A Patriot's History of the Modern World (44 page)

Later, under Roosevelt's New Deal policies, farm subsides became permanently enshrined in the system of federal giveaways under various schemes such as guaranteeing 90 percent of parity, requiring and limiting federal planting allocations (such as with peanuts or tobacco), thereby criminalizing the growing of food without owning an allocation or permit from the federal government, and the “Soil Bank” (which paid farmers to move
agricultural land out of cultivation to reduce production). Most of those programs continue today, and some became the basis for nonagricultural policy meddling, such as ethanol subsidies touted as energy conservation measures.

Bleeding from the agricultural wound soon spread into the banking system, a development that went almost entirely unnoticed by all but the unfortunate depositors of small-town banks who suddenly found them closed. Most financial institutions west of the Mississippi were local, often capitalized with as little as $5,000, serving only small farm or mining communities.
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Some 80 percent of Kansas's banks chartered between 1920 and 1929 had less than $25,000 capital. Bankers usually came from the ranks of general store owners or merchants, who had previously provided credit at their businesses and operated with an on-site safe for cash, before finally constructing a formal banking building. State regulations were lax and state bank examiners often came through only once a year to hastily examine the books, although bankers and customers tended to police themselves with some success. Not only was the banker himself usually well known in the town (and his finances generally a matter of public knowledge), but the building was a solid asset, and the loans were to neighbors who could be carried for a few months if necessary. There was enough competition to keep the banks efficient, but not so much as to force them to operate on razor-thin margins. Hence, the only real danger was one that threatened all of the bank's assets simultaneously, such as a drought or disease (pinkeye among cattle, for example), or a drastic plunge in international prices. Unfortunately, that was precisely what occurred.

Western and southern banks in particular were ravaged during the 1920s by these factors, especially the weather. The upper tier of the West, for example, was hit in the mid-1920s with severely cold weather. Ranchers lost entire herds, and bankers found their books frozen shut.
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In sixteen western states, the total number of banks fell from 8,092 in 1920 to 4,036 in 1932, and Montana alone saw 214 banks fail between 1920 and 1926, bankrupted by 11,000 vacated farms and stricken by the highest levels of bankruptcies in the nation.
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Arizona lost 38 of its 86 banks from 1920 to 1929.
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Something as seemingly unimportant as a boxing match involving Jack Dempsey, labeled a sure thing by local investors, took down a Great Falls, Montana, bank when overflow crowds turned into mobs and, Woodstock-style, took over the seating without paying.
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Southern states likewise saw a drastic contraction in the farm sector. In
1920, South Carolina's farms had a value of $813 per farm, yet only two years later, value had fallen 54 percent (even though total acreage fell only by 8 percent).
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The South was afflicted by a different malady, a massive infestation of the boll weevil that ended Sea Island cotton production among other widespread damage. Linked to farm failure, the number of banks in South Carolina dropped steadily—26 closed in 1927, 17 in 1928, 15 in 1929, along with 30 mergers and consolidations. From 1920 to 1936, South Carolina lost almost 8 percent of its banking institutions.
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Despite the various reasons, the result was the same and almost every southern and western state saw its local banks drift into insolvency. Even the South's strong branch banking system, which diversified risk away from a bad economy in a single town or strip of towns, was helpless when the main crops of an entire state were pummeled. Who was at fault? Greedy bankers? Lax regulators? Droughts and insects? In fact, most bank failures of the 1920s were due in large part to insurance schemes developed by the states—anticipating the FDIC under Franklin Roosevelt—which ostensibly provided an umbrella of security for the financial institutions. States with compulsory deposit insurance, in fact, proved the most susceptible to banking weakness, precisely because owners and bank managers did not feel the need to diversify their loan portfolios or develop branch banking, a much safer alternative which was often prohibited anyway by states to force banks to be more local in orientation.
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By 1930, the closure of thousands of smaller banks, which scarcely drew the attention of a low-level vice president in New York, was eating away at the money supply. A slow, steady decline relative to goods, services, and productivity ensued. Free-market critics (and even a few otherwise erstwhile supporters, such as British historian Paul Johnson) have looked at the boom on Wall Street and projected that onto the American monetary base. In fact, manufacturing and productivity outpaced money growth throughout the twenties, creating the deflationary paradigm of “too many goods chasing too few dollars.” From 1921 to 1929, nominal GNP grew by more than 6 percent a year, consistently faster than the money supply.
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Instead of lubricating the entrepreneurial growth with money, the Fed was restrictive at best, and deflationary at worst.

