by David Stockman
During the Great War America became the granary and arsenal to the European Allies—-triggering an eruption of domestic investment and production that transformed the nation into a massive global creditor and powerhouse exporter virtually overnight.
American farm exports quadrupled, farm income surged from $3 billion to $9 billion, land prices soared, country banks proliferated like locusts and the same was true of industry. Steel production, for example, rose from 30 million tons annually to nearly 50 million tons during the war.
Altogether, in six short years $40 billion of money GDP became $92 billion in 1920—a sizzling 15 percent annual rate of gain.
Needless to say, these fantastic figures reflected an inflationary, war-swollen economy—-a phenomena that prudent finance men of the age knew was wholly artificial and destined for a thumping post-war depression. This was especially so because America had loaned the Allies massive amounts of money to purchase grain, pork, wool, steel, munitions and ships. This transfer amounted to nearly 15 percent of GDP or $2 trillion equivalent in today’s economy, but it also amounted to a form of vendor finance that was destined to vanish at war’s end.
Carter Glass’ Bankers’ Bank: The Antithesis Of Monetary Central Planning
As it happened, the nation did experience a brief but deep recession in 1920, but this did not represent a thorough-going end-of-war “de-tox” of the historical variety. The reason is that America’s newly erected Warfare State had hijacked Carter Glass “banker’s bank” to finance Wilson’s crusade.
Here’s the crucial background: When Congress acted on Christmas Eve 1913, just six months before Archduke Ferdinand’s assassination, it had provided no legal authority whatsoever for the Fed to buy government bonds or undertake so-called “open market operations” to finance the public debt. In part this was due to the fact that there were precious few Federal bonds to buy. The public debt then stood at just $1.5 billion, which is the same figure that had pertained 51 years earlier at the battle of Gettysburg, and amounted to just 4 percent of GDP or $11 per capita.
Thus, in an age of balanced budgets and bipartisan fiscal rectitude, the Fed’s legislative architects had not even considered the possibility of central bank monetization of the public debt, and, in any event, had a totally different mission in mind.
The new Fed system was to operate decentralized “reserve banks” in 12 regions—most of them far from Wall Street in places like San Francisco, Dallas, Kansas City and Cleveland. Their job was to provide a passive “rediscount window” where national banks within each region could bring sound, self-liquidating commercial notes and receivables to post as collateral in return for cash to meet depositor withdrawals or to maintain an approximate 15 percent cash reserve.
Accordingly, the assets of the 12 reserve banks were to consist entirely of short-term commercial paper arising out of the ebb and flow of commerce and trade on the free market, not the debt emissions of Washington. In this context, the humble task of the reserve banks was to don green eyeshades and examine the commercial collateral brought by member banks, not to grandly manage the macro economy through targets for interest rates, money growth or credit expansion—to say nothing of targeting jobs, GDP, housing starts or the Russell 2000, as per today’s fashion.
Even the rediscount rate charged to member banks for cash loans was to float at a penalty spread above money market rates set by supply and demand for funds on the free market.
The big point here is that Carter Glass’ “banker’s bank” was an instrument of the market, not an agency of state policy. The so-called economic aggregates of the later Keynesian models—-GDP, employment, consumption and investment—were to remain an unmanaged outcome on the free market, reflecting the interaction of millions of producers, consumers, savers, investors, entrepreneurs and even speculators.
In short, the Fed as “banker’s bank” had no dog in the GDP hunt. Its narrow banking system liquidity mission would not vary whether the aggregates were growing at 3 percent or contracting at 3 percent.
What would vary dramatically, however, was the free market interest rate in response to shifts in the demand for loans or supply of savings. In general this meant that investment booms and speculative bubbles were self-limiting: When the demand for credit sharply out-ran the community’s savings pool, interest rates would soar—thereby rationing demand and inducing higher cash savings out of current income.
This market clearing function of money market interest rates was especially crucial with respect to leveraged financial speculation—such as margin trading in the stock market. Indeed, the panic of 1907 had powerfully demonstrated that when speculative bubbles built up a powerful head of steam the free market had a ready cure.
