New Deal or Bad Deal?

Franklin Roosevelt was wrong. In the most quoted phrase of the Great Depression, he promised the American people that the only thing they had to fear was fear itself. By the end of that debilitating decade, what the American people had learned to fear most was the government. The President, and his well-intentioned New Dealers of inspiring rhetoric but confused and counter-productive socialist policies, had prolonged the pain, developed make-work projects instead of real jobs, made scapegoats of business and businessmen, scared off capital and saddled the taxpayer with a mountain of debt. That ordinary taxpayer, the Forgotten Man of Amity Shlaes’s comprehensive account of the Great Depression, ended up paying for it.

Any reader would find the parallels with present-day Australia remarkable. By the end of the book, one is left with the uncanny impression that Australia’s Prime Minister has modelled his rhetoric, his vituperative criticisms of Wall Street greed and his ideological commitment to big government and central planning on those of the American President and his New Deal. In Roosevelt’s view, capitalism had failed. Kevin Rudd boasted that his mission was to save capitalism from itself. There is a further parallel: both Roosevelt and Rudd came to office after more than a decade of Republican or Liberal Party governments which then lapsed into demoralised oppositions.

A Yale University philosopher, William Graham Sumner, coined the phrase of the book’s title at the turn of the century, writing in an essay:

“The characteristic of all social doctors is, that … forgetting that a government produces nothing at all … the State cannot get a cent for any man without taking it from some other man, and this latter must be a man who has produced and saved it. This latter is the Forgotten Man.”

In a wireless broadcast in April 1932 in his run for president, Roosevelt misappropriated the Forgotten Man. He inverted the sense to suit his call for “plans that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid”.

Despite his own patrician background, Roosevelt soon proved himself a virulent anti-capitalist who blamed greed for the 1929 crash and excessive competition for the Depression. His New Deal tilted the balance in America from a country of free enterprise to one of interfering centralised government, empowering the so-called progressive movement which dominated American politics until the Reagan era. The president even changed the language; where once the word “liberal” stood for the individual, in future it would stand for groups.

The Great Depression generated great myths. Few of the forty or so books on the Depression published in the last ten years have been willing to puncture them, but The Forgotten Man does. Roosevelt did not end the Depression; his policies prolonged it, and when recovery was well under way, in Australia and elsewhere, they renewed it in America. It is a myth that Keynes’s prescriptions were responsible for Roosevelt’s policies. The great economist’s reputation and influence were built after the Second World War; it was the massive war spending that seemed to validate his theory of demand stimulus. During the 1930s, Keynes’s increasingly critical letters to the president revealed his frustration that the erratic and contradictory measures of the New Deal were negating his advice. Indeed, Roosevelt’s scepticism was revealed after their first meeting when he said Keynes had left him with “a rigmarole of figures. He must be a mathematician rather than a political economist.”

Shlaes’s book is a narrative history, written, as one American reviewer put it, almost like a novel. Like an intricate petit-point tapestry, it stitches personality portraits and anecdotes of individual despair onto the background canvas of the depressing politico-economic story that was the 1930s. Its impact has been considerable. First published two years ago, its best-seller status has been responsible for a widespread debate in the United States about economic policy and political direction that has only increased with the progression of the current global crisis—a debate that has hardly been echoed in Australia.

Her book’s success is due to Shlaes’s approach as an economic journalist, not an economist, political scientist or sociologist. As a result her tale is told through the people at the centre, not through details of their programs and their statistics. That said, its density and breeziness can make it a difficult book for non-Americans. It takes a knowledge of American history for granted, requiring constant referral to other sources for explanation of institutions, legislation, geography, acronyms and some of the more obscure protagonists. The lack of indexed footnotes is a hindrance. For many Australians, a computer mouse and a search engine would be essential tools to a full understanding.

