Assignment 3
New Deal Evaluation Assignment
a. New Deal Myths of Recovery
The new deal was a political gong show, not a golden era of enlightened
economic policy. It shattered the foundation of sound money and inaugurated a
régime of capricious fiscal and regulatory activism that inexorably fueled the growth
of state power and the crony capitalism which thrives on it. But it did not end the
Great Depression or save capitalism from the alleged shortcomings which led to the
crash.
In fact, the New Deal introduced a severe dose of economic nationalism and
autarky at a time when the only hope for speedy recovery was a reopening of world
trade and reestablishment of a stable international monetary régime. The singular
contribution of Franklin D. Roosevelt, however, was slamming the door on that
possibility so decisively, unequivocally, and irreversibly as to guarantee the nation a
long slog in a depression economy. FDR and most of his so-called brain trust failed to
comprehend that the United States was in a deep depression because its export
markets had collapsed. Consequently, its great industries—capital goods, autos, steel,
chemicals, and agriculture—had way too much capacity for the domestic market
alone. During the Great War and the Roaring Twenties, these industries exported
heavily based on an unsustainable artifice; namely, US vendor-financed loans to
worldwide customers who ultimately could not afford to repay.
These vast vendor loans, totaling more than $3 trillion at today’s economic
scale, came from the US Treasury during the war and from Wall Street during the last
five years of the great stock market boom. When the stock market crashed in 1929,
however, the giant Wall Street market in foreign bonds cratered even more severely.
Yet without fresh funding foreign borrowers soon defaulted in droves. Their purchases
of US farm and industrial goods dried up almost instantly, causing output and capacity
utilization to plummet during 1930 and the two years thereafter.
The United States needed to take bold action to rejuvenate its foreign
customers, but the list of potential actions was short. First and foremost, a sharp
reduction in import tariffs and other trade barriers was needed to enable foreign
customers to earn enough foreign exchange to buy American goods without further
debt extensions. Washington also needed to cancel the war debts of England and
France, so that the French especially would desist in their destructive campaign to
extract crushing reparations from the faltering German economy. And the United
States needed to take the lead in reestablishing stable foreign exchange markets
around fixed currency rates and gold convertibility in order to revive confidence,
trade, and capital flows in international commerce.
Roosevelt inherited a weak hand from his predecessor. Herbert Hoover was a
stalwart proponent of free enterprise and fiscal rectitude, but unfortunately a
McKinley Republican who embraced a fatal contradiction: the gold standard for
money but protectionism on trade. Striking a mortal blow at the recovery of
international commerce, Hoover thus signed the infamous Smoot-Hawley tariff bill in
June 1930. It caused international commodity prices and trade volumes to take
another sharp leg down, further debilitating American agriculture and export-
dependent industry. As is well known, it resulted in a destructive spiral of retaliation
and beggar-thy-neighbor nationalism, which intensified as the decade unfolded and
caused international trade and capital markets to lapse into somnolence.
To his credit, Hoover did implement a one-year moratorium on reparation
payments in June 1931, but by then the central European banking system was
unraveling and political reaction and economic demoralization were setting deep
roots. England’s default on its obligation to redeem pounds sterling for gold in
September of that year further exacerbated the downward international spiral. So
when FDR took the oath of office on March 4, 1933, he was confronted by a grave
crisis. But it was not the domestic banking crisis sensationalized by his liberal
hagiographers; the infamous lines at the teller windows happened almost exclusively
during the final three weeks of the long interregnum between November and March
and were entirely of Roosevelt’s own making.
The events leading up to the crisis were complex and multifaceted, with roots
stretching back to the transition period between the outgoing Hoover administration
and the incoming president-elect. The trigger for the crisis was the president-elect's
steadfast refusal to cooperate with the Hoover administration on stabilizing the local
crisis that struck the Detroit banks in mid-February. This obdurate stance created a
climate of uncertainty and instability in financial markets, as investors and the public
alike grappled with the implications of a lack of coordinated action to address the
unfolding crisis.
At the heart of the president-elect's refusal to cooperate with the Hoover
administration was a deep-seated commitment to fiscal conservatism and a
determination to distance himself from perceived inflationary money schemes. In the
wake of the Great Depression and the collapse of the banking system, policymakers
and the public alike were acutely aware of the dangers of inflation and the need for
prudent fiscal management. The president-elect's insistence on maintaining a hardline
stance against inflationary policies was seen as a necessary safeguard against the risk
of runaway inflation and economic instability.
However, the president-elect's refusal to cooperate with the Hoover
administration had unintended consequences, as it exacerbated tensions and mistrust
between the incoming and outgoing administrations. This lack of cooperation and
coordination only served to deepen the sense of uncertainty and instability in financial
markets, as investors struggled to make sense of conflicting signals and unclear policy
direction.
Moreover, the crisis in the Detroit banks served as a stark reminder of the
fragility of the financial system and the interconnectedness of local and national
economies. The failure of the Detroit banks sent shockwaves through the banking
industry, triggering a wave of panic and withdrawals as depositors rushed to withdraw
their funds and protect their savings. This run on the banks threatened to spread to
other financial institutions, creating the potential for a full-blown banking crisis with
far-reaching consequences for the broader economy.
In response to the crisis, policymakers scrambled to contain the damage and
restore confidence in the financial system. Emergency measures were put in place to
provide liquidity to struggling banks and reassure depositors that their funds were
safe. At the same time, efforts were made to address the underlying causes of the
crisis and prevent similar episodes of instability in the future.
In conclusion, the crisis that struck the Detroit banks in mid-February was the
result of a confluence of factors, including the president-elect's refusal to cooperate
with the Hoover administration and his commitment to fiscal conservatism. This lack
of cooperation and coordination exacerbated tensions and uncertainty in financial
markets, leading to a crisis of confidence that threatened to spread to other financial
institutions. While emergency measures were ultimately successful in containing the
crisis, the episode served as a stark reminder of the fragility of the financial system
and the need for vigilant oversight and cooperation among policymakers.
The banking crisis was over in a matter of weeks. The roughly $2 billion of
currency hoarded in mattresses flowed back into the banking system, not because of
the New Deal but due to an unremarkable bank reopening plan that Hoover’s
outgoing Treasury Department had actually designed and stayed on to implement. By
contrast, the real crisis was the de facto shutdown of world trade and the chaos in the
monetary system and foreign exchange markets. The last hope for reversing this
breakdown was the upcoming London Economic Conference in June, which Hoover
had organized but for which FDR had again resolutely refused to cooperate in the
planning and preparatory meetings.
b. Not Your Krugman’s New Deal
FDR personally torpedoed the London Conference in early July 1933. In so
doing he struck down the international gold standard, left the reparations issue to
fester amid international recriminations, and did not even address the need to open the
US market to foreign imports in order to revive international trade. In short, Hoover
landed a haymaker on the requisites for recovery of the American export-dependent
economy and FDR finished the job—no gold, no trade, no capital flows, and no
cancellation of the destructive war debts. There can be little doubt that these crucial
matters did not even register with Franklin D. Roosevelt, because on matters of
economics he was a relentless dilettante with an affinity for quixotic schemes and
downright quackery.
