The Great Deformation

by David Stockman

  Not surprisingly, the farm movement had an elaborate scheme for levitating the price of wheat, corn, cotton, milk, and a host of other commodities. This price-fixing contraption had been known as the McNary–Haugen bill during the 1920s.

  At the time, American consumers had escaped being fleeced by its crude levies. The doughty Calvin Coolidge had simply refused to sign a Republican farm bill which enabled self-appointed farm lobbies to form what amounted to a legally binding cartel for every agricultural commodity.

  By contrast, FDR embraced agricultural price fixing enthusiastically, planting the seeds of what became another destructive New Deal legacy. The AAA’s original seven-crop cartel included corn, wheat, cotton, rice, milk, peanuts, and tobacco, and provided for government controlled acreage and production restrictions and artificial price supports. These schemes were amended repeatedly over the decades such that each became a distinct self-contained domain of rural crony capitalism.

  Like in all instances of crony capitalism, economic outcomes are as much as gift of the state as they are the fruits of capitalist virtue. Consequently, the USDA’s crop cartels have been vigilantly stationed at the epicenter of American fiscal politics ever since the New Deal, always ready to logroll among themselves, and to trade their votes for virtually anything of interest to urban delegations.

  Indeed, the “food stamp” program, which has nothing to do with nutrition and is actually just an income transfer paid in alternative currency, has become an integral part of the USDA budget. It also is also a central element of the periodic authorizing legislation upon which the crop cartels depend, and a potent means of enlisting “urban farmers” in the cause of their perpetuation.

  Small-state senators have a hugely disproportionate weight in American governance, and nowhere as much as in the fiscal politics practiced by the crop cartels. Indeed, today’s bloated welfare state and corrupted tax code reached their current metastasized condition in large part because at critical inflection points over the decades, farm-state senators—the natural opponents of Big Government—have regularly sold out the public purse in favor of the rural crony capitalists who populate their states.

  And in this logrolling, there was nothing for which the farm senators did not swap their votes: housing programs, urban development grants, oil industry tax loopholes, weapons systems, even money for handicapped education were all part of the great legislative trading bazaar.

  In fact, the farm programs are anachronistic and economically stupid and could not survive without this raw power politics. Meanwhile, the heavy financial burden resulting from this expression of crony capitalism is paid by the American public in their role as consumers or taxpayers.

  The $1 trillion seventy-five-year battle of the rural crony capitalists against the free market’s inexorable shrinkage of the nation’s agricultural districts has been an exercise in futility. In 1935 there were 35 million people on 7 million farms, who accounted for about 25 percent of national output. Today there are fewer than 2 million Americans on the farm; there are less than 250,000 remaining commercial-scale agricultural enterprises; and farm output represents a mere 4 percent of GDP.

  The New Deal’s crop cartels, therefore, did not even remotely restore the golden age of World War I farm prosperity. Instead, they ended up institutionalizing vast abuses of state power and conferring undeserved windfall land rents on a privileged segment of rural crony capitalists for generations to come.

  Worst of all, they saddled the nation’s fiscal politics with a large bloc of swing votes permanently on offer to the highest bidder. Accordingly, the AAA was not just another New Deal program that failed to foster recovery from the Great Depression; it was actually the political axis on which much of the modern welfare state was built.

  FDR’S HAYSEED COALITION:

  ROOTS OF MODERN MONEY PRINTING

  It was not the anti-gold fulminations of J. M. Keynes at the time of the British crisis in 1931 that finally brought down the gold standard and sound money. Instead, its real demise came two years later in the form of the Thomas Amendment, a powerful expression of the monetary populism which animated FDR’s hayseed coalition.

  The amendment was hatched at midnight on April 18, 1933, during FDR’s famous White House rendezvous with the fiery leader of the hardscrabble farm belt, and embodied four “discretionary” presidential options to debauch the gold dollar. These measures have been dismissed by historians as a casual sop by FDR to farm state radicals, but they could not be more mistaken.