The author begins to set the scene by reaching back into the 1920s, where the seeds of the Depression were sown, and where the great crash of 1929 was just another casualty, and not its cause. The standard history, she points out, is that the 1920s were a period of false growth and low morals. A dangerous inflation caused by speculating margin traders brought down the nation (so it went) but the country returned to sanity and morality with Roosevelt and his New Deal, a period when Americans learned that government spending was important to recoveries. The consumer alone could solve the problem of “excess capacity” on the production side. It was the beginning of the debate between “trickle-down” and “bottom-up” economics.

On the contrary, Shlaes writes, the 1920s was a decade of true economic gains; the growth of those years was not an illusion; unemployment fell from 5 per cent to 2 per cent; Ford’s production rose from 6000 cars a day to 8500; the new inventions of the radio and the telephone were remaking home and work; inflation was low; American capitalism did not break in 1929. Nor did Roosevelt rebuild it after the Depression (as Kevin Rudd wrote in his misinformed essay on the financial crisis). The annihilating event that neither President Hoover nor President Roosevelt understood was deflation. Both underestimated the strength of the American economy and both mistrusted the stock market.

The loss of international trade due to the tariff war sparked by Hoover’s Smoot-Hawley Act in 1930 played an enormous role; also, part of the problem was the transition from agriculture to industrialisation. Just as predictions of cataclysmic climate change are spooking people today, freakish weather—devastating floods and the Dust Bowl blowing away the “good earth” of the farmlands—“seemed to validate the sense of apocalypse”. Roosevelt, an Episcopalian (Anglican) like Rudd, “found laissez-faire economics immoral and disturbingly un-Christian”. Caring little for constitutional niceties, his remedies, usually on a grand scale, “were often inspired by socialist or fascist models abroad”.

While projects such as the Civilian Construction Corps created small local infrastructure still enjoyed today, these were mostly what we would call “work for the dole” jobs lasting months, not years. Establishing the Securities and Exchange Commission had a stabilising effect, despite its errors. But these initiatives were outweighed by other interventions which helped make the Depression great. Shlaes shows that despite a perpetual promise of recovery, the economy never made it back to 1929 levels, either in employment or in the stock market, until the Second World War. However, the lasting damage wrought on the United States was the creation of the modern concept of entitlement which stemmed from Roosevelt’s systemisation of interest-group politics.

Amity Shlaes, now senior fellow in economic history at the Council on Foreign Relations, believes the Great Depression is a bit like the Bible—the more we return to it, the more we find. Extending that analogy, The Forgotten Man is another book of the Depression Bible. So it may come as a surprise to a foreigner to find how much events in far-off Europe determined the course of the Great Depression in the USA. The Russian revolutionary experiment in socialism and Mussolini’s dictatorial stamp on the disorder of Italy fascinated the intelligentsia of American academia and the trade unions. They derived inspiration from these movements for their ambitions to change America. When their efforts to advance the Socialist Party failed in the elections of 1928, they hitched their wagon to the Democratic Party and the receptive Governor of New York with his presidential aspirations.

In a chapter titled “The Junket”, Shlaes takes us on the pilgrimage to Russia made by a group of professors, teachers, trade unionists, economists and writers in 1927. These intellectuals of the American Left included Rexford Tugwell, Stuart Chase, James Maurer, Paul Douglas and Roger Baldwin, all of whom went on to positions of considerable influence in the New Deal and its programs. Some in the party were communists, open or covert. Five travellers gained an audience with Stalin, who sought to use the interview to win over American labour, and to gain diplomatic recognition for the regime, as a step towards solving Russia’s pressing need for cash. This was the group from which Roosevelt largely drew his “brains trust”, the panel that helped formulate his policies for the 1932 presidential election, and afterwards continued to help put them into practice. Although he was not on the Russian tour, a young lawyer, Alger Hiss, later unmasked as a Soviet spy, occupied senior positions in the Agriculture Administration and the State Department throughout the 1930s. Admiration for Mussolini (at least until his invasion of Ethiopia) and for Stalin’s collectivisation continued well into the 1930s. In 1931, 10,000 Americans visited Russia to see the great experiment for themselves.