This simplistic belief in the president-elect's economic strategy was
particularly evident in his attribution of the Great Depression to low prices, and his
proposed solution of initiating a "reflation" of key commodities such as cotton, wheat,
hogs, and steel through Washington-led interventions. This approach reflected a
narrow understanding of the complex factors that contributed to the severity of the
Great Depression and the challenges facing the nation's economy.
The president-elect's focus on commodity prices as the primary driver of
economic growth overlooked the deeper structural issues that underpinned the Great
Depression, including widespread unemployment, banking failures, and a collapse in
consumer confidence. While low prices may have exacerbated the economic
downturn, they were symptomatic of deeper underlying problems rather than the root
cause of the crisis.
Moreover, the president-elect's proposed solution of initiating a "reflation" of
commodity prices through Washington-led interventions raised questions about the
effectiveness and feasibility of such an approach. While targeted interventions to
support key industries may have provided temporary relief, they were unlikely to
address the underlying structural imbalances in the economy or stimulate sustainable
long-term growth.
Furthermore, the president-elect's emphasis on Washington-initiated
interventions in the economy overlooked the importance of market mechanisms and
private sector dynamism in driving economic recovery. A top-down approach to
economic policy, focused on government-led interventions and price controls, risked
stifling innovation and entrepreneurship, and undermining the efficiency of capital
allocation.
In addition, the president-elect's simplistic belief in the efficacy of price
reflation as a panacea for economic woes failed to account for the potential
unintended consequences of such policies, including inflationary pressures, distortions
in market signals, and the risk of exacerbating income inequality.
Overall, the president-elect's economic strategy reflected a misguided
understanding of the complex challenges facing the nation's economy and a misplaced
faith in simplistic solutions. While targeted interventions may have provided
temporary relief, they were unlikely to address the root causes of the Great
Depression or lay the foundation for sustainable long-term growth. As policymakers
grappled with the aftermath of the crisis, there was a growing recognition of the need
for a more holistic and nuanced approach to economic policy that addressed the
underlying structural issues and promoted inclusive and sustainable growth.
What FDR did not have, however, was an affinity for anything that resembled
full-strength Keynesian demand stimulus like the $800 billion plan that Larry
Summers, the chief economic advisor in the first years of the Obama administration
(and secretary of the treasury under Bill Clinton), claimed to have channeled from
FDR in February 2009. In fact, Roosevelt met with Professor Keynes once and found
the great economist’s pitch completely unintelligible, and in that reaction he had
considerable company. As outlined below, the only New Deal initiative that even
remotely embodied Keynesian demand stimulus was the giant veterans’ bonus
payment of 1936, and that was a political accident that FDR actually vetoed.
That the New Deal had virtually nothing to do with modern Keynesian
theories of countercyclical demand management is crucial to understanding the
nation’s present economic deformations. Contrary to the claims of unreconstructed
Keynesians like Professor Krugman, the giant programs of fiscal stimulus and money
printing after the September 2008 crisis had no trial run or validation during the Great
Depression. They are based on a false narrative from beginning to end; that is, about
why the depression happened and what the New Deal actually did.
In truth, the New Deal was a Chinese menu with little rhyme or reason. It
included quasi-fascist schemes to regiment industries and agriculture; public works
and regional pork barrel spending to reward the New Deal coalition; price support and
production control schemes to levitate farm prices; work relief and social programs to
relieve the immense destitution and suffering among the unemployed; and endless
special interest legislation sought by unions, the housing industry, and other organized
lobbies. Some of these programs provided humanitarian relief and a safety net. Most
either retarded recovery or were abandoned before they could do much harm. And a
few—like the industrial union legislation, universal social insurance, Fannie Mae,
bank deposit insurance, and farm price supports—lived on to cast a heavy and
debilitating shadow over the distant future.
But FDR’s opening blow was devastating and long lasting. He outright
abolished the basis for sound money at home and personally blocked the revival
abroad of stable exchange rates and common international money; that is, currencies
redeemable in gold. FDR accomplished all this during his first year in office. In the
process he revealed himself to be a veritable monetary primitive. Indeed, his monetary
actions and views made a mockery of the long-settled “sound money” platform of the
Democratic Party, and were embarrassingly similar to those of cranks like Father
Coughlin and Senator Huey Long.
c. The New Deal’s True Legacy: Crony Capitalism and Fiscal Demise
The new deal did not address the causes of the depression, even if its work
relief and other humanitarian measures did ameliorate for millions of citizens the
terrible costs of its unnecessary prolongation. Still, most of this safety net consisted of
ad hoc programs, such as the WPA, which were never institutionalized and did not
survive the 1930s. What did survive is a destructive legacy of fiscal profligacy and
crony capitalist abuse of state power. Policy measures like Fannie Mae, deposit
insurance, social insurance, the Wagner Act, the farm programs, and monetary
activism share a common disability.
Indeed, the critique of state intervention in the economy often centers around
the inherent flaws and vulnerabilities of government action, which can outweigh the
purported imperfections of the free market. One of the most significant criticisms is
that policies implemented with the intention of serving the public good often fall
victim to capture by special interests and crony capitalists, who manipulate
government resources and regulations for their own private gain.
At the heart of this critique is the recognition that the state, despite its noble
intentions, is susceptible to influence and manipulation by powerful vested interests.
Whether through lobbying, campaign contributions, or other forms of political
influence, special interests and crony capitalists are able to shape public policy to
serve their own narrow interests, often at the expense of the broader public good.
This phenomenon of regulatory capture is well-documented in numerous
industries and sectors, where powerful corporations and interest groups use their
influence to secure favorable treatment from government agencies and lawmakers.
From regulatory loopholes and tax breaks to subsidies and bailouts, the state is often
used as a tool to advance the interests of the wealthy and well-connected, rather than
to promote genuine economic opportunity and social welfare.
Moreover, the concentration of economic power and wealth in the hands of a
privileged few can exacerbate inequalities and undermine the democratic process
itself. When government policies are perceived as serving the interests of the elite,
rather than the needs of ordinary citizens, it can erode trust in public institutions and
fuel social unrest and political polarization.
Critics of state intervention argue that the solution to these problems lies not in
expanding the reach of government, but in reducing its influence and restoring power
to individuals and communities. By limiting the scope of government intervention in
the economy and promoting competition and decentralization, they argue, it is
possible to mitigate the risks of regulatory capture and empower individuals to pursue
their own economic interests.
However, proponents of government intervention argue that the state plays a
crucial role in correcting market failures and promoting social justice and equality.
They point to examples of successful government programs and policies, such as
social welfare programs, environmental regulations, and consumer protection laws, as
evidence of the positive impact that state action can have on society.
