The New Deal Was No Deal (part I)


Currently, one of the loci communes of economic history is that the New Deal was the right cocktail of state-mandated policies to pull the US economy out of the Great Depression that begun in 1929. The relevance of this interpretation has increased tremendously since the crisis of 2008 that many compare with the crisis of 1929. There is a quasi-general demand for a new New Deal. This essay is intended as another attempt at a short revisionist history of the 1933 – 1939 period.

[This is part I of an article previously published in Procesos de Mercado, vol. VII, no. 2, autumn 2010. Read part II, part III, part IV.]

Currently, one of the loci communes of economic history is that the New Deal was the right cocktail of state-mandated policies to pull the US economy out of the Great Depression that begun in 1929. The relevance of this interpretation has increased tremendously since the crisis of 2008 that many compare with the crisis of 1929.

There is a quasi-general demand for a new New Deal. This view is contended by the Austrian School of Economics. This essay is intended as another attempt, among others more brilliant and studious, at a short revisionist history of the 1933 – 1939 period.

The United States play a crucial role in the economic history of the XX century. The events during the presidency of Franklin Delano Roosevelt provide another great illustration for the theory of interventionism and especially of its particularization, the theory of the business cycle. In this essay we will give special attention to the analysis of the Rooseveltian pre-war years (1933-1939).

FDR and the Great Depression

I pledge you, I pledge myself to a new deal for the American people.[1]

Why, that’s just plain stealing, isn’t it Mr. President? [2]

The foremost spring of relevant information about the FDR era is the “hectic and tumultuous hurricane of laws and projects and orders in council which came to be known as the Hundred Days.”[3]

A first step in elucidating the Roosevelt part of the “Great Duration”[4] is to deduct the economic consequences that would have had to be expected from the supposed enforcement of the decrees. In other words we will try to answer the following question: how did the American economic picture differ, in the presence of these “laws”—supposing they were enforced—, from the situation that would have prevailed in the absence of the “laws and projects and orders” of the Hundred Days and after? Then, corroboration of historical facts can confirm whether the economic analysis was correct or we must adhere to alternative explanations.

The continuity of the New Deal

Although the term “New Deal” was coined in Roosevelt’s Chicago speech of acceptance of the presidential nomination in 1932, the wide-scale interventionist policies that characterize it were inaugurated by the Hoover regime with the advent of the crisis in 1929.

According to Rothbard, President Coolidge is responsible for the seminal inflationism that motivated the intensified interventionism of Hoover and then the fascist hysteria of the Roosevelt years:

If Coolidge made 1929 inevitable, it was President Hoover who prolonged and deepened the depression, transforming it from a typically sharp but swiftly disappearing depression into a lingering and near-fatal malady, a malady "cured" only by the holocaust of World War II. Hoover, not Franklin Roosevelt, was the founder of the policy of the "New Deal": essentially the massive use of the State to do exactly what Misesian theory would most warn against — to prop up wage rates above their free-market levels, prop up prices, inflate credit, and lend money to shaky business positions. Roosevelt only advanced, to a greater degree, what Hoover had pioneered. The result for the first time in American history, was a nearly perpetual depression and nearly permanent mass unemployment. The Coolidge crisis had become the unprecedentedly prolonged Hoover-Roosevelt depression. (Rothbard (1996), p. 79)

Indeed, it may be argued along with the historian Ralph Raico that the New Deal was the consequence of the damage done by Theodore Roosevelt’s regime:

It was the age of "progressivism," a vague term, but one that connoted a new readiness to use the power of government for all sorts of grand things. H.L. Mencken, the great libertarian journalist and close observer and critic of presidents, compared him to the German kaiser, Wilhelm II, and shrewdly summed him up: "The America that [Theodore] Roosevelt dreamed of was always a sort of swollen Prussia, truculent without and regimented within." (Raico, (2001))

Robert Higgs argues[5] that the Great Depression, with its New Deal policies, was a remnant manifestation of the economic regimentation inaugurated in United States by the First World War:

Many of the institutional arrangements created during the Hundred Days merely reactivated programs and agencies employed during World War I. […] Moreover, the men selected to administer the revised institutions were often those who had played leading roles during 1917-1918, especially the War Industries Board and the Army.

