A Patriot's History of the United States: From Columbus's Great Discovery to the War on Terror (113 page)

That was seen in a third factor, the slowing of the manufacturing sector in mid-1928. Contrary to demand-side economists like John Kenneth Galbraith and the renowned John Maynard Keynes, demand did not disappear in the late 1920s, and wages remained high enough to purchase most of the vast number of new conveniences or entertainments. But firms could not add new production facilities without bank loans, which, instead of increasing, tightened when the Fed grew concerned about speculation. Members of the Fed’s board of governors mistakenly thought banks were funneling depositors’ money into the stock market, and further dried up credit, instigating a shrinkage of the money supply that would not stop until 1932, when it had squeezed one dollar in three out of the system. Evidence suggests that corporations sensed the tightening money supply, and cut back in anticipation of further credit contraction.
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One factor that can account for the sudden nature of the crash, however, was the Smoot-Hawley Tariff. This tariff increased rates already enacted under the Fordney-McCumber Tariff, by about 20 percent on average, but rates were increased much higher on some specific goods. Obviously, the passage of the tariff in 1930 discredits assertions that it shaped perceptions in late 1929—unless one takes into account the legislative process. Former
Wall Street Journal
writer Jude Wanniski raised the argument in 1978 with his book
The Way the World Works
that uncertainties over the effects of the tariff may have triggered the stock market sell-off.
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In the 1990s a new generation of scholars interested in trade revisited Wanniski’s views, with Robert Archibald and David Feldman finding that the politics of the tariff generated significant business uncertainty, and that the uncertainty began in 1928 (when manufacturing turned down) and grew worse in late 1929.
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The timing is crucial. The bill cleared key hurdles in committees in the autumn of 1929, with key votes coming just prior to the Great Crash. Certainly if business leaders became convinced that the tariff, which promised to raise the tax on imports of virtually all items by as much as 30 percent, would drive production costs up, and thus reduce sales, they would have prepared for it as soon as possible. From that perspective, it is entirely possible that expectations that Smoot-Hawley would pass may have caused a massive sell-off in October 1929. And after the crash the worst fears of the Smoot-Hawley opponents came to pass as European nations enacted higher tariffs on American goods, forcing prices on those imports up further and reducing demand. Companies’ expectations were, in fact, critical. If companies believed that the tariff would pass, and if they therefore expected hard times in 1930, it stands to reason that among other precautions they would take, firms would increase liquidity by selling off some of their own stock. Such sales alone could have sent dangerous signals to average investors, which then could have sparked the general panic.

Were businesses right to expect problems associated with Smoot-Hawley? Hadn’t business interests lobbied for many of the duties that Congress tacked on to the original bill? Business had indeed favored tariffs for decades, but favoring something in general and specifically assessing its impact are completely different. It becomes easier to discover the source of industry’s unease from hindsight. Among other things recent research has shown, the tariff reduced imports by 4 to 8 percent in nominal terms, but when deflationary effects are factored in—and it seems that almost everyone in the country except the Federal Reserve understood that some degree of deflation had set in by late 1929—the real decline in trade attributable to Smoot-Hawley accounts for one quarter of the 40 percent decline in imports after 1930.
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Other research has shown that changes in trade had a ripple effect throughout the economy, and the tariff alone could have reduced the U.S. GNP by 2 percent in the 1930s. Moreover, “had such tariffs been introduced in any other time period they could have brought about a recession all by themselves.”
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Thus we are left with some fairly obvious conclusions: (1) the Smoot-Hawley Tariff had important disruptive effects; (2) few people knew exactly what form those disruptive effects would take; and (3) unknown to anyone at the time, the Fed made the harmful effects even worse through its policy of deflation. The only link that seems to remain for further research is how much the perceptions of impending chaos affected securities sales prior to the Great Crash.

