers and the restoration of global trade and capital flows.
The American delegation led by the magnificent statesman, Cordell Hall, had molded a tentative agreement among the British and French, and thereby had attained a crucial inflection point in the post-war struggle for resumption of the old international order. Yet FDR defied his advisers to the very last man, including the nationalistic and protectionist-minded Raymond Moley, who the President had sent to London as his personal emissary.
Roosevelt’s message, penned by moonlight on the luxurious yacht of his chum, Vincent Astor, was undoubtedly the most intemperate, incoherent and bombastic communique ever publicly issued by a US President. It not only stunned the assembled world leaders gathered in London and killed the monetary stabilization agreement on the spot, but it also locked in a destructive worldwide regime of economic nationalism and autarky.
Accordingly, high tariffs and trade subsidies, state-dominated recovery and rearmament programs and manipulated currencies became universal after the London Conference failed, leaving international financial markets demoralized and chaotic.
The irony was that the Great Depression was the step-child of the Great War. American entry had unnecessarily extended it; had greatly amplified its destructive impact on the liberal international order; and had contributed a witch’s brew of Wilsonian nostrums to a Carthaginian peace that laid the planking for a new world war. FDR then delivered the coup de grace, extinguishing the last hope for resumption and insuring that autarky, revanchism and rearmament would hurtle the world to an even greater eruption of carnage, and an even more debilitating rendition of the Warfare State.
Krugman’s Lie: WWII Was Not A Splendid Exercise in Keynesian Debt Finance
World War II soon delivered another blow to the old-time fiscal religion. Not only did that vast expansion of war production fuel the illusion that New Deal statism had alleviated an endemic crisis of capitalism, but it also became heralded as a splendid exercise in Keynesian deficit finance when, in fact, it was nothing of the kind.
The national debt did soar from less than 50 percent of GDP in 1938 to nearly 120 percent at the 1945 peak. But this was not your Krugman’s benign debt ratio— or proof that the recent surge to $17 trillion of national debt has been done before and had been proven harmless.
Instead, the 1945 ratio was an artefact of a command and control war economy which had banished civilian goods including new cars, houses and most consumer durables, and tightly rationed everything else including sugar, butter, meat, tires, shoes, shirts, bicycles, peanut brittle and candied yams.
With retail shelves empty the household savings rate soared from 4 percent in 1938-1939 to an astounding 35 percent of disposable income by the end of the war.
Consequently, the Keynesians have never acknowledged the single most salient statistic about the war debt: namely, that the debt burden actually fell during the war, with the ratio of total credit market debt to GDP declining from 210 percent in 1938 to 190 percent at the 1945 peak!
This obviously happened because household and business debt was virtually eliminated by the wartime savings spree; households paid off what debts they had left after the liquidation of the 1930s depression and business generally had no ability to borrow except for war production.
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