The Mythical Banking Crisis and the Failure of the New Deal

794px-Wpa1by David Stockman 

From David Stockman’s Contra Corner. Remarks to the Committee For The Republic, Washington DC, February 2014 (Part 4 in a 6-Part Series) Go to Part 1.

The Great Depression thus did not represent the failure of capitalism or some inherent suicidal tendency of the free market to plunge into cyclical depression—absent the constant ministrations of the state through monetary, fiscal, tax and regulatory interventions.  Instead, the Great Depression was a unique historical occurrence—the delayed consequence of the monumental folly of the Great War, abetted by the financial deformations spawned by modern central banking.

But ironically, the “failure of capitalism” explanation of the Great Depression is exactly what enabled the Warfare State to thrive and dominate the rest of the 20th century because it gave birth to what have become its twin handmaidens—-Keynesian economics and monetary central planning. Together, these two doctrines eroded and eventually destroyed the great policy barrier—-that is, the old-time religion of balanced budgets— that had kept America a relatively peaceful Republic until 1914.

To be sure, under Mellon’s tutelage, Harding, Coolidge and Hoover strove mightily, and on paper successfully, to restore the pre-1914 status quo ante on the fiscal front.  But it was a pyrrhic victory—since Mellon’s surpluses rested on an artificially booming, bubbling economy that was destined to hit the wall.

The Hoover Recovery of 1932

Worse still, Hoover’s bitter-end fidelity to fiscal orthodoxy, as embodied in his infamous balanced budget of June 1932, got blamed for prolonging the depression.  Yet, as I have demonstrated in the chapter of my book called “New Deal Myths of Recovery”, the Great Depression was already over by early summer 1932.

At that point, powerful natural forces of capitalist regeneration had come to the fore. Thus, during the six month leading up to the November 1932 election, freight loadings rose by 20 percent, industrial production by 21 percent, construction contract awards gained 30 percent, unemployment dropped by nearly one million, wholesale prices rebounded by 20 percent and the battered stock market was up by 40 percent.

So Hoover’s fiscal policies were blackened not by the facts of the day, but by the subsequent ukase of the Keynesian professoriat. Indeed, the  “Hoover recovery” would be celebrated in the history books even today if it had not been interrupted in the winter of 1932-1933 by a faux “banking crisis” which was entirely the doing of President-elect Roosevelt and the loose-talking economic statist at the core of his transition team, especially Columbia professors Moley and Tugwell.

The Pre-1933 Banking Failures Were Caused By Insolvency

The truth of the so-called banking crisis is that the artificial economic boom of 1914-1929 had generated a drastic proliferation of banks in the farm country and in the booming new industrial centers like Chicago, Detroit, Youngtown and Toledo, along with vast amounts of poorly underwritten debt on real estate and businesses.

When the bubble burst in 1929, the financial system experienced the time-honored capitalist cure—-a sweeping liquidation of bad debts and under-capitalized banks.  Not only was this an unavoidable and healthy purge of economic rot, but also reflected the fact that the legions of banks which failed were flat-out insolvent and should have been closed.

Indeed, 10,000 of the 12,000 banks shuttered during the years before 1933 were tiny rural banks located in communities of less than 2,500.  Most had been chartered with trivial amounts of capital under lax state banking laws, and amounted to get-rich-quick schemes which proliferated during the export boom.

Indeed, a single startling statistic puts paid to the whole New Deal mythology that FDR rescued the banking system after a veritable heart attack: to wit, losses at failed US banks during the entire 12-year period ending in 1932 amounted to only 2-3 percent of deposits. There never was a sweeping contagion of failure in the banking system.

Milton Friedman’s Huge Error: The Fed Did Not Cause the Bank Runs of 1930-1933

Nor did the Fed’s alleged failure to undertake a massive bond-buying program in 1930-1932 to pump cash into the banking system constitute the monumental monetary policy error that Milton Friedman so dogmatically claimed, and which has become the raison d’etre of contemporary central banking.

In fact, fifty years after the fact, Bubbles Ben 2.0 essentially zeroxed the errors in Friedman’s treatise and got awarded a PhD for this tommyrot by Professor Stanley Fischer of MIT, who Obama has now seen fit to make Vice-Chairman of the Fed. Bernanke then passed himself off as a scholar of the Great Depression and a Friedman disciple, thereby bamboozling the ever gullible Bush White House into appointing a rank money-printer and Keynesian to head the Fed.

Bernanke then proceeded to follow Friedman’s bad advice about 1932 and flooded the banking system with money during the so-called financial crisis, and thereby bailed out the rot on Wall Street instead of purging it as the Board of Governors had the good sense to do in the early 1930s.

But…I digress—slightly!