Another factor in the mix was the gold standard. All developed nations in the 1920s played by the rules of the gold standard, whereby trade balances were settled by transfers of gold (usually these were just accounting gymnastics, but occasionally actual bullion was moved). According to the
great economist Milton Friedman, the process worked when a nation whose exports fell below the imports of another nation's goods had to make up the difference in gold, whereupon the nation with the trade deficit would see its gold reserves fall. That, in turn, would lead to more restrictive credit in that nation, followed by fewer loans to businesses, and eventually, more unemployment. On the other end of the equation, the nation receiving the gold expanded its money supply based on the new reserves, loaned more to businesses, and saw unemployment fall. However, once the economy heated up, prices would rise in the nation receiving gold while the trade-deficit nation would see prices fall—and thus the teeter-totter of prices would cause consumers to change their habits, and the process would slowly reverse. The key was the response of the governments, which had to allow domestic unemployment to rise (with a negative trade imbalance) or prices to rise (with an inflow of gold). However, governments proved unwilling (or incapable) to let business cycles adjust themselves without interfering.

Under the American system of fractional reserve banking, wherein a bank's capitalization was but a small fraction of its assets and offsetting liabilities, the physical money actually in circulation was leveraged through lending out the remainder of the funds. Each little western bank that failed “destroyed” money through a reversal of the money multiplier, in which a dollar deposited yielded several times its amount in dollars “created” through new loans. Now, dollars being withdrawn or walled up inside closed institutions were lost, along with all the “other” dollars they would have “created.” When a bank actually failed, not only did the bank lose its capital and the depositors their money, but all the loans that would have normally been supported by those funds also disappeared.

Following the lead of the most famous (but not always right) economic voice of the age, John Maynard Keynes, virtually every major banker, chancellor of the exchequer, finance minister, and treasury secretary in the West was an interventionist (that is, one who actively sought to affect financial markets by injecting or removing cash through government operations). Certainly the central bankers favored activist monetary policy: that, after all, was the message delivered by America's leading banker, J. P. Morgan, Sr., almost two decades before, when he explained after the Panic of 1907 that he and his syndicates could no longer be counted on to rescue the country's banking system. Certainly, the American Bankers Association had approved such a position with its support of the Federal Reserve Act, but beyond that, a broad international network of leading financial lights
agreed with the proposition that government (or, in the case of the Fed, a private corporation not subject to government oversights but which shared profits with the government) had to stabilize the economy through monetary and fiscal policy. Émile Moreau, governor of the Bank of France, British economist A. J. Balfour, Kuhn Loeb partner Otto Kahn, Hjalmar Schacht of the Reichsbank, the Bank of England's Montagu Norman, Paul Warburg of Kuhn Loeb and the Warburg banking interests in Hamburg, Lionel Rothschild, the managing partner of N M Rothschild & Sons, and, of course, the governor of the New York Federal Reserve Bank, Benjamin Strong, were all disciples of the stabilization school.

Where the stabilization model went awry was that for the whole to be healthy, at any given time one of the parts might be sick; for the teeter-totter to be up, one end had to be down. Yet no democratic government would long permit its economy to stay sick, and with Keynesian rationale, it would devalue its currency, inflate, impose tariffs, or in some way seek to raise its end of the teeter-totter. Gresham's law (“Bad money drives out good”) would arrive with deadly punctuality, as the bad money of the “cheaters” would drive out the gold reserves of the faithful nations, and the pressure would mount until the entire system collapsed. So long as one or two dominant powers, such as Britain and the United States, could withstand the currency manipulations of smaller economies, the system still worked. By the 1920s, however, the combined weight of many developed nations simultaneously seeking to buffer their own recessionary cycles proved the undoing of the entire network. And that was precisely why the heavy hand of the fascist states seemed so appealing: they did not have democratic constituencies to worry about.

