The Great Deformation (36 page)

THE HAYSEED COALITION'S EASTERN BRANCH:

PROFESSOR IRVING FISHER OF YALE

This provision of the Thomas Amendment embodied the so-called “compensated dollar” plan, the brainchild of Professor Irving Fisher of Yale. It is in the direct lineage of the T-bill monetary standard whose author, Professor Milton Friedman, essentially appropriated Fisher's deflation theory in his own work. Friedman claimed that the Great Depression had been caused by too little money supply, or M1.

Fisher's compensated dollar was based on the proposition that business cycles were the result of mistakes by businessmen in reacting to wide swings in the price level. They would overinvest in production, inventories, and fixed assets when prices rapidly rose. Then when interest rates increased in response to rising commodity prices they would sharply curtail
borrowing, liquidate inventories, and reduce production and cutback capital spending, thus triggering the next recessionary cycle or even depression.

Furthermore, these sharply falling prices and customer orders would then induce the opposite mistake, causing businessmen to become too pessimistic about the future. They would then under produce and underinvest in inventories and fixed capital, thereby perpetuating a deflationary cycle like that embodied in the Great Depression.

Fisher's view was that businessmen were forever making mistakes and, therefore, a monetary arrangement was needed to nip these foolish errors in the bud. To that end, Professor Fisher proposed creation of an elite board of government wise men to stabilize the commodity price level by deftly varying its gold content. Once the state insured that commodity prices would never change, businessmen on the free market would never again make mistakes!

Fisher's magical compensated dollar plan, therefore, was the original version of monetary central planning: his “great moderation” would abolish the business cycle and thereby generate permanent prosperity and perpetual full employment. Accordingly, fiddling the gold price was thus an early form of the contemporary Greenspan-Bernanke prosperity management model based on fiddling money market interest rates.

Unlike the incomprehensible J. M. Keynes, Fisher was lucid and made every effort to appeal to politicians, including FDR. During the spring of 1933 Fisher prowled Washington's corridors, and not solely out of the patriotic belief that the depression could be ended by adopting his compensated dollar plan.

His own animal spirits were bludgeoned by the depression. He famously proclaimed ten days before the October 1929 crash that the stock market had reached a “permanently high plateau” and invested accordingly. Unfortunately, though, Fisher lost both the personal fortune he made from inventing the Rolodex and his wife's inherited fortune. In any event, after having advised his greatest Washington disciple, Senator Elmer Thomas, on the amendment which bore his name, Fisher also obtained an audience with FDR in May 1933. He came away elated. “Our fortune is saved!” said the note to his wife, which he scribbled that evening on the stationary of Washington's Carlyle Hotel.

FDR's embrace of the Thomas Amendment and his subsequent bombshell letter to the London Economic Conference were both nearly pure expressions of the Fisher compensated dollar plan as was FDR's subsequent capricious fiddling with gold prices during his escapades with Professor Warren (see
chapter 8
).

FDR's aim in manipulating the gold content of the dollar had consistently been to raise farm and industrial commodity prices, believing that higher prices would pump purchasing power back into the pockets of both labor and business, and thereby catalyze the engines of economic recovery. So FDR was a firm believer in “pump priming.” But it was based on a Fisherite, not a Keynesian framework.

The obstacle to Fisher's reflation scheme, however, was the prostrate condition of world trade where massive excess capacity in worldwide export industries had caused a stunning collapse in the prices of tradable goods. By the spring of 1933, for example, the international wholesale index for industrial raw materials such as cooper and rubber was down by 60 percent, while the index for a standard basket of food prices was down 55 percent. Even the price index for traded manufactures had tumbled by 40 percent from its 1929 peak.

In this context, the US dollar price of gold was a pretty frail lever with which to jack up global commodity prices. Indeed, the only effective route to sustained reflation would have been a sharp rebound in world trade and absorption of this massive export capacity overhang. Yet that was blocked everywhere by trade barriers and competitive currency depreciation.

