America's Fiscal Constitution (32 page)

Hoover sought cooperation from Democrats, who held a House majority after 1930. Bushy eyebrows, pink cheeks, and a mischievous smile gave a benign appearance to their leader, Speaker John Nance Garner. Garner, who amused his colleagues with profane wit, treated the rising debt as a serious matter. In early 1932 the Speaker descended from his rostrum to make an unusual personal appeal for bipartisan cooperation in efforts to
balance the budget. When he asked House members to stand up to show their resolve to support higher taxes, almost everyone rose.

In early 1932 the Ways and Means Committee endorsed a bill containing a mix of higher sales and income taxes. All but one of the members of the powerful committee voted for the bill. The dissenting vote belonged to Robert Lee Doughton, a polite sixty-eight-year-old farmer and small-town banker from North Carolina. Doughton once described tax legislation as getting “the most feathers you can with the fewest squawks from the goose.”
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Doughton himself squawked at higher sales taxes championed by both President Hoover and Speaker Garner. His constituents, mostly farmers who were struggling even before the onset of the Great Depression, had experienced a collapse of the cash economy and feared higher sales taxes. The constituents of progressive Republican Fiorello La Guardia from New York shared those fears. Doughton and La Guardia persuaded House members to increase sales taxes by less than the amount proposed by the Hoover administration and House leadership. Congress passed the tax bill in the summer of 1932 with hopes that it would produce a billion dollars in additional revenue.

Hoover blamed Congress for delaying the tax cut and prolonging the deficit. Critics later blamed the tax bill for deepening the Great Depression, but in fact the new taxes took little purchasing power out of the economy. Incomes and purchasing power had already plummeted so much that higher taxes on anything other than tobacco yielded only minimal revenue.

Members of the Federal Reserve Board of Governors and its regional banking associations did not know how to slow the economic descent or preserve the nation’s banking system. They interpreted low interest rates as a sign of sufficient availability of credit. The Federal Reserve also believed that it lacked the legal authority to inject liquidity directly into banks by monetizing federal debt or other loans in bank portfolios.

The Federal Reserve worried about the nation’s gold reserves. A run on gold in Germany and Austria spread to Great Britain, where many worried that the government would devalue the pound in order to monetize its large budget deficits. Great Britain shocked the world by departing from the gold standard in September 1931, while France’s central bank began hoarding gold. The run on gold further imperiled US national banks, which were required to maintain reserves in the form of gold and short-term commercial paper.
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On the advice of Federal Reserve Chairman Eugene Meyer, President Hoover asked Congress to create the Reconstruction Finance Corporation (RFC) for the purpose of lending money to banks, many of which lacked the liquidity to extend mortgages that typically matured in five years. Hoover observed how congressional leaders “seemed shocked at the revelation that our government for the first time in peacetime history might have to intervene to support private enterprise.”
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Garner sympathized with the RFC’s purpose, though he worried about whether it might “linger on as a pipeline to the United States Treasury for chiselers and drone businesses, which . . . partisan favor will give them.”
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Garner insisted that the president appoint sound bankers—including former vice president Charles Dawes and Texan Jesse Jones—to lead the RFC. In January 1932 Congress created the RFC, appropriated $500 million for its capital, and authorized it to borrow $1.5 billion.
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Like the Troubled Asset Relief Program created during the Great Recession of 2008, the RFC tried to bolster bank balance sheets.

In early 1932 Senator Carter Glass helped pass the first of two Glass-Steagall Acts, which allowed the Federal Reserve to buy federal debt with new currency. The Federal Reserve used that power to monetize more federal debt in 1932 than in any other year between World War I and World War II. By then, however, creditworthy consumers and businesses were reluctant to borrow, and banks were reluctant to lend. The second and better known Glass-Steagall Act, passed in June 1933, separated commercial and investment banking and authorized the RFC to buy loans from troubled banks.

As is typical during troubled economic times, partisan leaders blamed their political opponents for the severity of the downturn. Their rhetoric contributed to decades of partisan lore that blamed federal tax and spending policies—too much or little—for the sharp downward slide in production, prices, credit, and employment from 1929 to 1933. In fact, federal budget policies had far less impact on economic activity than did a variety of other factors leading to the collapse of a private debt bubble, a fragile farm economy, and the consequences of a severe European downturn. The money supply fell sharply, characterized by what economist Milton Friedman later called “the Great Credit Contraction.” Another economist, Ben Bernanke, demonstrated decades later that the collapse of commercial banking deepened and prolonged the Great Depression. Economists would eventually come to describe the stagnation as a “liquidity trap,” in which a belated
expansion of credit failed to stimulate economic activity once consumers were too fearful to spend and businesses too nervous to invest.

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By 1932 the reaction to the economic tragedy—fear itself—ripped apart the nation’s social fabric. Cities struggled to keep schools open. Angry mobs stormed courthouses to block foreclosure sales of family farms. Gaunt, hungry men filled urban streets. The normally resilient Calvin Coolidge articulated the mood of the country before his death in January 1933: “In other periods of depression it has always been possible to see some things which were solid and upon which you could base hope, but . . . I see nothing to give ground for hope.”
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Despair nurtured radicalism. Union leaders worried aloud about a groundswell of support for socialism. A Farm Bureau leader observed that one could not “find a conservative farmer today,” while the American Legion passed an ominous resolution declaring that the economic crisis could not be resolved “by existing political methods.”
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When Congress cut the pay of federal employees in 1932, President Hoover quietly urged it to exempt soldiers who might be needed to maintain domestic order. An ambitious army officer, Douglas MacArthur, led cavalry and tanks to disperse a gathering of unemployed World War I veterans encamped in the nation’s capital.