In conclusion, the debate over the role of the state in the economy is a
complex and contentious issue, with strong arguments on both sides. While critics
highlight the dangers of regulatory capture and government overreach, proponents
emphasize the need for state intervention to address market failures and promote
social welfare. Finding the right balance between state action and market forces is an
ongoing challenge, one that requires careful consideration of the trade-offs involved
and a commitment to promoting the public good above narrow self-interests.
Roosevelt’s unprincipled and unbridled activism is a powerful case in point.
Orthodox historians have positioned FDR as the scourge of “economic royalists” and
the champion of the common man. He was neither. In fact, he was the patron saint of
crony capitalism. As a power-driven politician he recognized no rules or standards for
public policy or any particular limits on the role of the state. Indeed, FDR has been
nearly defied for being a “pragmatist” who experimented until he found something
that “worked.”
The paradox of government intervention in the economy, as exemplified by
the New Deal policies of President Franklin D. Roosevelt, is that while such programs
were ostensibly designed to serve the public good and address the inequalities and
injustices of the Great Depression, they ultimately became vulnerable to capture and
manipulation by the very capitalists that Roosevelt purported to despise.
This phenomenon, known as regulatory capture, occurs when government
agencies and policies intended to regulate or oversee private industry are co-opted by
the industries they are meant to regulate, leading to outcomes that benefit the industry
at the expense of the public interest. In the case of the New Deal, the expansion of
government intervention in the economy, including the establishment of regulatory
agencies and the implementation of social welfare programs, created opportunities for
powerful vested interests to influence policy decisions and shape the regulatory
environment to their advantage.
For example, industries such as banking, finance, and agriculture were able to
leverage their political influence and financial resources to secure favorable treatment
from government agencies and lawmakers. This often took the form of regulatory
loopholes, subsidies, tax breaks, and other forms of preferential treatment that allowed
these industries to maintain their dominance and stifle competition.
Moreover, the expansion of government intervention in the economy under the
New Deal created a vast bureaucracy that was susceptible to capture by special
interests and entrenched elites. As government agencies grew in size and scope, they
became increasingly distant from the needs and concerns of ordinary citizens, making
them more susceptible to manipulation and corruption by powerful insiders.
The consequences of regulatory capture were far-reaching and profound,
undermining the effectiveness of New Deal policies and perpetuating inequalities and
injustices in the economy. While Roosevelt may have sought to challenge the power
and influence of big business, the reality was that his administration's policies
ultimately reinforced the existing power structures and entrenched the interests of the
economic elite.
In hindsight, it is clear that the New Deal's failure to adequately address the
root causes of economic inequality and corporate power laid the groundwork for the
resurgence of capitalism and the consolidation of corporate dominance in the post-war
period. By legitimizing government intervention in the economy and establishing the
precedent for state involvement in social welfare and economic regulation, Roosevelt
unwittingly paved the way for the very capitalists he sought to challenge to capture
and exploit government programs for their own ends.
In conclusion, the story of the New Deal is a cautionary tale about the risks
and limitations of government intervention in the economy. While well-intentioned
efforts to address economic inequality and social injustice may have been made, the
reality is that such efforts are often vulnerable to capture and manipulation by
powerful vested interests. As policymakers grapple with the challenges of governing
in a complex and interconnected world, it is essential to remain vigilant against the
dangers of regulatory capture and to strive for policies that truly serve the public
good.
d. The New Deal Origins of Fannie Mae and The Housing Complex
Fannie Mae is a classic crony capitalist progeny of the New Deal that began
life in 1938, quite innocently, as still another ad hoc New Deal program to boost the
depression-weakened housing market. It grew into something quite different: a
monster that deeply deformed and corrupted the nation’s entire financial system
seventy years later. The policy aim of Fannie Mae was “forcing water to flow uphill”
in the residential mortgage market so that low-rate thirty-year home mortgages
became available to wage-earning households of modest means. Such mortgages did
not then exist for a good reason: they were not economic. No prudent local bank or
thrift would take the underwriting risk.
Fannie Mae would thus override the market’s veto by turning local banks and
thrifts into government contractors or agents, rather than mortgage debt underwriters.
Accordingly, they would be relieved of their aversion to the risk of default loss by
means of a Washington-funded “secondary market.” The latter would purchase these
commercially unappealing mortgage loans for cash, enabling local bankers to reloan
this cash again and again in a government-supported rinse and repeat cycle.
Meanwhile, the default losses that the market refused to underwrite would be shifted
to taxpayers, since Fannie Mae’s funding would implicitly depend on the public credit
of the United States. The slowly recovering residential housing sector would thus
receive the kind of booster shot much favored by the New Dealers.
What Fannie Mae also did, unfortunately, was to start the home mortgage
market down a slippery slope. This included separating the loan origination process
from the long-term servicing and ownership of the resulting mortgage, in an alleged
financing “innovation” that would give rise to predatory mortgage-broker boiler
rooms a few generations down the road. Likewise, it opened the door to the funding
of home loans in the global markets for U. S. sovereign debt, rather than out of the
savings deposits of local bank customers. This became possible because Fannie Mae
took on quasi-sovereign status, meaning that investors were funding the general credit
of the United States, not the specific risk of local mortgage borrowers and separate
residential markets.
There were several crucial upgrades in ensuing decades to the original New
Deal scheme before it reached its stunning dénouement in Washington’s panicky $6
trillion nationalization and bailout in September 2008. Among these milestones were
LBJ’s maneuver to put Fannie “off-budget” in 1968 in order to hide its exploding use
of Uncle Sam’s credit card. LBJ’s so-called privatization plan, in turn, paved the way
for Fannie to morph into a hybrid entity called a GSE (government-sponsored
enterprise) in which ownership was private but its debt issues were implicitly
government guaranteed. Politicians and policy makers who inherited FDR’s “anything
that works” mantle were pleased to describe the GSEs as creative “public/private
partnerships.” They were no such thing. The GSEs were actually dangerous and
unstable freaks of economic nature, hiding behind the deceptive good-housekeeping
seal afforded by their New Deal–sanctioned mission to support middle-class housing.
This was especially the case after Fannie’s initial public offering and subsequent
ability to tap the public capital markets for virtually limitless funds.
Another crucial step was Wall Street’s perfection of the mortgage
securitization model. This “innovation” vastly improved Fannie’s ability to sweep up
mortgages originated by local bankers on a massive wholesale basis, and then
guarantee and package them for distribution into increasingly broad and liquid
national and international capital markets. When this was combined with high speed
computerized underwriting in the 1990s, disasters like Countrywide Financial became
inevitable. As time passed, the evolution of the Fannie Mae monster only got more
fantastical. Thus, the rise of the worldwide T-bill standard generated a nearly
inexhaustible appetite among mercantilist central banks for US government or quasi-
government GSE paper. These vast monetary roach motels were not exactly honest
“markets” for mortgage loans from Cleveland or Fort Myers, but GSEs went into
overdrive supplying the unquenchable thirst of foreign central banks for dollar
liabilities, especially when heavy currency pegging began after 1994.