In fact, it is important to refute the scary bedtime stories that have been handed down about the pre-New Deal banking crisis because they are the predicate for the Fed’s current lunacy of QE, ZIRP and massive monetization of the public debt, which, in turn, enables the perpetual deficit finance on which the Warfare State vitally depends.

The Unnecessary February 1933 Bank Panic: FDR’s 10-Day Fumble

In truth, the banking liquidation was over by Election Day, failures and losses had virtually disappeared, and as late as the first week of February 1933, according the Fed’s daily currency reports, there were no unusual demands for cash.

The legendary “bank runs” occurred almost entirely during the last two weeks before FDR’s inauguration. The trigger was Henry Ford’s vicious spat with his former partner and then Michigan Senator, James Couzens, over responsibility for the failure of a go-go banking group in Detroit that had been started by his son Edsel and Goldman Sachs.  Always Goldman!

The hapless Herbert Hoover secretly wrote FDR begging him to cooperate in resolving the Michigan banking crisis. Instead, Roosevelt failed to answer the President’s letter for two weeks; lost Carter Glass as his Treasury Secretary because the President-elect refused to affirm his commitment to the sound money platform on which he had campaigned; and allowed Tugwell to leak to the press a radical plan to reflate the economy by reneging on the dollar’s 100-year old linkage to one-twentieth ounce of gold.

Within days there was a massive run on gold at the New York Fed and a scramble for cash at teller windows across the land. Unlike historians today, citizens back then knew that the Fed could not legally issue more currency unless it had 40 percent gold-backing—hence the sudden outbreak of currency hoarding.

In this context, the daily figures for currency outstanding give ringing evidence of FDR’s culpability for the midnight-hour run on the banks.  After rising by a trivial $8 million per day in early in the month, cash outstanding rose by $200 million per day by late February and by a staggering half billion dollars on the day before the FDR’s inauguration. All told, 80 percent of the increase in currency outstanding—from $5.6 billion to $7.5 billion—occurred in the last ten days before FDR took office.

Then, even more fantastically, nearly all of the hoarded cash flowed back into the banking system on its own when 95 percent of the banks were re-opened in an “as is, where is” condition during the three weeks after FDR’s inauguration.  Moreover, the mass re-opening scheme was actually drafted and executed by Hoover hold-overs at the Treasury, and had been completely accomplished before the heralded banking reforms of the New Deal and deposit insurance had even had Congressional hearings.

In short, the banking system never did really collapse and the true problem was bad debt and insolvency—not Fed errors or an existential crisis of capitalism.

New Deal: Political Gong Show

Beyond that, the New Deal was a political gong show that amounted to a grab-bag of statist gimcrack. The mild fascism of the NRA and AAA caused the economy to further contract, not recover. The legendary WPA cycled violently between 1 million make-work jobs in the off-years and 3 million make-vote jobs in the election years—-before even a Democratic Congress was compelled to shut it down in a torrent of corruption in 1939.

Likewise, the TVA was a senseless boondoggle and environmental curse; the Wagner Act paved the way for the kind of coercive, monopolistic industrial unionism that resulted in “Rust Bucket America” five decades later; and the legacy of New Deal housing stimulants like Fannie Mae speaks for itself.

Finally, universal social insurance enacted in 1935 was actually a fiscal doomsday machine. When in the context of modern political democracy the state offers universal transfer payments to its citizenry without proof of need it thereby offers to bankrupt itself—eventually.

To be sure, during the middle 1930s, the natural rebound of the nation’s capitalist economy continued where the Hoover Recovery left off— notwithstanding the New Deal headwinds.  Yet the evidence that FDR’s policies retarded recovery screams out of the last year of pre-war data for 1939:  GDP at $90 billion was still 12 percent below 1929, while manufacturing value added was off by 20 percent and business investment by 40 percent.

Most telling of all was private non-farm man-hours worked: the 1939 level was still 15 percent lower than what the BLS recorded in 1929.

How FDR Torpedoed Recovery and Sowed the Seeds of Autarky, Rearmament, Revanchism and War 

So the New Deal did nothing to help the domestic economy. But FDR did personally torpedo world recovery and paved the way toward WWII with his so-called “bombshell” message to the London Economic Conference in July 1933. The latter had been the world’s last best hope for rescue of the failed task of post-war resumption. Specifically, the conferees had shaped a plan for restoring convertibility by means of pegging the pound sterling at a lower exchange rate to the dollar and gold, thereby alleviating the beggar-thy-neighbor pressure on the remaining gold standard countries like France, the Netherlands and Sweden.

In turn, monetary stabilization would pave the way for reduction of Smoot-Hawley instigated tariff barriers and the restoration of global trade and capital flows.