Raw Deal

Herbert Hoover's interventionist Progressive policies—including the RFC, increased taxation, and the Smoot-Hawley Tariff—fell far from reaching their desired goal of reassuring the markets, spooking them even further. Hoover had ignored Mellon's advice to “liquidate everything” (allowing prices for labor and goods to fall to their natural levels and purge the rotten businesses from the economy). An inveterate planner with disproportionate faith in the ability of government to find solutions, Hoover never considered keeping his hands off the levers. Like other Progressive administrators, he believed in a static view of an economy, in which changes in taxation or regulations did not drive individuals' future actions. For example, in the
static model, if federal revenues fall, a tax hike would correct it and balance the budget. But in the dynamic world of market economics, tax hikes reverberate through all sorts of individual decisions—people's attitudes toward future investment or consumption. John Maynard Keynes made the same miscalculations in his analyses. Tax hikes could cause federal revenues to
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further as people stopped investing (and thus creating more jobs) out of fear of higher taxes. Likewise, Hoover's RFC fiasco had proven a textbook case of unintended consequences of a government bailout, causing more bank failures, not fewer. When U.S. unemployment reached nearly 25 percent in 1932, Herbert Hoover was finished as president. Still, the Left saw his policies as inadequate from their perspective: he hadn't spent enough money, hadn't implemented a full-scale socialist change. It is doubtful with the impact of the Smoot-Hawley Tariff and the Federal Reserve's tightfistedness that Hoover could have avoided a severe recession. But by straddling the fence, Hoover ensured a crushing defeat.

He would have lost to almost any Democrat, but his opponent in 1932 was not just “any Democrat.” Franklin D. Roosevelt was a New York elitist politician, clever and well groomed in the art of dispensing favors from his brief career as state senator and governor. Supported throughout life by his mother, FDR briefly worked in a Wall Street legal firm and had never experienced work in the private sector outside the law. But his impeccable social credentials gave him ready entry to the world of politics. No intellectual, Roosevelt was famously described by Justice Oliver Wendell Holmes as having “a second-rate intellect and a first-rate temperament.” He had a reputation for adopting any process that worked—and which advanced his career. While assistant secretary of the Navy, he embraced the time-motion studies of Frederick Winslow Taylor to the cheers of Navy brass and the dismay of the unions. Roosevelt had just enough association with the military to be credited with some familiarity with defense issues, serving as assistant secretary of the Navy from 1913 to 1920 (and developing a particular fondness for the Navy over the Army, particularly for the submarine). Although he resigned to run for vice president in 1920, FDR was already tainted by the Navy's Newport sex scandal, in which a homosexual ring operated at the Newport Naval Training Station Hospital was infiltrated by federal agents. As assistant secretary, Roosevelt had approved the investigations and the detainment of many sailors without trial, as well as the requirement that undercover agents engage in illicit sexual acts against their will. For that, he became the target of outraged letters by local ministers
in Rhode Island and Maine, and was subsequently denounced in the Senate Committee on Naval Affairs. Roosevelt dodged the accusations, using the Navy as a shield and admonishing the committee for using the branch as a political football. The episode overshadowed his strenuous opposition to President Woodrow Wilson's demobilization of the Navy at the end of the war.
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In 1921, Roosevelt contracted polio. His rehabilitation took five years, essentially removing him from politics and leaving him unbloodied during the victorious Republican years of the twenties. Learning to stand with leg braces, FDR downplayed his handicap and won the New York governor's race in 1929. From there he staged his run on the U.S. presidency.
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