Not surprisingly, when Treasury Secretary Hank Paulson’s fabled bazooka
failed and Washington had to nationalize the GSEs, foreign central banks and other
state institutions owned more than $2 trillion of American home mortgages, including
upward of $1 trillion domiciled at the People’s Printing Press of China. In short,
Fannie Mae’s journey started in 1938 with a Washington, DC, filing cabinet
containing a few thousand mortgage notes which had been gussied up and christened
as the nation’s “secondary mortgage market.” Yet the progeny of this innocent filing
cabinet ended up eighty years later scattered around the globe in the trust accounts of
Norwegian fishing villages and as a trillion-dollar stash in the central bank vault of
Red China.
In the interim, massive social costs and economic losses built up inside the
housing marketplace and became ripe to explode. In the process, the principal assets
of the American middle class, family residences, were turned into an ATM machine
and became the object of frenzied buying, selling, and serial refinancing.
Unfortunately, this ruinous journey was far more inexorable than it was merely
accidental. At each step along the way, powerful special interest groups—mortgage
bankers, real estate developers, home builders, building material suppliers, Wall Street
underwriters, law and title firms, appraisers, and brokers— drove policy toward their
own benefit.
The changes, elaborations, enlargements, and aggrandizements made to the
Fannie Mae (and Freddie Mac) mortgage-financing machine were driven by a
common purpose: to facilitate the harvesting of ever greater volumes of mortgages,
thereby generating increased profits and fees for the government-sponsored
enterprises (GSEs).
At the heart of this expansionary drive was the desire to capitalize on the
growing demand for mortgage financing and homeownership in the United States. As
the housing market boomed in the decades leading up to the financial crisis, fueled by
factors such as demographic shifts, lax lending standards, and financial innovation,
Fannie Mae and Freddie Mac sought to position themselves as key players in the
mortgage market, facilitating the flow of capital from investors to homeowners.
To achieve this goal, the GSEs embarked on a series of initiatives aimed at
expanding their reach and influence in the mortgage market. This included the
development of new mortgage products and underwriting standards designed to attract
a broader range of borrowers, as well as the expansion of their portfolios to include
riskier and more exotic mortgage-backed securities.
Moreover, the GSEs actively lobbied policymakers for favorable treatment
and regulatory exemptions that allowed them to operate with minimal oversight and
scrutiny. This included efforts to weaken capital requirements, circumvent prudential
regulations, and gain access to cheaper funding sources, such as the implicit
government guarantee of their debt obligations.
In addition, Fannie Mae and Freddie Mac engaged in aggressive marketing
and advertising campaigns aimed at promoting homeownership and encouraging
borrowers to take on more debt. This included partnerships with mortgage lenders,
real estate agents, and homebuilders to promote their products and services, as well as
the sponsorship of educational programs and community outreach initiatives to raise
awareness about the benefits of homeownership.
The consequences of these efforts were far-reaching and profound, ultimately
contributing to the buildup of systemic risk and the eventual collapse of the housing
market. By facilitating the proliferation of subprime and other risky mortgage
products, Fannie Mae and Freddie Mac helped fuel a speculative bubble in housing
prices that ultimately burst, leading to widespread foreclosures, bank failures, and
economic hardship.
In hindsight, it is clear that the pursuit of ever greater volumes of mortgages
and profits by Fannie Mae and Freddie Mac came at a significant cost to both
taxpayers and the broader economy. The collapse of the housing market and the
subsequent bailout of the GSEs by the federal government underscored the dangers of
unchecked expansion and regulatory capture in the financial system, serving as a
cautionary tale for policymakers and market participants alike.
In conclusion, the changes, elaborations, enlargements, and aggrandizements
made to the Fannie Mae (and Freddie Mac) mortgage-financing machine were driven
by a desire to maximize profits and fees for the GSEs. However, these efforts
ultimately contributed to the buildup of systemic risk and the eventual collapse of the
housing market, highlighting the dangers of unchecked expansion and regulatory
capture in the financial system.
Indeed, the Fannie Mae saga demonstrates that once crony capitalism captures
an arm of the state, its potential for cancerous growth is truly perilous. More
importantly, it underscores that the resulting carnage can be vastly disproportionate to
the alleged social ill that justified the original policy intervention. In this case, the
housing market had essentially recovered before Fannie Mae opened its doors. After
hitting bottom at 125,000 units per year in 1931–1933, the volume of new starts had
nearly tripled by the late 1930s. By then, it was by no means evident that the nation’s
remaining willing lenders and solvent borrowers were producing the wrong answer
with respect to the number of housing starts. So fiddling with an arbitrary goal of
higher housing starts, the New Dealers gave birth to what eventually became a crony
capitalist monster, and that was all.
e. War Finance and The Twilight of Sound Money
The new deal’s ad hoc statism was eventually superseded by the real thing: the
full-bore warfare state spawned by the Japanese attack on Pearl Harbor. Under the
exigencies of total war, all of the tools of modern fiscal expansion and monetary
manipulation were discovered, tested, amended, and perfected. But when the peace
came in 1945, the victory of these warfare state– inspired policy tools was neither
complete nor immediate. Indeed, over the next quarter century the canons of financial
orthodoxy found intermittent, and sometimes poignant, expression under Presidents
Harry Truman and Dwight D. Eisenhower, and the long-reigning Fed chairman
William McChesney Martin. Even President John F. Kennedy kept orthodoxy alive, at
least in the Treasury Department and its international dollar policies.
So the road from Pearl Harbor to Richard Nixon’s decision to default on the
nation’s Bretton Woods obligation to redeem its debts in gold, eventually ushering in
printing-press money and giant fiscal deficits, is important to retrace. In the interim
there occurred episodes of fiscal and monetary discipline that have long since been
purged from mainstream memory. Yet these were signal moments of inspired
governance which underscore just how much was lost with the waning of the old-time
financial orthodoxy. One was President Harry Truman’s insistence on financing the
Korean War the honest way, with higher current taxes.
Another significant aspect of Eisenhower's economic policy was his refusal to
adopt tax-cut stimulus measures during the two recessions that occurred during his
presidency, a decision motivated by his commitment to achieving his highest fiscal
priority: balancing the federal budget.
Eisenhower's stance on fiscal responsibility and budgetary discipline was
shaped by his experiences as a military leader during World War II, where he
witnessed firsthand the consequences of runaway government spending and budget
deficits. As president, he viewed balancing the federal budget as essential to
maintaining the long-term health and stability of the economy, as well as preserving
the nation's credibility and standing in the international community.
However, Eisenhower's commitment to fiscal discipline was put to the test
during his presidency by two significant recessions: the recession of 1953-1954 and
the recession of 1957-1958. In both instances, there were calls from some quarters for
the adoption of tax-cut stimulus measures to spur economic growth and alleviate the
hardship caused by rising unemployment and falling output.