In America’s Great Depression, Rothbard evokes Hoover’s idea of his part in the New Deal:

Hoover summarized the measures he had taken to combat the depression: higher tariffs, which had protected agriculture and prevented much unemployment, expansion of credit by the Federal Reserve, which Hoover somehow identified with “protection of the gold standard”; the Home Loan Bank system, providing long-term capital to building-and-loan associations and savings banks, and enabling them to expand credit and suspend foreclosures; agricultural credit banks which loaned to farmers; Reconstruction Finance Corporation (RFC) loans to banks, states, agriculture, and public works; spreading of work to prevent unemployment; the extension of construction and public works; strengthening Federal Land Banks; and, especially, inducing employers to maintain wage rates. Wage rates “were maintained until the cost of living had decreased and the profits had practically vanished…” (Rothbard (2000), pg. 321-322)

Faced with these departures from the free market order, what is the State, epitomized by its President, to do? The reasonable reaction in front of the debacle of interventionist measures is not more interventionism, but cancellation of the interventionist measures that have caused social harm in the first place.

From what we will see, not only didn’t Roosevelt put out Hoover’s fire, but he has even poured more gas on it. Instead of wondering whether Roosevelt got Americans out the Great Depression, we should ask: Has the Roosevelt Administration ever done anything of good economic consequence?

There is a plethora of legislative acts that the Congress has decreed, in some cases as a post-factum justification of Roosevelt’s actions. We will review a series[6] of decrees that illustrates the sheer size of Roosevelt’s interventionism. They made such changes, “on such a scale and left such an enduring ideological residue that they represent a quantum leap of statism in American history.” (Raico, 2001)

The avalanche of interventionism could be categorized into several chapters: monetary-financial; labor and public works; agriculture; housing; taxation and redistribution; manufacture and industry. This categorization will allow for a theoretical interpretation, in light of economic theory, of some of the over forty decrees enumerated. Also, we will see what the actual consequences were.

The monetary-financial measures

Economics teaches that any amount of extra money introduced into an economy by the government, through any channel, is going to distort the structure of relative prices and will practically[7] lead to a further unsustainable squandering of scarce and valuable resources by malinvestment in a production structure discoordinated to a greater degree than in the absence of monetary manipulation. The Roosevelt regime has worked under the sway of inflationism from its very inception.

The Bank Holiday

Hoover ended his mandate in economic chaos. In January 1933, all over United States panic and bank runs were causing the disappearance of bank reserves into gold in circulation. A virulent wave of partial bank closures —imposed by state governors— culminated in Roosevelts first economic measure: the instauration of a nationwide bank “holiday” starting March 6, 1933. Many say that the inauguration of his presidency with a banking holiday was inevitable. The entire monetary system was at risk of collapse, with ruinous consequences for the economy. Against this view, Murray Rothbard argues that in the 1933 bank run episode the United States faced a classic interventionist’s fork:

Essentially, there were two possible routes. One was the course taken by Roosevelt; the destruction of the property rights of bank depositors, the confiscation of gold, the taking away of the people’s monetary rights, and the placing of the Federal Government in control of a vast, managed, engine of inflation. The other route would have been to seize the opportunity to awaken the American people to the true nature of their banking system, and thereby return, at one swoop, to a truly hard and sound money.

The laissez-faire method would have permitted the banks of the nation to close—as they probably would have done without governmental intervention. The bankrupt banks could then have been transferred to the ownership of their depositors, who would have taken charge of the invested, frozen assets of the banks. There would have been a vast, but rapid, deflation, with the money supply falling to virtually 100 percent of the nation’s gold stock. The depositors would have been “forced savers” in the existing bank assets (loans and investments). This cleansing surgical operation would have ended, once and for all, the inherently bankrupt fractional- reserve system, would have henceforth grounded loans and investments on people’s voluntary savings rather than artificially extended credit, and would have brought the country to a truly sound and hard monetary base. The threat of inflation and depression would have been permanently ended, and the stage fully set for recovery from the existing crisis. But such a policy would have been dismissed as “impractical” and radical, at the very juncture when the nation set itself firmly down the “practical” and radical road to inflation, socialism, and perpetuation of the depression for almost a decade. (Rothbard (2000), p. 329)

Although Rothbard’s solution in this case is open to critique from his own intellectual camp —on ethical grounds— the Hoover-Roosevelt apparent consensus was clearly not preoccupied with the proper way of doing justice to the depositors when it closed the banks nation-wide. Rather, the purpose was to avoid a further run of gold reserves from the banking system and the associated prospect of prolonged and deepened deflation.