  The Thomas Amendment was a nascent version of today’s delusion that economic setbacks, shortfalls, and disappointments are caused by too little money. The true cause, both in the early 1930s and today, was actually an excess of debt. This explanation is never appealing to politicians because there is no real cure for the liquidation of excess debt, except the passage of time and the forfeiture of the ill-gotten gains from the financial bubbles preceding it.

  By contrast, the populists of the New Deal era believed that the state could easily and quickly remedy a shortage of money by printing more of it. In this respect they are in a line of descent that extends to the depredations of the Bernanke Fed in the present era.

  The line of continuity started with FDR and Senator Thomas and included the latter’s guru, Professor Irving Fisher of Yale. It then extended into the present era via Professor Milton Friedman of Chicago, who embraced wholeheartedly Fisher’s quirky theory of deflation. The latter, in turn, became the virtual obsession of Friedman’s acolyte, Professor Bernanke of Princeton, whose academic work is based on Friedman’s erroneous interpretation of the Great Depression.

  Upon becoming chairman of the Fed, Bernanke then foisted the Fisher-Thomas-Friedman deflation theory upon the nation’s economy in a panicked response to the Wall Street meltdown of September 2008. Yet monetary deflation was no more the cause of the 2008 crisis than it had been the cause of the Great Depression.

  The monetary populists of the 1920s and 1930s, including Professor Fisher, had “cause and effect” backward. The sharp reduction after 1929 in the money supply was an inexorable consequence of the liquidation of bad debt, not an avoidable cause of the depression. The measured money supply (M1) even in those times consisted mostly of bank deposit money rather than hand-to-hand currency. And checking account money had declined sharply as an arithmetic consequence of the collapse of what had previously been a fifteen-year buildup of bad loans and speculative credit.

  During 1929–1933 commercial bank loans outstanding declined from $36 billion to $16 billion. Not surprisingly, as customer loan balances fell sharply, so did checking accounts or what can be termed “bank deposit money” as opposed to currency in circulation. The latter actually grew by $1.1 billion during the four years after 1929, to about $5.5 billion.

  By contrast, it was the loan-driven checking account portion of M1 which dried up, declining from $25 billion to $17 billion over the same period. And the reason was no mystery: the way banks create demand deposits is to first issue loan credits to their customers. Indeed, in the modern world money supply follows credit, and rarely do central bankers inordinately restrict the growth of the latter.

  In truth, loan balances and checking account money rose to inordinate heights during the financial bubble preceding the 1929 crash and unavoidably declined thereafter. This had nothing to do with causing the depression. The real reason the American economy was stalled in the early 1930s is that it had lost its foreign customers.

  The reduction of M1 owing to the liquidation of bad credit, by contrast, was a sign of returning financial health. Indeed, the major component of bank credit shrinkage had been the virtual evaporation of the $9 billion of margin loans against stock prices that had reached lunatic levels before the crash. In blaming the Fed for the Great Depression, therefore, Professors Friedman and Bernanke implicitly held that the Fed should have under-written the margin-loan-based speculative mania of 1926–1929 in order to keep M1 from shrinking!

  THE
THOMAS AMENDMENT’S DEAD-END OPTIONS:

  FORESHADOWING OF THE BERNANKE FED

  The Thomas Amendment thus amounted to a road map for the Bernanke money-printing policies of the present era. While some of its specific mechanisms for injecting money into the economy had a slightly archaic aura, they nevertheless embodied the same destructive theories of monetary central planning that plague policy even today.

  The first Thomas Amendment option was an authorization for the Federal Reserve to purchase up to $3 billion of government bonds in the open market. This would have more than doubled the Fed’s holdings of government debt (from $2.4 billion to $5.4 billion) in a manner similar to what the Bernanke Fed actually did in 2008–2011. While massive government bond buying, or debt monetization, is supposed to put “money” in the banking system, the contemporary Bernanke escapade proves otherwise.