Despite these pressures, Eisenhower remained steadfast in his refusal to
embrace deficit spending as a means of stimulating the economy. Instead, he favored
a more cautious and conservative approach to economic policy, focused on promoting
stability and gradual growth through prudent fiscal management and targeted
government intervention.
One of the key reasons behind Eisenhower's reluctance to adopt tax-cut
stimulus measures was his belief that such measures would undermine the
government's ability to maintain a balanced budget and could potentially lead to
inflationary pressures and other adverse economic consequences. He was also wary of
the political and social implications of deficit spending, fearing that it could erode
public confidence in the government's ability to manage the economy and ultimately
undermine the nation's economic strength and stability.
Instead of relying on tax cuts to stimulate the economy, Eisenhower pursued
other strategies to promote economic growth and job creation, including investment in
infrastructure, education, and research and development. He also emphasized the
importance of fiscal discipline and responsible government spending as essential
components of a sound and sustainable economic policy.
In the end, Eisenhower's refusal to adopt tax-cut stimulus measures during the
recessions of the 1950s reflected his steadfast commitment to fiscal responsibility and
budgetary discipline. While his approach may have been criticized by some at the
time, it ultimately contributed to the long-term stability and prosperity of the
American economy, laying the groundwork for the economic expansion and growth
that followed in the decades to come.
Still another shining moment came in August 1958 when Fed chairman
William McChesney Martin moved to “take away the punch bowl” in order to
discourage stock market speculation only four months after the economic recovery
had begun. And rarely noted is that President Kennedy’s first economic policy address
was a ringing commitment to maintain the nation’s Bretton Woods obligations and to
defend the gold dollar. It is entirely accurate and warranted to say that Nixon’s
embrace of Professor Friedman’s floating paper dollar was the fatal turning point
which brought a final end to sound money.
The journey leading up to August 1971, when President Richard Nixon made
the historic decision to sever the last ties between the US dollar and gold, reveals a
nuanced and complex narrative that challenges the notion of inevitability surrounding
Nixon's actions. What emerges is not a straightforward path towards the abandonment
of the gold standard, but rather a series of events and decisions that gradually eroded
the foundations of sound money.
The twilight of sound money can be traced back to the aftermath of World War
II, when the Bretton Woods system was established as a framework for international
monetary cooperation. Under this system, the US dollar was pegged to gold at a fixed
exchange rate, and other currencies were pegged to the dollar. This arrangement
provided a degree of stability and predictability to the global financial system, but it
also placed significant constraints on monetary policy and economic flexibility.
As the post-war economic boom gave way to a period of slower growth and
rising inflation in the 1960s, cracks began to appear in the Bretton Woods system. The
United States, facing mounting trade deficits and fiscal pressures from the Vietnam
War and Great Society programs, found it increasingly difficult to maintain the
convertibility of the dollar into gold at the agreed-upon rate.
Meanwhile, other countries, particularly those in Europe, began to express
dissatisfaction with the dominance of the US dollar in international trade and finance.
They argued that the fixed exchange rate system disadvantaged their economies and
limited their ability to pursue independent monetary policies. Calls for reform and
renegotiation of the Bretton Woods agreements grew louder, putting further strain on
the stability of the system.
Against this backdrop of mounting economic challenges and geopolitical
tensions, Nixon's decision to abandon the gold standard in August 1971 can be seen as
a response to a confluence of factors rather than an inevitable outcome. While the
move may have been motivated in part by short-term political considerations and the
desire to address immediate economic pressures, it also reflected deeper structural
shifts in the global economy and the limitations of the Bretton Woods system in the
face of evolving economic realities.
In hindsight, the twilight of sound money was not a sudden or inevitable
event, but rather a gradual and multifaceted process driven by a combination of
economic, political, and technological factors. The decision to abandon the gold
standard marked a turning point in the history of global finance, ushering in a new era
of floating exchange rates and fiat currencies. However, it was not the end of the story
but rather the beginning in the ongoing evolution of monetary systems and economic
governance.
f. War Finance and The Rise of The Fed’s Open Market Bond and Billy Buying
Once war was declared, the Roosevelt administration dusted off the techniques
discovered during the Great War mobilization of 1917–1918 and soon imposed a
complete command-and-control régime that reached into every nook and cranny of
the American economy. The steel, auto, metalworking, machinery, and other heavy
industries were commandeered to make ships, planes, and tanks. Production of
housing, autos, household durables, and other discretionary items was eliminated
almost entirely. In a civilian economy bereft of consumer goods, all prices and wages
were put under a straitjacket of bureaucratic controls. Likewise, private incomes were
drafted into war service either by means of confiscatory taxation or as quasi-forced
savings via the incessant war bond campaigns.
Not surprisingly, the money markets and the capital markets went into deep
hibernation in this completely war mobilized economy. Likewise, the Federal Reserve
became the financing arm of the warfare state. Making short shrift of any pretense of
Fed independence, Treasury Secretary Henry Morgenthau simply decreed that interest
rates on the federal debt would be “pegged.” Treasury bills would yield three-eighths
of 1 percent and longterm bonds would pay a 2.5 percent coupon. Obviously, the only
way to enforce this peg was for the nation’s central bank to purchase any and all
Treasury paper that did not find a private sector bid at or below the pegged yields.
As economic conditions evolved, the Federal Reserve found itself in a position
where it increasingly became a significant purchaser of Treasury securities, effectively
engaging in the practice known as "monetizing" federal debt on a scale unprecedented
in its history. This shift in the central bank's role had profound implications for
monetary policy, fiscal management, and the broader economy.
The Federal Reserve's transition into a major buyer of Treasury securities was
driven by a combination of factors, including changes in the economic landscape,
shifts in government financing needs, and developments in monetary policy. As the
United States grappled with the aftermath of the Great Recession and faced mounting
fiscal challenges, the demand for Treasury securities surged, putting pressure on the
government to find buyers for its debt issuance.
At the same time, the Federal Reserve was seeking ways to stimulate
economic growth and support financial markets in the wake of the financial crisis.
One tool at its disposal was open market operations, through which the central bank
purchases or sells Treasury securities to influence the money supply and interest rates.
In response to the economic downturn, the Federal Reserve embarked on a series of
large-scale asset purchase programs, commonly known as quantitative easing, aimed
at lowering long-term interest rates and providing liquidity to the financial system.
These asset purchase programs had the effect of increasing the Federal
Reserve's holdings of Treasury securities, effectively monetizing a significant portion
of the federal debt. While the primary motivation behind these purchases was to
support the economy and stabilize financial markets, they also had the effect of
facilitating government borrowing by providing a ready buyer for Treasury securities.
The scale of the Federal Reserve's intervention in the Treasury market was
unprecedented, with its balance sheet expanding to levels never before seen. This
raised concerns among some economists and policymakers about the potential risks
and unintended consequences of such large-scale asset purchases, including the
possibility of inflationary pressures, distortions in financial markets, and a loss of
confidence in the central bank's ability to unwind its balance sheet in an orderly
manner.