From the time he decided to contest the Democratic Party nomination, Franklin Roosevelt showed himself both the consummate politician and an economic illiterate. Shlaes demonstrates how this led to the many contradictions of his experimental policies. He had the luck to be born into the great era of radio, and the further luck to be a great radio speaker, with a warm, “reasonable” voice. (Today we can prove that for ourselves through access to the audio archives of the American Presidency Project.) His inspired innovation was the “Fireside Chat” in which he reached out to the people, characterising himself as their inspirational leader out of disaster.

His first radio speech described the common man as “the infantry of our economic army … the forgotten, the unorganised but indispensable units of economic power”. On Thanksgiving Day 1932, shortly after he massively defeated Hoover, he turned to the Book of Common Prayer: “Remember in pity such as are this day destitute, homeless or forgotten of their fellow-men.” But as time went on, his tone became more strident in denunciation of capitalist greed. In his First Inaugural Address he fulminated against “practices of the unscrupulous money changers [that] stand indicted in the court of public opinion, rejected by the hearts and minds of men”. He declared: “there must be an end to a conduct in banking and in business which too often has given to a sacred trust the likeness of callous and selfish wrongdoing”. Four years later, seeking an extension of his mandate, he ramped up the rhetoric: “We are beginning to abandon our tolerance of the abuse of power by those who betray for profit the elementary decencies of life”, asserting that “we must find practical controls over blind economic forces and blindly selfish men”.

These are sentiments Australians can easily recognise in the recent writings of their Prime Minister.

Ignoring the first two years under Hoover, who did so much damage by his policies of pegging wages, reducing hours and raising farm prices, the American Depression divides neatly into the two periods of Roosevelt’s first two terms. The first, from 1932 to 1936, was a time of zig-zag incoherent policies in which Shlaes categorises the president as the Experimenter. His exhortations to the people had contained no coherent statement on the role of government in the crisis. He experimented with the price of gold, on one occasion thinking of raising it by twenty-one cents, because, as he told aides, “it’s a lucky number—three times seven”. Treasury Secretary Henry Morgenthau confided to his diary: “If anybody ever knew how we really set the gold price through a combination of lucky numbers, I think they would be frightened.” The President next made it illegal to hold gold, and then invalidated the gold clauses in contracts. Shlaes describes this as a primitive revenge act of social redistribution which transferred $200 million of wealth from creditors to debtors. Keynes told him his gold purchase program looked like “a gold standard on the booze”. Finally, the President decided to abandon the gold standard, devaluing the currency from $20.33 to $35.

Americans had to see that the administration was doing something. Will Rogers summed up the mood of the nation with his quip that the President could have burned down the Capitol and the people would have applauded. The first great project was the National Industrial Recovery Act (NIRA). It established the Public Works Administration, whose spending on infrastructure was to fix the economy. It also created new labour rights to increase pay, on the theory that workers would have more money to spend. Finally, the NIRA established the National Recovery Administration (NRA), run by a retired general as a military operation. This “stole the socialists’ clothes while they were swimming” as one commentator put it, regulating industries, setting minimum wages, limiting child labour and restricting competition. It destroyed the traditional free market system, suspended anti-trust laws, institutionalised price collusion and increased business costs when many companies were struggling. Keynes wrote in the New York Times: “The NRA probably impedes recovery and has been put across too hastily.” The 600 industry codes, with 10,000 pages of regulations, published in a blaze of nationalistic fervour under the “Blue Eagle” banner, contained such absurd rules as prohibiting people from buying the chicken of their choice. This eventually led, as Shlaes details in her chapter “The Chicken Versus the Eagle”, to the Supreme Court finding the whole NIRA unconstitutional.

Parallel legislation in the farm sector, the Agricultural Adjustment Administration (AAA), was equally wrong-headed. It too, was later ruled unconstitutional. Roosevelt was persuaded that falling farm prices were due to over-supply. The AAA mandated output reductions which cost $110 million in subsidies, paying farmers not to produce. Ten million acres were taken out of the cotton crop, 4 million hay bales were left on the farms, and 6.4 million piglets and sows were slaughtered at a time when many people were starving. This all had a devastating effect on sharecroppers and accelerated the Okies’ migration down Route 66 to California. Ogden Nash satirised the production cuts:

Mumbledy pumbledy, my red cow

She’s co-operating now.

