Modern Times: The World From the Twenties to the Nineties (47 page)

The German objection, influenced by the monetarists of the Viennese school, L. von Mises and F.A.Hayek, was that the whole inflationary policy was corrupt. The French objection was that it reflected British foreign economic policy aims, with the Americans as willing abettors. As Moreau put it in his secret diary:

England, having been the first European country to re-establish a stable and secure money, has used that advantage to establish a basis for putting Europe under a veritable financial domination …. The currencies will be divided into two classes. Those of the first class, the dollar and sterling, based on gold, and those of the second class based on the pound and the dollar – with part of their gold reserves being held by the Bank of England and the Federal Reserve of New York, the local currencies will have lost their independence.
²⁰

Moreau was making a general point that economic policies shaped for political purposes, as Anglo—American currency management undoubtedly was, are unlikely to achieve economic objectives in the long run. That is unquestionably true, and it applies both in the domestic and the international field. At home, both in America and Britain, the object of stabilization was to keep prices steady and so prevent wages from dropping, which would mean social unrest; abroad, cheap money and easy loans kept trade flowing despite US protectionism and Britain’s artificially strong pound. The aim was to avoid trouble and escape the need to resolve painful political dilemmas.

The policy appeared to be succeeding. In the second half of the decade, the cheap credit Strong—Norman policy pumped into the world economy perked up trade, which had failed to reach its pre-war level. Whereas in 1921–5 the world-trade growth rate, compared with 1911–14, was actually minus 1.42, during the four years 1926–9 it achieved a growth of 6.74, a performance not to be exceeded until the late 1950s.
²¹
Prices nevertheless remained stable: the Bureau of Labor Statistics Index of Wholesale Prices, taking 1926 as 100, shows that the fluctuation in the US was merely from 93.4 in June 1921 to a peak of 104.5 in November 1925 and then down to 95.2 in June 1929. So the notion of deliberate controlled growth within a framework of price stability had been turned into reality. This was genuine economic management at last! Keynes described ‘the successful management of the dollar by the Federal Reserve Board from 1923–8’ as a ‘triumph’. Hawtrey’s verdict was: ‘The American experiment in stabilization from 1922 to 1928 showed that early treatment could check a tendency either to inflation or to depression …. The American experiment was a great advance upon the practice of the nineteenth century.’
²²

Yet in fact the inflation was there, and growing, all the time. What no one seems to have appreciated is the significance of the phenomenal growth of productivity in the US between 1919 and 1929: output per
worker in manufacturing industry rising by 43 per cent. This was made possible by a staggering increase in capital investment which rose by an average annual rate of 6.4 per cent a year.
²³
The productivity increase should have been reflected in lower prices. The extent to which it was not reflected the degree of inflation produced by economic management with the object of stabilization. It is true that if prices had not been managed, wages would have fallen too. But the drop in prices must have been steeper; and therefore real wages – purchasing power – would have increased steadily,
pari passu
with productivity. The workers would have been able to enjoy more of the goods their improved performance was turning out of the factories. As it was, working-class families found it a struggle to keep up with the new prosperity. They could afford cars – just. But it was an effort to renew them. The Twenties boom was based essentially on the car. America was producing almost as many cars in the late 1920s as in the 1950s (5,358,000 in 1929; 5,700,000 in 1953). The really big and absolutely genuine growth-stock of the 1920s was General Motors: anyone who in 1921 had bought $25,000 of
GM
common stock was a millionaire by 1929, when
GM
was earning profits of $200 million a year.
²⁴
The difficulty about an expansion in which cars are the leading sector is that, when money is short, a car’s life can be arbitrarily prolonged five or ten years. In December 1927 Coolidge and Hoover proudly claimed that average industrial wages had reached $4 a day, that is $1,200 a year. But their own government agencies estimated that it cost $2,000 a year to bring up a family of five in ‘health and decency’. There is some evidence that the increasing number of women in employment reflected a decline in real incomes, especially among the middle class.
²⁵
As the boom continued, and prices failed to fall, it became harder for the consumer to keep the boom going. The bankers, in turn, had to work harder to inflate the economy: Strong’s ‘little
coup de whiskey’
was the last big push; next year he was dead, leaving no one with either the same degree of monetary adventurism or the same authority.