Moreover, the practice of monetizing federal debt raised broader questions
about the relationship between monetary policy and fiscal policy, and the appropriate
role of the central bank in government financing. While the Federal Reserve is legally
prohibited from directly purchasing Treasury securities at auction, its purchases in the
secondary market effectively serve to monetize the debt by providing a source of
demand for government bonds.
In conclusion, the Federal Reserve's role as a significant purchaser of Treasury
securities represents a significant departure from its traditional role as a guardian of
price stability and financial stability. While the central bank's interventions in the
Treasury market were motivated by the need to support the economy and stabilize
financial markets, they also had the effect of monetizing a significant portion of the
federal debt, raising important questions about the appropriate boundaries of
monetary policy and the risks of excessive government intervention in financial
markets.
As policymakers grapple with the multifaceted challenges of managing the
post-crisis economy, the legacy of the Federal Reserve's unprecedented role in
monetizing federal debt will undoubtedly continue to shape and inform the ongoing
debates about monetary policy, fiscal sustainability, and the broader role of the central
bank in modern economies. This legacy is deeply intertwined with the various
interventions and unconventional measures the Federal Reserve undertook during
periods of economic turmoil, particularly in the wake of the financial crisis of 2008
and the subsequent economic disruptions that followed.
The financial crisis of 2008 marked a turning point for central banking
practices, pushing the Federal Reserve to adopt a series of extraordinary measures to
stabilize the economy and prevent a complete financial collapse. Among these
measures was the large-scale purchase of Treasury securities, a practice that came to
be known as quantitative easing (QE). Through QE, the Federal Reserve injected
massive amounts of liquidity into the financial system by buying up government
bonds, which effectively increased the money supply and aimed to lower long-term
interest rates.
The immediate objective of these actions was to support financial markets,
encourage lending, and stimulate economic activity during a period of severe
economic contraction. However, the long-term implications of such extensive bond-
buying programs have sparked a wide range of discussions among economists,
policymakers, and financial analysts. The Federal Reserve's expanded balance sheet
and its role in financing government debt have raised critical questions about the
future direction of monetary policy and the potential risks associated with sustained
central bank intervention in the bond markets.
One major area of concern revolves around the potential for inflation. By
significantly increasing the money supply, the Federal Reserve's actions could, in
theory, lead to higher inflation rates if the growth in money outpaces economic
output. Although inflation remained relatively subdued in the years immediately
following the financial crisis, the long-term effects of persistent monetary expansion
continue to be a subject of intense scrutiny and debate.
Another key issue is the impact on fiscal sustainability. The Federal Reserve's
purchases of Treasury securities have made it easier for the government to finance
large budget deficits without facing immediate upward pressure on interest rates.
While this has provided short-term relief and facilitated countercyclical fiscal policies
during economic downturns, it also raises concerns about the potential erosion of
fiscal discipline. The ease with which the government can finance its spending
through the central bank may reduce the incentive to address underlying structural
deficits and implement necessary fiscal reforms.
Moreover, the intertwining of monetary and fiscal policy has implications for
the independence of the Federal Reserve. Central bank independence is considered
crucial for maintaining credibility and ensuring that monetary policy decisions are
made based on economic considerations rather than political pressures. However, the
extensive involvement of the Federal Reserve in purchasing government debt blurs
the lines between monetary and fiscal policy, potentially compromising the perceived
independence of the institution.
Additionally, the Federal Reserve's interventions have influenced financial
markets and investor behavior. By keeping interest rates artificially low for an
extended period, the central bank has encouraged investors to seek higher returns in
riskier assets, contributing to asset price inflation and potentially creating financial
imbalances. The eventual unwinding of the Federal Reserve's balance sheet and
normalization of interest rates pose significant challenges, as abrupt changes in
monetary policy could lead to market volatility and financial instability.
In conclusion, the legacy of the Federal Reserve's role in monetizing federal
debt is a complex and multifaceted issue that will continue to shape debates about the
future of monetary policy, fiscal sustainability, and the central bank's role in modern
economies. As policymakers navigate the post-crisis economic landscape, they must
carefully consider the long-term consequences of unconventional monetary
interventions and strive to strike a balance between supporting economic recovery and
maintaining fiscal and monetary discipline. The lessons learned from this period will
be crucial in informing future policy decisions and ensuring the stability and
prosperity of the economy in the years to come
The magnitude of this bond- and bill-buying campaign is dramatically evident
in the Fed’s balance sheet footings, which showed holdings of $2.3 billion of Treasury
debt at the start of the war. By the end of 1945, these holdings had soared to $24.3
billion, a twelvefold expansion during the four years of world war. The nation’s
central bank thus became schooled in the art of rigging the government bond market
and the Treasury yield curve by persistent massive open-market purchases of Treasury
paper. Today this is business as usual, but then it was a radical departure, a theretofore
rarely used tool that now became institutionalized owing to the exigencies of wartime
finance. The Fed opened its doors in November 1914. But owing to the exigencies of
wartime its purpose and modus operandi were twice turned upside down during its
first thirty-one years. It can be fairly said that the Fed became a permanent denizen of
the government debt market during its service to the warfare state, forging the T-bill
standard, as it were, in the crucible of war.
The massive government bond buying undertaken by the Federal Reserve
represented a significant departure from the original intent of the legislative authors
who drafted the Federal Reserve Act of 1913. When the Act was passed, its primary
objective was to establish a central banking system that would provide stability to the
financial system, ensure the availability of credit to meet the demands of commerce
and industry, and prevent financial panics and crises.
At the time of its enactment, the focus of policymakers was on addressing the
perceived shortcomings of the existing banking system, which was fragmented and
prone to instability. The Federal Reserve was designed to serve as a lender of last
resort, providing liquidity to banks in times of crisis and acting as a stabilizing force
in the financial markets.
However, the role of the Federal Reserve evolved over time, particularly in
response to the challenges posed by the Great Depression and subsequent economic
crises. In the aftermath of the stock market crash of 1929 and the ensuing banking
panics, the Federal Reserve began to expand its activities beyond its traditional role as
a lender of last resort.
During the Great Depression, the Federal Reserve engaged in unprecedented
measures to support the economy and stabilize financial markets, including large-
scale purchases of government bonds and other securities. These actions were
intended to inject liquidity into the financial system, lower interest rates, and stimulate
economic activity.
While these measures were initially seen as necessary responses to the
extraordinary economic challenges of the time, they represented a significant
departure from the original intent of the Federal Reserve Act. Instead of simply
providing liquidity to banks in times of crisis, the Federal Reserve became actively
involved in influencing interest rates, managing the money supply, and conducting
monetary policy.
The expansion of the Federal Reserve's role in the economy continued in the
decades that followed, particularly during periods of economic downturns and
financial instability. The central bank's actions came to encompass a wide range of
activities, including open market operations, discount window lending, and regulatory
oversight of the banking system.