The American delegation led by the magnificent statesman, Cordell Hall, had molded a tentative agreement among the British and French, and thereby had attained a crucial inflection point in the post-war struggle for resumption of the old international order. Yet FDR defied his advisors to the very last man, including the nationalistic and protectionist-minded Raymond Moley, who the President had sent to London as his personal emissary.

Roosevelt’s message, penned by moonlight on the luxurious yacht of his chum, Vincent Astor, was undoubtedly the most intemperate, incoherent and bombastic communique ever publicly issued by a US President. It not only stunned the assembled world leaders gathered in London and killed the monetary stabilization agreement on the spot, but it also locked in a destructive worldwide regime of economic nationalism and autarky.

Accordingly, high tariffs and trade subsidies, state-dominated recovery and rearmament programs and manipulated currencies became universal after the London Conference failed, leaving international financial markets demoralized and chaotic.

The irony was that the Great Depression was the step-child of the Great War.  American entry had unnecessarily extended it; had greatly amplified its destructive impact on the liberal international order; and had contributed a witch’s brew of Wilsonian nostrums to a Carthaginian peace that laid the planking for a new world war.  FDR then delivered the coup de grace,  extinguishing  the last hope for resumption and insuring that autarky, revanchism and rearmament would hurtle the world to an even greater eruption of carnage, and an even more debilitating rendition of the Warfare State.

Go to Part 5.


  1. Lee Ohanian addresses banking panics in all of his writings with Hal Cole.

    Monetary and banking panic explanations of the 1930s U.S. depression must explain:
    • Why the Depression was so immediately severe in manufacturing industry before significant monetary contraction and banking panics,
    • Why the Depression was so asymmetric across sectors – the great depression did not start as a garden variety recession for manufacturing industry. The drop in hours was immediate and deep,
    • Provide a theory for the fact that industrial sector wages were persistently well above their market-clearing level.
    • Canada was even more depressed in the 1930s than the U.S. but had not a single bank failure.

    Ohanian has repeatedly reminded that most of the Depression-era banks that closed were either very small or merged. The share of deposits in banks that either closed or temporarily suspended operations for the four years from years 1930–1933 was 1.7 percent, 4.3 percent, 2 percent, and 11 percent, respectively.

    The Depression was indeed “Great” before any of the monetary contraction or banking crises identified by Friedman and Schwartz (1963) occurred.

    Lee Ohanian and Hal Cole refer to the 1921 depression frequently in their attacks on monetary and banking panic explanations of the U.S. great depression. If the 20% deflation of the 1930s caused the Great Depression, why didn’t the 20% deflation of the 1920s also cause a major depression?

    Ohanian recently used the unionisation threat hypothesis to explain how Hoover’s offer of protection from them could influence wages and keep them high. Ohanian attributes the massive drop in manufacturing hours in 1929 and early 1930 to President Hoover’s labour policies, which kept nominal and real wages high.

    Hours worked in agriculture were roughly unchanged during the early 1930s but nominal wages fells perhaps 40%, which indicates that the initiating factor behind the Great Depression was sector-specific. Labour market data indicate that this initiating factor prevented the industrial labour market from clearing.

    Rothbard rejected unions and the threat of the same as a cause of high wages from 1929 onwards because about 6% of the workforce was unionised.

    My doubts about the Ohanian hypothesis that large manufacturers kept wages high from 1929 to 1931 in return from Hoover’s protection from unions is collusive agreements are vulnerable to cheating. Roosevelt needed a massive new regulatory framework to enforce his wage fixing policies as well explained by Cole and Ohanian (2004).

    The ABCT is a candidate reply to Ohanian because ABCT posits different sector specific effects on employment and production with the large fluctuations concentrated in capital good industries.

    ABCT offers are better chance of explaining a sectoral collapse in employment and hours worked after a long boom. Ohanian said a monetary explanation of the Great Depression requires a theory of a very large and very protracted monetary non-neutrality. ABCT indentifies a large and protracted monetary non-neutrality: a long boom under the mask of stable prices followed by a monetary contraction in 1928. From 1933, the new deal is a massive supply-side shock that depressed the economy further.

  2. According to Cole and Ohanian
    • about 5 percent of deposits were in failed/suspended banks between 1930-33.
    • if bank failures was a key factor, states with the biggest fractions of deposits in the suspended or failed banks should have had bigger depressions, but they did not.

    Most interestingly, they refer to long Irish bank strikes in the 1960s and 1970s that did not cause a recession. One strike lasted 6 months. Apparently, a lot of people started banking at the pub.

    See Murphy, A. E. (1978). Money in an economy without banks: The case of Ireland.

  3. This is very interesting, but I have read on previous Mises articles that Hoover’s policies were not fiscally sound or Laissez-Faire as they are reported in history to demonize Laissez-Faire economics.

    But this article seems to paint Hoover’s policies favorably and that we were on the road to recovery.

    Not sure what to think about this.

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