So FDR's approach to countercyclical management of the domestic economy by means of the Fisher compensated dollar strategy was largely a fizzle. The January 1934 reduction of the dollar's gold content by 40 percent (to $35 per ounce) was supposed to catalyze a further energetic rise in the wholesale prices, but it never happened. The wholesale price index, which had recovered substantially before FDR took office, then stood at 80 and simply flat-lined around that level for years; it was still at just 77 when the US economy was about to shift to a war footing in mid-1939.

In short, the peacetime New Deal did embrace a form of countercyclical policy, but it was Fisher's reflation rather than the deficit finance of Keynes. Nevertheless, at the end of the day the nation's fiscal demise was enabled by the Thomas Amendment's destruction of the gold dollar. Now it was only a matter of time before Professor Friedman would provide Richard Nixon with the rationale to finish the job FDR had started.

GOLD REVALORIZATION AND THE

WHITE HOUSE SLUSH FUND

The one thing that FDR raised with his Fisherite levitations was a White House slush fund called the Exchange Stabilization Fund (ESF). At the stroke of FDR's pen, the price of gold went from $20.67 per ounce to $35, thereby causing the value of the nation's gold stock to rise from $4.2 billion to $7 billion.

Most of this $2.8 billion “revalorization” gain was assigned to the newly created ESF. Under the terms of the Thomas Amendment the fund was available for such purposes as the president directed. During the remainder of the peacetime 1930s, therefore, Secretary of the Treasury Morgenthau became a virtual monetary czar. This dominance was facilitated by the fact that the nation's actual central bank, the Federal Reserve, was near dormant. The reason for the Fed's irrelevance was not hard to fathom. By 1934–1935 the domestic banking system was becoming saturated with idle cash, reflecting negligible demand for loans from the somnolent US economy.

Indeed, the striking evidence that cash was king lies in the buildup of excess bank reserves parked at the Fed. These soared from $2.7 billion in 1933 to $11.7 billion by 1939, and accounted for 75 percent of the Fed's balance sheet growth during the period.

All this money resulted in short-term interest rates which were persistently below 1 percent after 1934. Indeed, there was never any monetary stringency during the 1930s that the Fed failed to alleviate. On the contrary, the record shows conclusively that in the midst of sustained debt liquidation, increases in bank reserves result merely in “pushing on a string,” not credit expansion and economic stimulus.

Ironically, the Fed today is generating excess bank reserves in an identical manner to what occurred during the mid-1930s, and with the same lack of effect. Bernanke's reputation as an expert on monetary policy during the Great Depression is thus wholly undeserved: he is pushing on the same string that the great Fed chairman of the day, Marriner Eccles, knew to be incapable of fostering recovery.

To be sure, the massive growth of excess domestic bank reserves during the mid-1930s was due to large-scale inflows of gold from abroad rather than Federal Reserve money printing. Yet that is merely a technical difference. Bank reserves could come from either source. Yet under the prevailing cycle of debt deflation, neither source of bank reserves resulted in a single extra solvent customer for loans.

FDR'S BALEFUL LEGACY: STATE MONEY WHICH ENABLED PERMANENT FISCAL DEFICITS

As the war clouds gathered in Europe, the United States increasingly became a safe haven. Consequently, the nation's official gold reserves doubled from $10 billion to $20 billion during the second half of the decade and reached two-thirds of total global gold reserves. This gold inflow brought persistent upward pressure on the dollar's exchange value, inducing the Treasury Department to intervene chronically in foreign exchange markets, using its ESF slush fund to do so. Consistent with its Fisherite monetary
views, the aim of this White House currency market intervention was mainly to prop up the franc and pound sterling and weaken the dollar.

And so went the string of New Deal monetary policy actions which began with the April 6, 1933, confiscation of private gold. The thread was extended through FDR's embrace of the Thomas Amendment, the London bombshell letter, the breakfast-time gold buying with Professor Warren, the 1934 revalorization of the gold price, and these ESF's foreign exchange market interventions.