Strong’s last push, in fact, did little to help the ‘real’ economy. It fed speculation. Very little of the new credit went through to the mass-consumer. As it was, the spending-side of the US economy was unbalanced. The 5 per cent of the population with the top incomes had one-third of all personal income: they did not buy Fords or Chevrolets. Indeed the proportion of income received in interest, dividends and rents, as opposed to wages, was about twice as high as post-1945 levels.
²⁶
Strong’s
coup de whiskey
benefited almost solely the non-wage earners: the last phase of the boom was largely speculative. Until 1928 stock-exchange prices had merely kept pace
with actual industrial performance. From the beginning of 1928 the element of unreality, of fantasy indeed, began to grow. As Bagehot put it, ‘All people are most credulous when they are most happy.’
²⁷
The number of shares changing hands, a record of 567,990,875 in 1927, went to 920,550,032.

Two new and sinister elements emerged: a vast increase in margin-trading and a rash of hastily cobbled-together investment trusts. Traditionally, stocks were valued at about ten times earnings. With high margin-trading, earnings on shares, only 1 or 2 per cent, were far less than the 8–12 per cent interest on loans used to buy them. This meant that any profits were in capital gains alone. Thus, Radio Corporation of America, which had never paid a dividend at all, went from 85 to 420 points in 1928. By 1929 some stocks were selling at fifty times earnings. As one expert put it, the market was ‘discounting not merely the future but the hereafter’.
²⁸
A market-boom based on capital gains is merely a form of pyramid-selling. The new investment trusts, which by the end of 1928 were emerging at the rate of one a day, were archetypal inverted pyramids. They had what was called ‘high leverage’ through their own supposedly shrewd investments, and secured phenomenal growth on the basis of a very small plinth of real growth. Thus, the United Founders Corporation was built up into a company with nominal resources of $686,165,000 from an original investment (by a bankrupt) of a mere $500. The 1929 market value of another investment trust was over a billion dollars, but its chief asset was an electric company worth only $6 million in 1921.
²⁹
They were supposed to enable the ‘little man’ to ‘get a piece of the action’. In fact they merely provided an additional superstructure of almost pure speculation, and the ‘high leverage’ worked in reverse once the market broke.

It is astonishing that, once margin-trading and investment-trusting took over, the Federal bankers failed to raise interest rates and persisted in cheap money. But many of the bankers had lost their sense of reality by the beginning of 1929. Indeed, they were speculating themselves, often in their own stock. One of the worst offenders was Charles Mitchell (finally indicted for grand larceny in 1938), the Chairman of National City Bank, who, on 1 January 1929, became a director of the Federal Reserve Bank of New York. Mitchell filled the role of Strong, at a cruder level, and kept the boom going through most of 1929. Of course many practices which contributed to the crash, and were made illegal by Congress and the new Securities and Exchange Commission in the 1930s, were regarded as acceptable in 1929. The ferocious witch-hunt begun in 1932 by the Senate Committee on Banking and the Currency, which served as a prototype for the witch-hunts of the 1940s and early
1950s, actually disclosed little law-breaking. Mitchell was the only major victim and even his case revealed more of the social
mores
of high finance than actual wickedness.
³⁰
Henry James would have had no complaints; but the Marxist zealots were disappointed. ‘Every great crisis’, Bagehot remarked, ‘reveals the excessive speculations of many houses which no one before suspected.’
³¹
The 1929 crash exposed in addition the naivety and ignorance of bankers, businessmen, Wall Street experts and academic economists high and low; it showed they did not understand the system they had been so confidently manipulating. They had tried to substitute their own well-meaning policies for what Adam Smith called ‘the invisible hand’ of the market and they had wrought disaster. Far from demonstrating, as Keynes and his school later argued – at the time Keynes failed to predict either the crash or the extent and duration of the Depression – the dangers of a self-regulating economy, the
dégringolade
indicated the opposite: the risks of ill-informed meddling.