At first she didn’t understand

That milk production must be planned …

But now the government reports

She’s giving pints instead of quarts.

In the 1930s electricity was the broadband promise of the era. Under the New Deal, power to all homes and farms would raise living standards and create a more prosperous society. For Roosevelt, it also provided the weapon to smash the power of the holding companies that had built the generation and distribution. Power was too important to stay in the private sector, he said in one of his Fireside Chats. To avoid the constitutional problem of states’ rights, the New Deal created regional entities based on river basins. The Tennessee Valley Authority (TVA) was the first, conceived originally as a flood mitigation and farmland beneficiation project. But as the dams filled, the potential for developing hydro-electric power at subsidised rates (the capital cost was not booked) enabled the government to crush the private generators. The most important of these, Commonwealth and Southern, controlled by Wendell Willkie (the unsuccessful Republican candidate in the 1940 presidential election) was eventually forced to sell its Tennessee business to the TVA for $45 million. The shareholders did well, but Willkie pointed out nobody could predict what the government would do now it could set monopoly pricing. Seven “little TVAs” across the country were to follow.

In 1935 Roosevelt switched dramatically from utopia to politics. His political instincts told him to convert what Shlaes calls “ephemeral bits of legislation” into solid law benefiting specific groups of voters. Focusing on farmers, big labour, pensioners, veterans, and perhaps women and blacks, would cement the support of constituencies who would ensure his re-election the next year. What followed were additions to the alphabet soup of instrumentalities: the WPA (Works Progress Administration) to employ millions on 100,000 “shovel-ready” projects (at the time lampooned as “We Piddle Around” and many of the jobs as “boondoggles”); the FWP (Federal Writers Project) to set unemployed writers and newspapermen to work on chronicling the achievements of the recovery programs; the NYA (National Youth Administration) to provide work for high school leavers; and the FTP (Federal Theatre Project), headed by Hallie Flanagan, a socialist director who modelled her plays and performances on the “realist” propaganda of the Soviet theatre, which she had visited and studied.

Then the President turned to his enemies: big companies, employers, the wealthy, and especially the utilities. He sent Congress a message railing against “the great accumulation of wealth” and called for a tax bill to change society. It raised the top income tax rate to 79 per cent, the top property tax to 70 per cent and lowered thresholds so more families paid higher taxes. There was also a graduated corporations tax and a dividend tax on retained earnings. He then signed the National Labor Relations Act (the Wagner Act). At one blow it set up the trade unions as one of the greatest power blocs in America, institutionalising the closed shop and the guaranteed right to strike. The Public Utilities Holding Company Act then limited the electricity utilities to one state and forced divestment of their subsidiaries.

Finally came the Social Security Act, for which Roosevelt is best remembered. This omnibus act covered public health and unemployment, but its central feature was America’s first old-age pension scheme. Just before the 1936 election, 26 million working people received a document assuring them that their contribution of three cents in the dollar, up to an income of $3000, and matched by their employer, would assure their retirement. A monthly cheque for the rest of their lives would come as their right.

Other writers have been more critical of the Act than Shlaes. Burton Folsom, of the Foundation for Economic Education in New York, writes in his New Deal or Raw Deal that the structure was hugely regressive. He describes it as a Ponzi scheme requiring future generations to pay for benefits to earlier ones. America’s leading expert on welfare policy, Professor Edward Berkowitz of George Washington University, went further, describing the Social Security Act as the cause of Roosevelt’s recession of 1937–38. In a communication to me, he explained that the old-age insurance part of the Act took money out of the economy at just the time when the economy needed stimulation.