In the years leading up to the financial crisis of 2008, the Federal Reserve
once again expanded its activities in response to the challenges posed by the housing
market collapse and the subsequent credit crunch. This included large-scale purchases
of mortgage-backed securities and other assets, known as quantitative easing, aimed
at lowering long-term interest rates and supporting economic recovery.
While these measures were seen as necessary to prevent a deeper economic
downturn and stabilize financial markets, they also raised questions about the
appropriate role of the Federal Reserve in the economy and the potential risks
associated with its expanded activities. Critics argued that the central bank's actions
had strayed far from the original intent of the Federal Reserve Act and raised concerns
about moral hazard and the long-term consequences of excessive government
intervention in the economy.
In conclusion, the massive government bond buying undertaken by the Federal
Reserve represented a significant departure from the original intent of the legislative
authors of the Federal Reserve Act of 1913. While the central bank's actions were
driven by the need to respond to evolving economic challenges and stabilize financial
markets, they also raised questions about the appropriate role of government in the
economy and the risks associated with excessive interventionism. As policymakers
grapple with the ongoing challenges of economic governance, the legacy of the
Federal Reserve Act continues to shape debates about monetary policy, financial
regulation, and the role of central banks in modern economies.
g. Eisenhower’s Defense Minimum and The Last Age of Fiscal Rectitude
Chairman william mcchesney martin’s quest to restore sound money was
aided immeasurably during the 1950s by a fiscal policy backdrop that would never
again recur. Beginning with Truman’s tax financing of the Korean conflict, monetary
policy was supported by two successive presidents who were firmly committed to
budgetary discipline and who were willing to expend political capital to achieve it.
As it happened, it was Eisenhower who really brought the old-time religion
back to the center of peacetime fiscal policy. Ike was a military war hero who hated
war. He was also the former supreme commander of the costliest military campaign in
history and revered balanced budgets.
Eisenhower's approach to fiscal policy during his presidency was marked by a
willingness to make tough decisions and prioritize fiscal discipline over other
considerations. One notable example of this was his willingness to wield the
budgetary knife when necessary, with the Pentagon often bearing the brunt of his
spending cuts.
While Eisenhower is often remembered for his role as a military leader during
World War II, he was also deeply aware of the dangers of excessive military spending
and the potential for it to undermine the nation's long-term economic stability. As
president, he sought to strike a balance between maintaining a strong national defense
and ensuring fiscal responsibility.
One of Eisenhower's first acts upon taking office was to order a
comprehensive review of the defense budget, with the goal of identifying areas where
spending could be reduced or eliminated without compromising national security.
This led to a series of budget cuts and efficiency measures aimed at streamlining the
Pentagon's operations and curbing wasteful spending.
Eisenhower's willingness to challenge the military-industrial complex and rein
in defense spending was not without controversy, however. He faced pushback from
powerful interests within the defense establishment and Congress, who argued that
cutting military spending would weaken national security and undermine America's
position on the world stage.
Despite these challenges, Eisenhower remained steadfast in his commitment to
fiscal discipline and prudent budget management. He believed that excessive military
spending was not only unnecessary from a strategic standpoint but also posed a threat
to the nation's economic well-being by diverting resources away from more
productive uses.
Eisenhower's efforts to rein in Pentagon spending were part of a broader
strategy to promote peace and prosperity at home and abroad. He recognized that
unchecked military expansion could lead to a dangerous arms race and increase the
risk of conflict, both of which would have negative consequences for the nation's
economy and global stability.
In addition to his focus on budgetary restraint, Eisenhower also pursued
diplomatic initiatives aimed at reducing tensions with America's adversaries and
promoting international cooperation. This included efforts to negotiate arms control
agreements, such as the Open Skies Treaty and the Partial Nuclear Test Ban Treaty,
which helped to mitigate the risks of nuclear proliferation and reduce the likelihood of
armed conflict.
In conclusion, Eisenhower's willingness to wield the budgetary knife and
prioritize fiscal discipline over other considerations, including military spending, was
emblematic of his pragmatic approach to governance. While his efforts to rein in
Pentagon spending were met with resistance from entrenched interests, they reflected
his belief in the importance of balancing national security priorities with the need for
fiscal responsibility. As policymakers grapple with similar challenges today,
Eisenhower's legacy serves as a reminder of the importance of prudent budget
management and the dangers of unchecked military expansion.
h. The Folly of War Deficits
The essence of Eisenhower’s immense fiscal achievement, an actual shrinkage
of the federal budget in real terms during his eight-year term, is that he tamed the
warfare state. In so doing, he paved the way for Uncle Sam to pay his bills out of
current taxation for the better part of a decade. The enormity of this achievement can
only be fully appreciated by contrast with its opposite—that is, three devastating
fiscal setbacks during the next half century under Lyndon Johnson, Ronald Reagan,
and George W. Bush.
The plunge of the nation's fiscal accounts deep into the red in each case was
indeed precipitated by a resurgence of massive warfare state budgets, a trend that ran
counter to the fiscal prudence and restraint that President Eisenhower had championed
during his tenure in office.
Eisenhower's steadfast resistance to the expansion of the warfare state
stemmed from his deep-seated belief in the importance of fiscal responsibility and his
recognition of the dangers posed by excessive military spending. As a former military
leader himself, Eisenhower was acutely aware of the costs and consequences of war,
both in human terms and in terms of its impact on the nation's finances.
During his presidency, Eisenhower sought to strike a balance between
maintaining a strong national defense and ensuring fiscal discipline. He recognized
the need for a robust military deterrent in the face of growing geopolitical tensions
and the threat of communism, but he also understood the dangers of unchecked
military expansion and the potential for it to undermine the nation's long-term
economic stability.
However, in the years following Eisenhower's presidency, the United States
experienced a series of conflicts and military engagements that put significant strain
on the nation's fiscal accounts. The Vietnam War, in particular, led to a dramatic
escalation in military spending, as the United States sought to combat the spread of
communism in Southeast Asia.
The costs of the Vietnam War, combined with other defense-related
expenditures, pushed the nation's fiscal accounts into the red, leading to growing
budget deficits and mounting national debt. Despite efforts to rein in military
spending and pursue more prudent fiscal policies, the demands of war and the
pressures of Cold War competition with the Soviet Union exerted significant upward
pressure on defense budgets.
This trend continued in the years that followed, as the United States embarked
on a series of military interventions and engagements around the world, including
conflicts in the Middle East and elsewhere. The costs of these conflicts, combined
with other defense-related expenditures, further exacerbated the nation's fiscal
challenges and contributed to the widening gap between revenues and expenditures.
In each case, the resurgence of massive warfare state budgets represented a
departure from the fiscal discipline and restraint that Eisenhower had advocated. The
growing reliance on deficit spending to finance military operations and defense-
related expenditures raised important questions about the sustainability of such
policies and the long-term consequences for the nation's fiscal health.