When all was said and done, these actions had congealed into a historic policy departure; that is, the nationalization of money. Henceforth, the nation's money would become a subordinated tool of the state's domestic stabilization policies. No longer would money occupy its historic role as a private instrument of commercial exchange and storehouse of value, redeemable for an asset whose price was fixed, intrinsic, and derived wholly apart from the state.

At the end of the day, this was the true New Deal break from the past and from what had earlier been Herbert Hoover's last stand for financial orthodoxy. To his credit, Hoover had never wavered from the gold standard, even as he had succumbed to a variety of dubious expedients such as the RFC bank bailouts, meddling in corporate wage and price setting, and the abomination of the Smoot-Hawley tariff.

The far-reaching implications of the New Deal's radical monetary policies have not been highlighted by contemporary analysts because they did not involve aggressive money printing by the Fed. But they amounted to the same thing. Owing to the weak economy and strong gold inflow, money market conditions were intrinsically easy, at least by the standards of the day. After 1934, commercial paper and T-bill rates were thus stuck under 0.5 percent, long-term government bonds yielded 2.5 percent, blue chip corporate debt yielded 3.5 percent, and cash was superabundant.

Under those conditions the Fed knew better than to “push on a string,” and had not yet even dreamed of employing open market operations as a tool of plenary macroeconomic management. Indeed, the Fed's paramount leader after 1934, Chairman Marriner Eccles, was a fiscalist who spent most of his time preaching to the White House about the need for more deficit spending, not easier money.

Still, Irving Fisher's “managed currency” theories, as embodied in the New Deal's monetary tinkering, established the crucial predicate; namely, that monetary manipulation is a legitimate tool of state policy. So doing, it paved the way for latter-day management of the gross domestic product (GDP) by means of Keynesian deficit spending and Greenspan-Bernanke-style monetary central planning.

The truth is, Keynesian policy was a nonstarter under the old régime of gold-convertible money. Fiscal deficits could be body checked at any time by the people themselves, who had the right to dump their paper money for gold whenever they lost confidence in the fiscal discipline of the state.

Thus, Fisher's “compensated dollar” undoubtedly sounds quaint to modern ears. Yet it was the crucial way station to the new world of permanent deficit spending and the T-bill standard money which was eventually to come.

KEYNESIANISM IN ONE COUNTRY: THE GREAT THINKER'S CASE FOR HOMESPUN GOODS AND MONEY

The New Deal also established a supplementary predicate which was equally crucial to an embrace of thorough-going Keynesian macro-management: Namely, the essentially protectionist notion of a closed domestic economy and the subordination of the rules with respect to international movement of goods, capital and money to the dictates of domestic policy. That predicate was the essence of FDR's London bombshell.

It was on the matter of autarky—America first—that the New Deal fell in line with Keynes' true contribution to the depression era policy debate. Indeed, the inspiration for the New Deal was never really the erudite ramblings of the 1936 “General Theory.” Instead, it was the rank protectionism of Keynes' 1933 essay entitled “National Self-Sufficiency.”

In the latter treatise, the great thinker averred that art, hospitality and travel might properly remain in the sphere of internationalization. But as to the core matter of economics—the movement of merchandise goods and financial capital—the time had come, as Keynes saw it, to roll-back the clock.

The prior 300 years of western progress by nearly every account had been based on international trade and comparative advantage, but Keynes had no compunction about pronouncing Adam Smith wrong. Based on an apparent flash of revelation that had been absent from his writings of even a few years earlier, Keynes now urged for an era of national autarky.

Operating behind moats at the border, the state would thus mobilize and command domestic economic life without interference: “I sympathize, therefore, with those who would minimize…economic entanglements between the nations…let goods be
homespun
whenever it is reasonably and conveniently possible; and, above all, let finance be primarily national.”