In that pre-Fed episode, money market rates soared to 20, 30 and even 90 percent at the peak of the bubble. In short order, of course, speculators in copper, real estate, railroads, trust banks and all manner of over-hyped stock were carried out on their shields—-even as JPMorgan’s men, who were gathered as a de facto central bank in his library on Madison Avenue, selectively rescued only the solvent banks with their own money at-risk.
Needless to say, these very same free market interest rates were a mortal enemy of deficit finance because they rationed the supply of savings to the highest bidder. Thus, the ancient republican moral verity of balanced budgets was powerfully reinforced by the visible hand of rising interest rates: deficit spending by the public sector automatically and quickly crowded out borrowing by private households and business.
How The Bankers’ Bank Got Hijacked To Fund War Bonds
And this brings us to the Rubicon of modern Warfare State finance. During World War I the US public debt rose from $1.5 billion to $27 billion—an eruption that would have been virtually impossible without wartime amendments which allowed the Fed to own or finance U.S. Treasury debt. These “emergency” amendments—it’s always an emergency in wartime—enabled a fiscal scheme that was ingenious, but turned the Fed’s modus operandi upside down and paved the way for today’s monetary central planning.
As is well known, the Wilson war crusaders conducted massive nationwide campaigns to sell Liberty Bonds to the patriotic masses. What is far less understood is that Uncle Sam’s bond drives were the original case of no savings? No credit? No problem!
What happened was that every national bank in America conducted a land office business advancing loans for virtually 100 percent of the war bond purchase price—with such loans collateralized by Uncle Sam’s guarantee. Accordingly, any patriotic American with enough pulse to sign the loan papers could buy some Liberty Bonds.
And where did the commercial banks obtain the billions they loaned out to patriotic citizens to buy Liberty Bonds? Why the Federal Reserve banks opened their discount loan windows to the now eligible collateral of war bonds.
Additionally, Washington pegged the rates on these loans below the rates on its treasury bonds, thereby providing a no-brainer arbitrage profit to bankers.
Through this backdoor maneuver, the war debt was thus massively monetized. Washington learned that it could unplug the free market interest rate in favor of state administered prices for money, and that credit could be massively expanded without the inconvenience of higher savings out of deferred consumption. Effectively, Washington financed Woodrow Wilson’s crusade with its newly discovered printing press—-turning the innocent “banker’s bank” legislated in 1913 into a dangerously potent new arm of the state.
Bubbles Ben 1.0
It was this wartime transformation of the Fed into an activist central bank that postponed the normal post-war liquidation—-moving the world’s scheduled depression down the road to the 1930s. The Fed’s role in this startling feat is in plain sight in the history books, but its significance has been obfuscated by Keynesian and monetarist doctrinal blinders—that is, the presumption that the state must continuously manage the business cycle and macro-economy.
Having learned during the war that it could arbitrarily peg the price of money, the Fed next discovered it could manage the growth of bank reserves and thereby the expansion of credit and the activity rate of the wider macro-economy. This was accomplished through the conduct of “open market operations” under its new authority to buy and sell government bonds and bills—something which sounds innocuous by today’s lights but was actually the fatal inflection point. It transferred the process of credit creation from the free market to an agency of the state.
As it happened, the patriotic war bond buyers across the land did steadily pay-down their Liberty loans, and, in turn, the banking system liquidated its discount window borrowings—-with a $2.7 billion balance in 1920 plunging 80 percent by 1927. In classic fashion, this should have caused the banking system to shrink drastically as war debts were liquidated and war-time inflation and malinvestments were wrung out of the economy.
But big-time mission creep had already set in. The legendary Benjamin Strong had now taken control of the system and on repeated occasions orchestrated giant open market bond buying campaigns to offset the natural liquidation of war time credit.
Accordingly, treasury bonds and bills owned by the Fed approximately doubled during the same 7-year period. Strong justified his Bernanke-like bond buying campaigns of 1924 and 1927 as helpful actions to off-set “deflation” in the domestic economy and to facilitate the return of England and Europe to convertibility under the gold standard.
But in truth the actions of Bubbles Ben 1.0 were every bit as destructive as those of Bubbles Ben 2.0.
In the first place, deflation was a good thing that was supposed to happen after a great war. Invariably, the rampant expansion of war time debt and paper money caused massive speculations and malinvestments that needed to be liquidated.