The Nationalization of Gold

His action, ingeniously claiming justification from a law passed during the First World War, the Trading with the Enemy Act, was covered ex-post, on March 9, 1933, when Congress passed the Emergency Banking Relief Act. This act represents a stab in the back of the American citizen, marking a permanent encroachment on property rights. Besides further enforcing and extending an older privilege[8] accorded to banks, shielding them from citizens’ property rights in taking back their own gold, the act bestowed upon the President the power to manipulate the dollar definition of gold. The next measures in the monetary area were, in a logical continuity, aimed against the gold standard. In April 5th and 19th gold possession was deemed illegal and gold reclamation by private citizens was abolished. Thus, America was taken off the gold standard.

The Thomas amendment to the Agricultural bill, dating from April 20th, was intended to create aggressive inflation: 6 billion of new dollars in purchases of government bonds and banknote printing and the power to devalue gold up to 50% were the main measures for increasing the monetary base and for further inflation.

Banning Short Selling

In the battle against “lower-than-normal prices”, the Roosevelt administration continued Hoover’s war on financial speculation in general and short selling in particular. The Federal Securities Act from May 1933 and the Securities Exchange Act from June 1934 were aimed mainly at fighting price deflation in the primary and secondary financial markets. The demand for “truth in securities prospectuses” had quite obviously the effect of hampering the issue of new securities. The introduction of a bureaucratic agency, the Securities and Exchange Commission, to hunt for the practice of insider trading, to discourage short selling and generally monitor the market in Big-Brother fashion could not have other effects than leading to increased discoordination and inhibition of the credit market and, so, to another step in the direction of general impoverishment.

The foreseeable effect of this type of regulation is wider fluctuation of prices, as the institution of short selling is known to mitigate price fluctuations[9]. Benjamin Anderson draws the verdict on the regulation and control against short-selling:

the Dow-Jones industrials rose from 108.64 on June 1, 1935, to 190.38 on August 14, 1937, and then dropped to 97.46 in March 31, 1938. This is not a brilliant record for a governmentally controlled, daily inspected, constantly managed stock market, designed to give protection to investors and to eliminate wide fluctuations in security prices. (Anderson (1979), p. 448)

Prohibition Of Gold Clauses

Roosevelt’s freedom in gold manipulation was thwarted by government’s long-term obligation to its citizens —e.g., gold bonds— and also by the citizens liberty to include gold clauses in private contracts. Therefore, on June 5th, he had Congress pass the abrogation of the gold clauses in contracts. According to Robert P. Murphy[10],

This continued prohibition of gold clauses is significant, and reflects the ultimate objectives of the government…Americans were now entirely at the mercy of those controlling the printing press.

The Glass Banking Act

Another piece of financial legislation was the Glass Banking Act of June 16, 1933. It contains regulations against abuses of the “wild period” of 1924-29. However, it is considered a failure to strike at the “basic evil”, the unsound FED policy, because it dealt with symptoms (such as securities underwriting and speculation).

It decreed separation of commercial and investment banking, interdiction for banks to underwrite bonds except federal, state and municipal, interdiction of loans to banks officers and interdiction of interest payment on deposits. This particular act could be among the few, if not the only one, that contains elements compatible with financial normalcy.

We are dealing here with provisions aimed at the elimination of the fraud of fractional reserve banking, the deliberate confusion of deposits with credit transactions: hence the interdiction of interest payments on deposits and the separation of commercial and investment banking.

But it is only a half-baked act, as the federal reserve system of pyramidal monetary expansion was not affected by this kind of minor regulations. This separation left untouched the confusion of the two distinct activities traditionally performed by banks: on the one hand deposit banking, i.e., the business of guarding in toto, accounting and making payments with the money deposited and received by clients, on their behalf, and on the other hand credit intermediation, i.e., the business of buying credit from clients who save and selling it to clients who borrow.