Fearing inflation, the Treasury tightened the money supply by raising banks’ reserve requirements. They in turn cut back lending, which taken together with the undistributed profits tax and steep wage rises won under the Wagner Act sent many companies into bankruptcy. The country suffered the steepest drop in industrial production in history, unemployment shot back up to 1931 levels, and the President complained about a strike of capital. Yet Treasury Secretary Morgenthau was pushing hard for a balanced budget! In a letter to the New York Times in 1934 Keynes had written: “I see the problem of recovery in the following light: How soon will normal business enterprise come to the rescue?” In 1937 and 1938, Shlaes points out, the New Deal was competing with the private sector, and frightening it.

Roosevelt turned vindictive. He threatened to pack the Supreme Court with six additional justices if the court continued to declare his statutes unconstitutional; the court buckled. He forced the tax commissioner to name and shame sixty-seven large wealthy taxpayers, including Pierre DuPont and William Randolph Hearst, alleging their tax returns, although perfectly legal, were not “conscientious”. He set investigators of the Revenue Service onto his most vocal critics and political opponents to press charges of tax fraud (but exempted his young protégé, Lyndon Baines Johnson). Elliott Roosevelt wrote candidly: “My father may have been the originator of the concept of employing the IRS as a weapon of political retribution.”

In her broad survey of the times, Shlaes recaptures the resourcefulness of Americans as well as their misery. When the money ran out—literally—in 1931, barter deals took its place. The citizens of Salt Lake City created a group that made its own money they called the vallar. When one in four Americans could not find work, even Bing Crosby could not console them with one of his most famous songs:

Once I built a railroad

I made it run

Made it race against time.

Once I built a railroad

Now it’s done

Brother, can you spare a dime?

In New York, George Baker, a black spiritual leader who became famous as Father Divine, offered sumptuous meals to people of any race, colour or creed, and campaigned to make people less dependent on government. Self-sufficiency might be possible in the country, but in the towns many depended on charity, or starved. A poem in the Atlantic Monthly in 1932 asked:

What’s the meaning of this queue

Tailing down the avenue,

Full of eyes that will not meet

The other eyes that throng the street …

Because the American Depression lasted so long, the suffering was much greater than in other countries. David Potts concludes in his account of the Australian experience, The Myth of the Great Depression: “In Australia no-one died of starvation due to poverty, malnutrition declined, infant mortality and general death rates fell, health improved and the great majority remained housed much as usual and were adequately clothed.”

In all the mismanagement and ideological vindictiveness, did the Depression crush America’s great innovative and entrepreneurial spirit? The era produced these inventions, none of them the result of government initiatives: air conditioning; colour film; commercial television; dishwashers; electric razors; photocopiers and fax machines; fluorescent lighting; nylon and plexiglass; supermarkets; Monopoly (the board game); tampons; and Alcoholics Anonymous. The government bequeathed the country: Federal Deposit Insurance, the SEC, Social Security and the five-day working week.

Shlaes’s account ends with a simple conclusion: what stands out is not how much the New Deal public works achieved, but how little. The public jobs did their work inefficiently, because they were scripted to serve political ends, not economic ones, she says. The private sector was incredibly productive, but the government was taking all the air in the room. Roosevelt set new criteria for government policy—to be caring, compassionate and humane instead of efficient and effective—criteria which still rule today.

What of the history wars sparked by the book? Dr Christina Romer, Chair of President Obama’s Council of Economic Advisers, argued before the Senate Banking Committee this year that large-scale stimulus programs were essential for a recovery. Roosevelt’s fiscal actions were a bold break from the past, she said, but too small relative to the size of the problem, and fiscal expansion was not sustained. It increased the deficit by only 1.5 per cent of GDP. Obama’s stimulus, she said proudly, was costing 3 per cent of GDP. Her testimony ended rather lamely that a final lesson from the 1930s was that the Great Depression did eventually end. 