Americans anxiously watched other nations lurch toward extremes. Japan’s Prime Minister Osachi Hamaguchi was killed when he attempted to curb the nation’s deficit by reducing defense spending, while communist and fascist militias battled in the streets of Germany.

Since the nineteenth century, American cities and counties had provided some “outdoor relief” in the form of food delivered to “paupers.” Older Americans and disabled citizens without subsistence income received “indoor relief” in crowded poorhouses or poor farms. The weight of the Great Depression’s hardship tore holes in this traditional safety net. City officials formed the US Conference of Mayors to seek federal assistance in preventing starvation and restoring employment.

State governments stepped in to supplement local humanitarian efforts. Voters in fifteen states approved bond issues for relief. Governor Franklin Roosevelt of New York funded local relief efforts with a voter-authorized bond issue backed by a large increase in the state income tax.
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Where state
constitutions did not allow voter-authorized bonds to fund public assistance, state officials tried to frame bond issues in other terms. Voters in Michigan declined to approve a bond issue for relief to prevent “incipient insurrection,” while the state of Washington incurred emergency debt for that very purpose.
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In July 1932 President Hoover vetoed an appropriation of $322 million for loans to fund state and local relief agencies and $2 billion for public works.
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He believed that the new spending would undermine the deficit reduction from the tax bill passed that summer. In August, facing an override of his veto, the president allowed a similar bill to become law. That legislation funded much of the early emergency relief attributed to his successor’s New Deal.

The Hearst newspapers promoted Speaker Garner for the 1932 Democratic presidential nomination. Garner had difficulty blaming Hoover for failing to balance the budget, since the Congress he led controlled the nation’s spending and taxes. Governor Roosevelt felt free to attack federal borrowing, and he did so with a vengeance. The outcome of the elections would not turn on policy platforms. Many Americans yearned for what one progressive Republican supporter of the New York governor called “another Roosevelt.” The tide of public support for the Democratic Roosevelt allowed his party to avoid the bitter nomination fights that had marred most of their conventions since the turn of the century. Garner withdrew from the contest and became Roosevelt’s running mate.

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Franklin Roosevelt always tried to maintain a balance between bold innovation and humble respect for fiscal traditions. The 1932 Democratic platform endorsed a 25 percent reduction in normal federal spending and the “maintenance of national credit by a federal budget annually balanced on the basis of accurate executive estimates within revenues.”
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Roosevelt called for a “stern and unremitting administration policy of living within our income.”
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His warm voice reminded radio listeners in July 1932 that temporary borrowing was sometimes necessary but chronic borrowing invariably led to the “poorhouse.”

The Democratic presidential nominee finessed the issue of federal spending required to prevent starvation. Weeks before the election he told a Pittsburgh audience that the “reduction in federal spending” was “one of
the most important issues in this campaign,” while noting that “if starvation and dire need on the part of any of our citizens makes necessary the appropriation of additional funds which would keep the budget out of balance, I shall not hesitate to tell the American people the full truth.”
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Hoover distinguished federal outlays for emergency relief from other, routine expenses. He pointed out that the federal government had cut expenditures for normal activities and challenged Roosevelt to show how he could reduce routine spending by 25 percent. Budgeted spending totaled $3.647 billion, including $2 billion for debt service and the military and $946 million for veterans.
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“If he stopped all public works, [Roosevelt] would finally have to take $500 million” from the veterans, Hoover asserted, calling that idea “a gross injustice.”
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The banking system imploded between Roosevelt’s landslide victory in November 1932 and his inauguration in March 1933. In three and a half years employment had dropped by a devastating 25 percent, leaving 13 to 15 million workers without jobs.
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Many people could only find part-time work. Economic output had fallen by 50 percent.
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In March 1933 one out of six American families depended on some sort of relief provided by public programs and, to a lesser extent, private charities.

In the fiscal year ending months after Roosevelt’s inauguration, the federal government borrowed far more than Hoover and Congress had ever imagined possible. Briefly in 1933, for the only time since the presidency of John Adams, federal revenues dropped to less than 10 percent of outstanding debt.
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A low ratio of revenues to debt squeezed the ability to both service the debt and continue to provide essential services such as an army and navy and pensions for veterans. Revenues available to service federal debt would never again be so low in relation to total debt until after the collapse of the American Fiscal Tradition in the twenty-first century.

Roosevelt paid homage to “pay as you go” budget planning during his first weeks in office. Within a week of his inauguration he asked Congress to slash normal federal spending, including civilian and military pay and all benefits for veterans without service-related disabilities. The president hoped that the spending cuts offered “a reasonable prospect that within a year the income of the government will be sufficient to cover the expenditures,” at least for normal functions apart from extraordinary relief.
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Over the dissent of ninety-two House Democrats, Congress quickly passed Roosevelt’s Economy Act, which was officially titled “A Bill to Maintain the Credit of the United States Government.” In 1934 Congress repealed
many of the bill’s draconian cuts, such as those for veterans’ benefits, and then overrode Roosevelt’s subsequent veto.

A strong mother, celebrated name, financial security, patrician charm, and curious intellect imbued Franklin Roosevelt with unusual self-confidence. Years of physical therapy to regain use of his polio-stricken legs in the 1920s gave him time to read and reflect on political history. He wrote his only book review, a glowing endorsement of
Jefferson and Hamilton: The Struggle for Democracy in America
by Claude Bowers. Like Bowers, Roosevelt sympathized with Thomas Jefferson and James Madison in their battles with Hamilton in the 1790s over fiscal policy. Roosevelt shared the belief of his party’s founders that excessive debt compromised the nation’s future.