The combination of concerns about Smoot-Hawley; the need for a real, but not necessarily large, correction; and the rapid sell-off by speculators triggered a sharp decline. On Tuesday, October twenty-ninth, the market traded more than 16 million shares (compared to a normal day’s 3 million shares traded), and the indexes fell sharply. For the month of October alone, the New York Stock Exchange (NYSE) dropped almost 40 percent in value. By March, manufacturing orders (which had already slowed nearly a year before) dried up. Enter Herbert Hoover, who now turned a bad, but cyclical, recession into the nation’s worst depression.

Hoover Accelerates the Decline

Almost immediately upon assuming office, Hoover tried to prop up farm prices, creating another new federal agency with the Agriculture Marketing Act of 1929. Then he turned his attention to the tariff, where Congress had expanded the number of items in the tariff bill and had also substantially increased rates on many other items. Once the crash hit, the banking crisis followed. When the Bank of the United States in New York failed in 1930, followed by the collapse of Caldwell and Company in Nashville, the sense of panic spread. People pulled out their deposits, and the Fed proved unable or unwilling to break the runs. Indeed, contrary to one of the tenets of its charter, the Fed did not even rescue the bank of the United States.
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Hoover did cut taxes, but on an across-the-board basis that made it appear he cared for average Americans, lowering the taxes of a family with an income of $4,000 by two thirds. As a symbol, it may have been laudable, but in substance it offered no incentives to the wealthy to invest in new plants to stimulate hiring. It was, again, a quintessential Keynesian response—addressing demand. For the first time since the war, the 1930 U.S. government ran a deficit, a fact that further destabilized markets. On the other side of the coin, however, Hoover taxed bank checks, which acclerated the decline in the availability of money by penalizing people for writing checks.
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Even after the initial panic subsided, the economic downturn continued. Smoot-Hawley made selling goods overseas more difficult than ever; and the public quickly went through the tiny tax cut—whereas a steep cut on the upper tier of taxpayers would have resulted in renewed investment and plant openings, thus more employment. Worse, Hoover never inspired confidence. When the Democrats won the off-term election, taking control of the House, it meant that any consistent policy, even if Hoover had had one, was doomed. As the unemployed and poverty stricken lost their houses and cars, a string of appellations beginning with “Hoover” characterized all aspects of the economic collapse. Shantytowns erected on the outskirts of cities were Hoovervilles, and a broken-down car pulled by a team of horses was dubbed a Hoover Wagon.

The most significant response by the Hoover administration was the Reconstruction Finance Corporation (RFC), created in January 1932. Viewed by Hoover as a temporary measure, the RFC provided $2 billion in funds for financial institutions that were teetering on the brink. Although the RFC made loans (which, for the time, seemed massive) to private businesses, conditions of the loans actually
generated
instability in the firms the RFC sought to save. Federal regulations required publication of the names of businesses and banks receiving RFC loans. Banks, which were in trouble because of the collapse in customer confidence anyway, suffered a terrific blow by public notice that they needed RFC funds. This sent depositors scrambling to remove their money, weakening the banks even further. Despite a doubling of its funding, the RFC was a fatally unsound program.

Having passed a “demand-side” tax cut in June 1932, Hoover then signed the largest peacetime tax increase in history. Whereas the earlier tax cut had proved ineffective because it had dribbled small reductions across too large a population, the tax hike took the form of a sales tax that threatened to further burden already-struggling middle-class and lower-class families. A tax revolt ensued in the House, and when Hoover signed the bill, he further alienated middle America and produced one of the most vibrant tax rebellions since the early national period.
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Banks found their positions going from bad to desperate. As banks failed, they “destroyed” money, not only their depositors’ accounts, but also whatever new loans those deposits would have supported. Without prompt Fed action, which never came, between 1929 and 1932 the U.S. money supply fell by
one third.
Had no other factors been at work—no Smoot-Hawley, no RFC, no government deficits—this alone would have pushed the economy over the edge.