Lee Ohanian, Professor of Economics at UCLA, also gave evidence to the Banking Committee. He argued that increased aggregate demand had relatively little to do with any New Deal recovery. The unemployment rate declined, (only to 14 per cent) but the hours worked fell by as much as 27 per cent because some New Deal programs included explicit work-sharing, reducing the average working week. Almost all of the increase in real GDP during the New Deal, he points out, is accounted for by increased productivity. Instead, programs which increased monopoly and raised wages above productivity significantly delayed what would have been a rapid recovery. There is a disturbing similarity between this analysis and Australia’s current unemployment statistics. The unemployment rate may have remained around 6 per cent, but a further 7 per cent are under-employed, on work sharing and shorter working weeks.

The Forgotten Man can be read as a case study in the unintended consequences of good intentions. The much-vaunted Tennessee Valley Authority project was funded by 100 per cent of taxpayers to benefit 2 per cent of the population. The scheme became a protection measure for the small farmers; their farms remained small and the valley’s productivity fell behind that of other farming areas. The Agricultural Adjustment Administration, by raising prices and restricting production, caused a massive eviction of tenant farmers on the southern cotton plantations, adding to unemployment figures and the relief burden.

Because the Social Security Act was not actuarially calculated, it benefited most the people who had contributed least. (In 1940, Ida May Fuller, the first person to receive a pension, got almost as much in her first monthly cheque as she had contributed in three years.) The benefit age of sixty-two was two years more than white workers’ average life expectancy, and fourteen years more than that of black workers. When challenged, Roosevelt admitted it was “politics all the way through”.

The Wagner Act sought to increase workers’ rights. But higher wages encouraged mechanisation that led to job reductions and union discrimination against blacks. The Act provoked and legitimised strikes that paralysed the auto and steel industries and saddled them with costs that were to destroy their competitiveness in the postwar years.

As Professor Ohanian has pointed out, all the stimulus to spending produced virtually no increase in per capita consumption; at the end of the decade, the average person was no better off. By then, Roosevelt was acknowledging that the American economy had become a “concealed cartel system like Europe”, and the Justice Department reinstated anti-trust prosecutions. The Supreme Court ruled sit-in strikes illegal. Later, faced with the realities of war, the government restricted union wage settlements to cost-of-living increases, further admitting the failure of New Deal labour and industrial policies.

How can the New Deal be considered a success? Its epitaph was written by one of its greatest supporters, Henry Morgenthau, Secretary of the Treasury, in evidence to the House of Representatives Ways and Means Committee in May 1939:

We have tried spending money. We have spent more than we have ever spent before and it does not work … I say after eight years of this Administration we have just as much unemployment as when we started … and an enormous debt to boot.

What then of Australia’s spending in this recession? The government’s New Deal-type policies have already cost the country a significant budget deficit and a record public debt. Gathering forces threaten to reverse any recovery, just as they did in the USA in 1937:

• Fair Work Australia legislation has reduced labour market flexibility, strengthened union power to gain wage increases, legitimised the closed shop, and limited small businesses’ ability to reduce costs.

• As in America’s Depression, significant reductions in working hours mask the real unemployment rate. The number of unemployed rose by a modest 2 per cent in a year, but 4.4 per cent more workers were on part-time. Working hours declined by 35 million, or 3 per cent.

• Spending as a result of stimulus packages and a renewed housing boom signal potential inflationary pressures; interest rate rises are now likely and openly canvassed.

• Ideological commitment to climate change mitigation by, in effect, taxing emissions and subsidising alternative energy sources without any cost-benefit analysis will impose unquantified costs on the economy. The creation of new tradeable emission certificates will launch a new speculative market to rival that of securitised mortgages.

This recession will have a fortunate outcome for Australia only if learns from the past. The great lesson of the Great Depression is that it’s time to bury the myths about the New Deal and John Maynard Keynes. By 1938, he had given up on Roosevelt. In February that year, he concluded his last open letter to the President in these words, salutary advice for all national leaders:

Businessmen have a different set of delusions from politicians, and need, therefore, different handling … You could do anything you liked with them, if you would treat them (even the big ones), not as wolves or tigers, but as domestic animals by nature, even though they have been badly brought up and not trained as you would wish. It is a mistake to think that they are more immoral than politicians.