The Bank of England’s Perfidy
Likewise, the barrier to normalization globally was that England was unwilling to fully liquidate its vast wartime inflation of wage, prices and debts. Instead, it had come-up with a painless way to achieve “resumption” at the age-old parity of $4.86 per pound; namely, the so-called gold exchange standard that it peddled assiduously through the League of Nations.
The short of it was that the British convinced France, Holland, Sweden and most of Europe to keep their excess holdings of sterling exchange on deposit in the London money markets, rather than convert it to gold as under the classic, pre-war gold standard.
This amounted to a large-scale loan to the faltering British economy, but when Chancellor of the Exchequer Winston Churchill did resume convertibility in April 1925 a huge problem soon emerged. Churchill’s splendid war had so debilitated the British economy that markets did not believe its government had the resolve and financial discipline to maintain the old $4.86 parity. This, in turn, resulted in a considerable outflow of gold from the London exchange markets, putting powerful contractionary pressures on the British banking system and economy.
A CONSERVATIVE BLACK ECONOMIST NAILS IT:
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Something to Think About
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March 2014
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Walter E. Williams is a professor of economics at George Mason University.
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People in the media and academia are mostly leftists hellbent on growing government and controlling our lives. Black people, their politicians and civil rights organizations have become unwitting accomplices. The leftist pretense of concern for the well-being of black people confers upon them an aura of moral superiority and, as such, gives more credibility to their calls for increasing government control over our lives.
Ordinary black people have been sold on the importance of electing blacks to high public office. After centuries of black people having been barred from high elected office, no decent American can have anything against their wider participation in our political system. For several decades, blacks have held significant political power, in the form of being mayors and dominant forces on city councils in major cities such as Philadelphia, Detroit, Washington, Memphis, Tenn., Atlanta, Baltimore, New Orleans, Oakland, Calif., Newark, N.J., and Cincinnati. In these cities, blacks have held administrative offices such as school superintendent, school principal and chief of police. Plus, there’s the precedent-setting fact of there being 44 black members of Congress and a black president.
What has this political power meant for the significant socio-economic problems faced by a large segment of the black community? Clearly, it has done little or nothing for academic achievement; the number of black students scoring proficient is far below the national average. It is a disgrace -- and ought to be a source of shame -- to know that the average white seventh- or eighth-grader can run circles around the average black 12th-grader in most academic subjects. The political and education establishment tells us that the solution lies in higher budgets, but the fact of business is that some of the worst public school districts have the highest spending per student. Washington, D.C., for example, spends more than $29,000 per student and scores at nearly the bottom in academic achievement.
Each year, roughly 7,000 -- and as high as 9,000 -- blacks are murdered. Ninety-four percent of the time, the murderer is another black person. According to the Bureau of Justice Statistics, between 1976 and 2011, there were 279,384 black murder victims. Contrast this with the fact that black fatalities during the Korean War (3,075), Vietnam War (7,243) and wars since 1980 (about 8,200) total about 18,500. Young black males have a greater chance of reaching maturity on the battlefields than on the streets of Philadelphia, Chicago, Detroit, Oakland, Newark and other cities. Black political power and massive city budgets have done absolutely nothing to ameliorate this problem of black insecurity. Most of the problems faced by the black community have their roots in a black culture that differs significantly from the black culture of yesteryear. Today only 35 percent of black children are raised in two-parent households, but as far back as 1880, in Philadelphia, 75 percent of black children were raised in two-parent households -- and it was as high as 85 percent in other places. Even during slavery, in which marriage was forbidden, most black children were raised with two biological parents. The black family managed to survive several centuries of slavery and generations of the harshest racism and Jim Crow, to ultimately become destroyed by the welfare state. The black family has fallen victim to the vision fostered by some intellectuals that, in the words of a sociology professor in the 1960s, "it has yet to be shown that the absence of a father was directly responsible for any of the supposed deficiencies of broken homes." The real issue to these intellectuals "is not the lack of male presence but the lack of male income." That suggests that fathers can be replaced by a welfare check. The weakened black family gives rise to problems such has high crime, predation and other forms of anti-social behavior.
The cultural problems that affect many black people are challenging and not pleasant to talk about, but incorrectly attributing those problems to racism and racial discrimination, a need for more political power, and a need for greater public spending condemns millions of blacks to the degradation and despair of the welfare state.
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