  In the context of systematic private debt liquidation, central bank bond buying mainly results in a huge buildup of excess reserves in member bank accounts stored in the Fed’s own vaults. In other words, money grows mainly when commercial bank credit expands, and no amount of Fed bond buying can force member banks to lend into a debt-saturated marketplace.

  The second option crafted by FDR and Senator Thomas was based on their recognition that the still sober minded Fed of that day might actually refuse to crank up the printing presses in order to go on a bond-buying spree. Therefore, the amendment also authorized the Treasury Department to activate its own printing press and issue $3 billion of new paper currency, or literally greenbacks.

  As a practical matter that option was beside the point. It would have nearly doubled the amount of currency in circulation, yet by late April 1933 the banking panic was over, and $2 billion of hoarded currency was already coming out of mattresses and flowing back into the banking system. Since there was no longer a shortage of currency, any greenbacks issued under the Thomas Amendment would have had no effect on household or business spending.

  This seemingly archaic option to print greenbacks, however, actually illuminates the folly of the Fed’s modern bond-buying campaigns. Had the White House chosen to exercise the currency-printing option it could have temporarily paid its bills by issuing interest-free greenbacks rather than the 2.5 percent Treasury bonds of the day, but that was a step even Roosevelt shied away from because it amounted to crackpot finance.

  Yet eight decades later, Washington finances itself exactly as the Thomas Amendment envisioned. The fact of the matter is that the “greenbacks” of historical ill repute were simply noninterest-bearing debt issued to finance the Civil War. Today the US Treasury issues greenback equivalents. Three-year notes that yield a fractional thirty-five basis points of interest, for example, are only a tiny step removed from printing-press currency.

  The US Treasury is able to sell notes at such aberrationally low yields only because the Fed stands ready to absorb any amount of issuance that does not clear the market at its targeted rates. That’s currency printing by any other name.

  The third option embraced by leaders of the hayseed coalition involved yet another way to artificially inject “money” into the economy. In this instance, the nation’s silver miners and speculators were to be the agents of economic uplift. Accordingly, the Treasury was authorized to purchase the entire output of America’s silver mines at approximately $1.25 per ounce and then coin these bullion purchases into circulating money.

  At the time, the world market price of silver was just $0.35 cents per ounce, so FDR and Senator Thomas were proposing to monetize silver at 3.5X its market value. While this evokes the crank economics of William Jennings Bryan, it involves the same principle as today’s money printing by the Bernanke Fed, except the markup on the Fed’s coining of digital dollars is nearly infinite.

  The resemblance of the Thomas Amendment’s silver option to today’s Fed policies was evident in another respect, as well. Massive silver purchases at way above world market prices would have obviously delivered a mighty windfall gain to the mining towns and silver speculators.

  Yet the New Deal could have created similar ill-gotten windfalls by monetizing tungsten or cow-hides. Indeed, monetization inherently showers speculators with ill-gotten gains. The windfalls harvested today by front-running traders who buy classes of Treasury securities and GSE paper targeted for purchase by the Fed would put to shame the modest windfalls harvested by silver speculators when FDR implemented this feature of the Thomas Amendment in 1934.

  The final option of the Thomas Amendment was the basis for FDR gold-tinkering campaigns, and for his January 1934 decree that gold would hence be worth $35 per ounce versus the $20 per ounce standard that had prevailed since 1832. Obviously, drastically altering the hundred-year-old gold content of the dollar amounted to the same thing as destroying the gold standard. After all, a “standard” which can be changed radically on a whim of the state is not a standard at all.

  However, the underlying rationale for changing the dollar’s gold content was the truly dangerous feature of the Thomas Amendment. It was the forerunner of today’s monetary central planning and embodied the notion that the nation’s entire GDP could be managed by simply raising the dollar price of a market basket of commodities. After an initial “reflation” of commodity prices, including gold, the depression would be ended instantly and thereafter the business cycle would be permanently eliminated.

  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 for
tune 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.