Both these activities continued to be performed by commercial banks after the passage of the Glass Banking Act. Tabarrok (1998) argues that the artificiality of the separation between commercial and investment banking is a result of the scheming rivalry between the two major special interest groups of the era, “the Morgans” and “the Rockefellers”, rather than a product of principled policy.

However, there are some of the measures contained in this act that could not possibly help with economic recovery. The introduction of the Federal Deposit Insurance Company was not in the least contrary to the inflationary drive of the banking system, since this kind of assurance of Fed rescue is creating a moral hazard towards more monetary expansion. We will analyze below the institution of deposit insurance, that continued its existence ever since.

The crowding-out of bond underwriting means that a relative burden was put on the issuing of bonds by the private sector and that the federal, state and municipal agencies could relatively more easily attract funds through the issuance of bank underwritten bonds.

Diminishing the Gold Definition of the Dollar

While private gold redemption was abandoned, the national monetary and banking system was still exposed to gold discipline since the internal gold standard renunciation was deemed only a transitory measure and the Fed was internationally bound to buy back the dollars sold by the other national banks with gold.

These “golden shackles” were further loosened on January 30, 1934, when the Gold Reserve Act fixed the devaluation of the dollar in terms of gold. The price of gold went from 20.67 dollars per ounce to 35 dollars per ounce. It meant a 69% increment of the monetary base.

Prior to this measure, Roosevelt backed temporarily Professor Warren, the “agricultural economist” with no monetary background, who came up with the idea of a gold variation program. He advised for the discretionary manipulation of the gold definition of the dollar. It was thought that dollar devaluation should turn internal prices up in paper dollar terms. Speculation thwarted this short-sighted initiative.

First of all, leaving aside for the moment all the complications introduced by the financial international setting at that time, even in the case of a purely paper money inflation the effects would come about after some time. Even if the market anticipates the coming inflation and the entrepreneurs know that they will have to charge increased prices in order to avoid capital consumption, there are several factors impeding instant price inflation.

First, there is the fact that new money are usually not uniformly dispersed by helicopter-like devices but introduced into the nexus of market exchanges at certain points —e.g., the Reconstruction Finance Corporation (RFC) was massively buying gold at increased dollar prices in the London market— and it takes time for them to reach the other market participants.

Also, some of the market participants will never see their real income increase as a consequence of this monetary injection. This process described by Cantillon could theoretically be alleviated by the use of credit. However, in a private property order the means of avoiding monetary-induced losses is limited by the amount of real saving existing in the economy.

The arbitrage in the time market will take the interest rate to such a height that some entrepreneurs, in spite of correct anticipation of the future purchasing power of the monetary unit, will realize that the interest rate at which they must borrow funds or take commercial credit makes them incur capital losses.

The only option available for this class of entrepreneurs, if they are really alert and visionary, is to unwind their businesses in due time or, what amounts to the same measure, short sell the stocks of their own businesses. This is how the Cantillon effect works: a monetary-induced change in the price structure brings about a shift of capital and resources in the market, under all circumstances.

In the Rooseveltian manipulation case, the facts were very different from a situation based on private property. The banking sector had the privileged power to fabricate paper credit with no correspondent in increased savings. But it also was still under an international gold standard and this is one reason why credit manipulation was not as easy as nowadays.

Effects in External Markets

What Roosevelt and his counselors should have had in mind, instead of lucky numbers[11] —when arbitrary fixing, over breakfast in bed, the dollar definition of gold—, was the obvious peril of a speculative drain on the money reserve and the subsequent further implosion of the inverted credit pyramid. Also, even with credit capacity intact, banking and the other entrepreneurs usually need the confidence of clear rules before starting risky new businesses by taking credit and bidding up prices in factor markets.

The resulting market reaction to this gold fumbling was foreign exchange speculation in the London market. A lot of sellers of gold were probably redeeming it from the other countries still on the gold standard (France, the Netherlands, Belgium, Switzerland) and selling it to the RFC at a higher dollar price in order to profit from a lagging exchange rate and a fixed gold definition at the other central banks.