Moreover, the expansion of the warfare state had broader implications for the
nation's economy and society, including its impact on economic growth, income
inequality, and social cohesion. As policymakers grapple with the legacy of these
trends, there is a growing recognition of the need for a more balanced and sustainable
approach to national security policy—one that prioritizes fiscal responsibility while
ensuring the safety and security of the nation.
In bringing down the fiscal roof, all three post-Eisenhower defense surges
were enabled by a vital accomplice: Keynesian theories of prosperity management
that manifested themselves in both a leftist “new economics” version and rightist
“supply side” variant. The pretension of both ideologies was that the correct policy
action by Washington could spur permanent economic growth at extraordinary rates,
such as 5 percent annually or even better. Consequently, by embracing this high GDP
growth illusion, the White House occupants during these three episodes were led to
believe that they could have war budgets without war taxes.
War deficits, of course, are what they actually got. Yet this was a good thing,
according to the Keynesian professors, because such deficits inject demand into the
economy, thereby lifting output closer to its full-employment potential. The supply-
side apostles of Art Laffer’s tax-cutting scheme agreed. The incremental GDP growth
from incentives to save, invest, and take risk would pay for all the war spending the
nation might ever need. In fact, war deficits are the worst fiscal policy imaginable.
They add to civilian demand but generate no marketable output of consumer products
or capital goods.
Indeed, the economic consequences of war deficits extend far beyond the
immediate costs of financing military operations and defense-related expenditures.
These deficits have a profound impact on the overall economy, tipping it toward
excess demand, inflationary pressures, rising interest rates, and financial instability.
Moreover, they can have long-lasting effects on wealth accumulation, income
distribution, and living standards for both current and future generations.
One of the most immediate effects of war deficits is the strain they place on
the government's fiscal accounts. As the government increases spending on military
operations and defense-related activities, it often finds itself facing growing budget
deficits and mounting national debt. This can lead to a crowding out of private
investment, as government borrowing competes for available funds in the financial
markets, driving up interest rates and reducing access to credit for businesses and
consumers.
The inflationary pressures associated with war deficits can also have a
significant impact on the economy. As government spending increases, demand for
goods and services rises, putting upward pressure on prices and leading to inflationary
bottlenecks in key sectors of the economy. This can erode the purchasing power of
wages and savings, reducing real incomes and lowering living standards for
households across the income spectrum.
Moreover, the inflationary effects of war deficits can spill over into other areas
of the economy, leading to broader price increases and contributing to a cycle of
wage-price spirals and inflationary expectations. This can undermine the stability of
financial markets and exacerbate financial instability, as investors and consumers
become increasingly uncertain about future economic conditions.
In addition to their inflationary effects, war deficits can also have long-lasting
consequences for wealth accumulation and income distribution. The burden of
financing government spending falls disproportionately on certain segments of the
population, particularly lower-income households and future generations who bear the
costs of servicing the national debt through higher taxes or reduced government
services.
Furthermore, the diversion of resources toward military activities and defense-
related expenditures can crowd out investments in other areas of the economy that are
critical for long-term economic growth and prosperity. This includes investments in
education, infrastructure, healthcare, and research and development, which play a
vital role in driving productivity gains, innovation, and competitiveness in the global
economy.
In conclusion, war deficits represent a significant economic burden that can
have wide-ranging and long-lasting effects on the overall economy, including excess
demand, inflationary pressures, rising interest rates, and financial instability.
Moreover, they can undermine wealth accumulation, income distribution, and living
standards for households across the income spectrum, while also diverting resources
away from investments that are critical for long-term economic growth and prosperity.
As policymakers grapple with the economic consequences of war deficits, there is a
growing recognition of the need for a more balanced and sustainable approach to
national security policy, one that prioritizes fiscal responsibility and investment in the
drivers of long-term economic growth and prosperity.
Since time immemorial, therefore, politicians have attempted to alleviate these
pressures by financing war bonds with printing-press money. Lyndon Johnson did it
and broke the resolve of Chairman Martin and the anti-inflation policy of the Fed.
Likewise, after global money went on the T-bill standard, Reagan and Bush did it, too,
by exporting their war bonds to the central banks of Japan and China, and thereby
postponing but not eliminating the day of reckoning.
Eisenhower's achievement in throttling the warfare state represented a pivotal
moment in American history, with far-reaching implications for both domestic and
foreign policy. While his efforts to restrain military spending and prioritize fiscal
discipline were indeed of singular significance, it is important to recognize the
broader context in which these actions took place and the complex forces that shaped
their outcomes.
At the heart of Eisenhower's approach to governance was a deep-seated
commitment to fiscal responsibility and prudence, tempered by a keen awareness of
the dangers posed by excessive military expansion. As a former military leader
himself, Eisenhower understood the costs and consequences of war, both in human
terms and in terms of their impact on the nation's finances and long-term prosperity.
During his presidency, Eisenhower took decisive action to rein in the growth
of the warfare state and prevent the unchecked expansion of military spending. He
recognized that the burgeoning defense budget threatened to undermine the nation's
economic stability and fiscal health, diverting resources away from critical domestic
priorities and eroding public confidence in government.
One of Eisenhower's most significant achievements in this regard was his
insistence on maintaining a balanced federal budget, even in the face of mounting
pressure to increase defense spending. He understood that fiscal discipline was
essential to preserving the nation's economic strength and stability, and he made
difficult choices to prioritize investment in areas such as infrastructure, education, and
scientific research over military expansion.
Moreover, Eisenhower's efforts to restrain the warfare state were not limited to
budgetary measures alone. He also pursued a pragmatic and diplomatic approach to
foreign policy, seeking to avoid unnecessary conflicts and promote peace and stability
through dialogue and negotiation. His decision to end the Korean War and resist calls
for military intervention in other global hotspots demonstrated his commitment to
avoiding the pitfalls of militarism and aggressive foreign policy.
However, despite Eisenhower's best efforts, the forces driving the expansion
of the warfare state proved to be formidable and persistent. The pressures of the Cold
War, combined with the influence of powerful military-industrial interests and the
growing demands of the national security establishment, ultimately undermined
Eisenhower's attempts to restrain military spending over the long term.
In the decades that followed Eisenhower's presidency, military spending
continued to escalate, fueled by a series of conflicts and military engagements around
the world. The Vietnam War, in particular, led to a dramatic increase in defense
expenditures, further eroding the gains made during Eisenhower's tenure and pushing
the nation's fiscal accounts deep into the red.
In conclusion, while Eisenhower's achievement in throttling the warfare state
was of singular significance, its transient nature underscores the enduring challenges
of balancing national security priorities with fiscal responsibility and prudent
governance. As policymakers grapple with these challenges in the modern era,
Eisenhower's legacy serves as a reminder of the importance of principled leadership,
fiscal discipline, and a commitment to peace and diplomacy in shaping America's role
in the world.