The credit inflation petered out at the end of 1928. The economy went into decline, in consequence, six months later. The market collapse followed after a three-month delay. All this was to be expected; it was healthy; it ought to have been welcomed. It was the pattern of the nineteenth century and of the twentieth up to 1920–1: capitalist ‘normalcy’. A business recession and a stock-exchange drop were not only customary but necessary parts of the cycle of growth: they sorted out the sheep from the goats, liquidated the unhealthy elements in the economy and turned out the parasites; as J.K.Galbraith was to put it: ‘One of the uses of depression is to expose what the auditors fail to find.’
³²
Business downturns serve essential purposes. They have to be sharp. But they need not be long because they are self-adjusting. All they require on the part of governments, the business community and the public is patience. The 1920 recession had adjusted itself within a year. There was no reason why the 1929 recession should have taken longer, for the American economy was fundamentally sound, as Coolidge had said. As we have seen, the Stock Exchange fall began in September and became panic in October. On 13 November, at the end of the panic, the index was at 224, down from 452. There was nothing wrong in that. It had been only 245 in December 1928 after a year of steep rises. The panic merely knocked out the speculative element, leaving sound stocks at about their right value in relation to earnings. If the recession had been allowed to adjust itself, as it would have done by the end of 1930 on any earlier analogy, confidence would have returned and the world slump need never have occurred. Instead, the market went on down, slowly but inexorably, ceasing to reflect
economic realities – its true function – and instead becoming an engine of doom, carrying to destruction the entire nation and, in its wake, the world. By 8 July 1932
New York Times
industrials had fallen from 224 at the end of the panic to 58. US Steel, selling at 262 before the market broke in 1929, was now only 22.
GM
, already one of the best-run and most successful manufacturing groups in the world, had fallen from 73 to 8.
³³
By this time the entire outlook for the world had changed – infinitely for the worse. How did this happen? Why did the normal recovery not take place?

To find the answer we must probe beneath the conventional view of Herbert Hoover and his successor as president, Franklin Roosevelt. The received view is that Hoover, because of his ideological attachment to
laissez-faire
, refused to use government money to reflate the economy and so prolonged and deepened the Depression until the election of Roosevelt, who then promptly reversed official policy, introducing the New Deal, a form of Keynesianism, and pulled America out of the trough. Hoover is presented as the symbol of the dead, discredited past, Roosevelt as the harbinger of the future, and 1932–3 the watershed between old-style free market economics and the benevolent new managed economics and social welfare of Keynes. Such a version of events began as the quasi-journalistic propaganda of Roosevelt’s colleagues and admirers and was then constructed into a solid historical matrix by two entire generations of liberal-democrat historians.
³⁴

This most durable of historical myths has very little truth in it. The reality is much more complex and interesting. Hoover is one of the tragic figures of modern times. No one illustrated better Tacitus’s verdict on Galba,
omnium consensu capax imperii nisi imperasset
(by general consent fit to rule, had he not ruled). As we have seen, the First World War introduced the age of social engineering. Some pundits wished to go further and install the engineer himself as king. Thorstein Veblen, the most influential progressive writer in America in the first quarter of the twentieth century, had argued, both in
The Theory of the Leisure Class
(1899) and
The Engineers and the Price System
(1921) that the engineer, whom he regarded as a disinterested and benevolent figure, should replace the businessman, eliminating both the values of the leisure class and the motives of profit, and run the economy in the interests of consumers.
³⁵
In the Soviet Union, which has embraced social engineering more comprehensively and over a longer period than any other society, this is more or less what has happened, engineers becoming the paramount element in the ruling class (though not as yet with much advantage to the consumer).