By 1933, the numbers produced by this comedy of errors were staggering: national unemployment rates reached 25 percent, but within some individual cities, the statistics seemed beyond comprehension. Cleveland reported that 50 percent of its labor force was unemployed; Toledo, 80 percent; and some states even averaged over 40 percent.
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Because of the dual-edged sword of declining revenues and increasing welfare demands, the burden on the cities pushed many municipalities to the brink. Schools in New York shut down, and teachers in Chicago were owed some $20 million. Private schools, in many cases, failed completely. One government study found that by 1933 some fifteen hundred colleges had gone belly-up, and book sales plummeted. Chicago’s library system did not purchase a single book in a year-long period.

Hoover, wedded to the idea of balanced budgets, refused to pay military service bonuses to unemployed veterans of World War I. The bonuses were not due until 1945, but the so-called Bonus Army wanted the money early. When Hoover refused, the vets erected a shack city on the outskirts of Washington. The police shied away from a confrontation, but the U.S. Army under General Douglas MacArthur was called in to disperse the Bonus Army in July 1932. Naturally, MacArthur’s actions were portrayed in the popular press as bloodthirsty and overzealous, but in fact the protesters’ claims had no basis in law, and their deliberate disruption and drain on the resources of an already depleted D.C. metropolitan area represented an attempt to foist off onto others their own desire for special privileges.

In subsequent decades Hoover would be assailed for his unwillingness to use the powers of government to halt the Depression, but the truth is that his activist policies deepened and prolonged the business downturn. Surprisingly, in subsequent decades, even Republicans came to buy the assertion that Hoover had stood for small government, when in fact he had more in common with Franklin Roosevelt than with Coolidge and Mellon.

Hoover planned to run for reelection, casting a gloom over the Republicans. The Democrats realized that almost any candidate could defeat Hoover in 1932. It happened that they chose the governor of New York, a wealthy man of an elite and established American family with a familiar presidential name. In Franklin Delano Roosevelt, the Democrats did not merely nominate
anybody,
but had instead put forth a formidable candidate. FDR, as he came to be known, was the first U.S. president who had never been obligated to work for a living because of his inherited wealth. After an education at Harvard and Columbia Law School, he served in the New York Senate, then, during World War I, he was the assistant secretary of the navy, where he had served well in organizing the supply efforts for the Allies over the ocean.

Franklin shared with his cousin Teddy the disadvantage of never having had to run or manage a business. He evinced a disdain for commerce; at best he held an aloof attitude toward enterprise and instead developed a penchant for wielding public funds, whether with the navy or as governor of New York. To that end, he had learned how to manipulate patronage better than any politician since Boss Tweed. But FDR also had distinctly admirable characteristics, not the least of which was his personal courage in overcoming polio, which at the time was a permanently crippling disease that frequently put victims in iron lungs to help them breathe. Yet Roosevelt never used his disability for political gain, and whenever possible he kept the disease private after it struck him in 1921.
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Tutored privately as a child, he went on to attend Groton prep school. There he absorbed the “social gospel,” a milk water socialism combined with social universalism, which was “the belief that it was unfair for anyone to be poor, and that government’s task was to eliminate this unfairness by siding with poorer over richer, worker over capitalist.”
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How much of this he really absorbed remains a matter of debate, but in a 1912 speech Roosevelt revived the themes of community over individual, emphasizing a new era of regulation. He proved less adept at managing his marriage to the plain Eleanor Roosevelt, carrying on with a social secretary (Lucy Mercer) as early as 1914. Alice Roosevelt Longworth, Eleanor’s acerbic cousin, had actually encouraged the illicit sex, inviting the couple to her home for dinner without Eleanor, noting sympathetically that Franklin “deserved a good time. He was married to Eleanor.”
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By 1918 Eleanor had confirmed her suspicions, discovering letters from Lucy to Franklin in a suitcase, and she offered FDR a divorce. Family and political considerations led him to an arrangement with his wife, wherein he would terminate his meetings with Lucy and keep his hands off Eleanor as well.

After a period of depression, FDR used his rehabilitation from polio to develop qualities he had never had before, including a sense of timing and patience to let political enemies hang themselves. Most of all, his rehabilitation had conferred on him a discipline that he never could have mastered otherwise, committing himself to details and studying public perceptions.