Also, we should keep note of the fact that the international monetary system was in a metamorphosis from the gold standard to the gold exchange standard, the latter including two paper currencies besides gold —the pound and the dollar— into the monetary base. Overall, the gold manipulation program led to the increase of Fed gold, and not to its decrease.

The only notable effect, however, besides destabilizing the other national monetary systems pyramided on gold,[12] was a weakened dollar in foreign exchange, amounting to external dollar inflation. Commodities markets did not rise, maybe because the international trade was hampered by protectionism, maybe for still other reasons.

Monetization of Silver

Further on, yielding to the silver interests and aiming at an even bigger increase of the monetary base and more paper money inflation on top of it, the Roosevelt regime came up with the Silver Purchase Act, passed by Congress on June 19, 1934.

In this decree, the government was to buy silver at a price higher than the market price (50 cents per fine ounce). It was applied to the stocks of the silver speculators, not to coins or jewelry or newly mined domestic silver. The Treasury issued legal tender silver certificates, “redeemable on demand in silver dollars”.

According to Benjamin Anderson[13], this measure rendered the dollar weak in the foreign exchange market and some gold was exported until the exchange recovered. The long term effect was a massive accumulation of silver in the vaults of the American government and the increase of the world silver price.

More Inflating Power for the Fed

Another step in monetary regimentation and control was the Banking Act of August 23, 1935. It revised the operation of the Federal Reserve System with the intention of bringing the member banks under the power of the Federal Reserve Board by monopolization of the open market operations and a looser definition of the monetary base. It established federal deposit insurance for deposits up to 5000 dollars.

The most important aspect of this act was that it meant to increase the monetary basis, by extending the type of eligible assets from gold, papers secured by government bonds and short-term commercial paper (maturing at less than 90 days) to any kind of asset deemed “sound” by the Fed.

Senator Glass initiated opposition and amended the bill to the effect that the maturity of these “assets secured to the satisfaction of the Fed” was to be extended to a maximum of 120 days and have a penalty rate of at least half percent over the usual discount rate. The Glass subcommittee succeeded also in putting the open market operations in the hands of an Open Market Committee in which the Board had only partial power.

From the perspective of a sound monetary policy, this kind of victory, where monetary inflation is to be done by the “Lesser Brothers” and not by the Big Brother himself is hardly a success. It may very well be that the moral hazard thus created leads eventually to an even bigger monetary expansion than under a system completely monopolized by a Central Bank.

We should clarify here that although the Glass opposition succeeded in bringing about a less pernicious solution than the one initially designed by the opponents, the starting point of this reform was already a flawed arrangement.

To the extent that the owner of a U.S. banknote —only international traders after march 1933— had the right to demand gold on spot at face value —at face quantity, to be more precise— in exchange for their banknotes, the answer to the question of monetary base definition is blunt: only gold and nothing else, however liquid, should constitute the monetary base.

These were the main decrees defining the inflationary financial and monetary foundation on which the other pillars of economic planning came.

[1] F.D. Roosevelt’s Nomination Address, Chicago, Ill., July 2, 1932. Cited in Raico (2001)

[2] Senator Thomas P. Gore from Oklahoma answering F.D. Roosevelt on the resolution abrogating the gold clause. Cited in Anderson (1979), p. 317.

[3] Flynn (1948), p. 10.

[4] Expression taken from Higgs (1997).

[5] Higgs (1987), p. 173.

[6] Sources: The Real Deal: The Battle to Define FDR’s Social Programs, An American Studies Website created by Paul Volpe, University of Virginia, (Accessed: May 25, 2009); Anderson (1979), Powell (2009).

[7] To the unlikely extent that the monetary expansion is anticipated by the entrepreneurs and thus the interest rate reaches the same level it would have reached in the absence of the expansion, the intertemporal malinvestment is avoided. See Hülsmann (1998).

[8] Huerta de Soto (2006), chapters 2, 3, and 8.

[9] Carden, Murphy (2008).

[10] Murphy (2009) p. 129.

[11] Flynn (1948) p. 57.

[12] Anderson (1979), p. 343.

[13] Anderson (1979), pg. 353-356.

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