Chapter Content
Okay, so, like, imagine this: World War I, right? A total disaster. But what if… what if we could have just, you know, pretended it didn't happen? Like, hit rewind and get back to where we were before all the madness started? Before the guns, the trenches, the… the everything?
I mean, things were actually pretty good before the war, you know? From, like, 1870 to 1914, the economy was booming. It was like an economic El Dorado, seriously. We were inventing all sorts of amazing stuff, making life easier, and, um, people were generally getting richer. Like, way richer than ever before. And it wasn't just about money. There were fewer slaves, more people voting… it felt like things were actually heading in the right direction. So, like, wouldn’t it have made sense to just go back, maybe tweak a few things to avoid another giant mess, and keep going?
I mean, obviously, things couldn't go *exactly* back to the way they were, right? Like, empires had crumbled, a lot of people had died. But couldn't we, like, adjust, you know? Fix the issues so the militarism, the crazy nationalism… all that stuff wouldn't lead us straight into another catastrophe? Seems like a no-brainer, right?
You'd think, after something like that, everyone would be on board with peace, with working together. Nationalism had clearly been a disaster, so wouldn't cosmopolitanism – that idea that we all share a "common home" – be the obvious choice? And think of the opportunity! All that money and resources that had been going to war could now be used for, like, actually useful stuff. We had, like, three times the technology we had back in 1870! Even with more people and some growing inequality, most people had a level of security their grandparents could only dream of. They were confident they'd have food, clothes, shelter...
So, why not just restore the system that got us to that better place? Or, if it needed fixing, why couldn't we have, like, figured out a consensus? Well, unfortunately, it didn't quite work out that way.
After the war, two pretty intense ideas emerged that wanted to totally rewrite the rulebook, you know? Like, not just tweak the existing system, but completely overhaul it. Those were Lenin's version of socialism and Mussolini's fascism. We'll get to those later in more detail.
But, hey, there were other ideas floating around, too. If my editor would let me write a super-long book, I’d get into all of them. Like, there was Joseph Schumpeter, talking about how we need to support entrepreneurs and "creative destruction" to balance out the growing bureaucracy. Then there was Karl Popper, who said we should double down on freedom to create a truly "open society." And Peter Drucker, who thought we needed managers and management to get people to actually work together cooperatively, because markets and socialist plans could only go so far. And also Michael Polanyi. He thought society needed, like, science and communities of legal interpretation and, you know, honorable journalism to advance the public interest.
But since I don’t have the space, I'm gonna focus on two main currents, okay? There's Friedrich von Hayek, who believed we just needed to purify and perfect market institutions, supported by a more conservative social order. And then there's Karl Polanyi, Michael's older brother, who argued that the market, in its pure form, ignores the fact that people have all sorts of rights that aren't just property rights. And that society will push back, one way or another. I’m also going to talk about how these two seemingly opposing forces were, like, kind of forced together by John Maynard Keynes. That's my big story, at least.
So, again, back to the main question: could we have turned back the clock and just kept going? Could we have taken that other path in 1919, the one that looked more like the good old days of 1870 to 1914? Well, history tells us that, yeah, that didn't happen.
One big reason? After 1918, there was no single country that could, like, take charge, you know? What my teacher, the economic historian Charlie Kindleberger, called the "hegemon". He said that economies need a hegemon to maintain prosperity. Now, most countries think that some other country will be the hegemon. However, if you're the biggest player in the economy, your people need to be the hegemon. But after World War I, the United States, the new potential hegemon, basically said, "Nah, we're good." Before the war, Britain could handle it, but afterward, "the British couldn't and the United States wouldn't." So everyone just looked out for themselves, and the whole system suffered.
The US hadn't been totally untouched by the war, but it wasn't the civilization-shattering experience it was for Europe. In the US, that "Belle Époque" feeling just kept going – we had Prohibition, the Jazz Age, crazy real estate booms, new factories, and a stock market that was totally divorced from reality. Basically, all the utopian hopes got poured into the US in the '20s. So, we were like, "Hey, we're doing okay, let the rest of the world figure it out."
Instead of being a world leader, the US went into isolationist mode. President Wilson, who was in a strong position after the war, didn't really do much with it. He let the British and French take the lead, and the US Senate refused to join the League of Nations, the international organization created for communication among countries.
On top of that, the US put up new barriers to immigration and raised tariffs. They weren't huge, but they were enough to make foreign producers wonder if they could really rely on the American market. So, yeah, there was no real return to normalcy. The economy didn't get back on its pre-war tracks. And, to make things worse, globalization had a dark side.
We should have seen it coming. A flu started in Uzbekistan in 1889. It spread quickly through the Russian Empire and then to the rest of the world. In the US, one newspaper wrote, "It is not deadly, not even necessarily dangerous, but it will afford a grand opportunity for the dealers to work off their surplus of bandanas." Globalization kept spreading diseases all over the world. But by far the deadliest plague in modern history was the Spanish flu of 1918–1920, which killed like 50 million people. It wasn't really a Spanish flu, but the Allied powers had censored news about the flu out of a fear it would be bad for morale.
As the plague spread, European governments tried to get back to how things were before the war. But they couldn't. First, there was no agreement about how the losing empires should be governed. Britain and France got mandates to rule some former colonies, but other territories were left to figure things out on their own, which usually meant fighting. The emperors were gone, and so were their aristocrats.
The Russian czar was killed, and Lenin shut down the assembly that was supposed to write a constitution. The German Kaiser abdicated, and socialist revolutionaries were quickly suppressed. The Austro-Hungarian emperor also abdicated, and his empire was carved up into smaller countries. The Ottoman Empire fell apart, and Mustafa Kemal Atatürk took power in Turkey.
Even in the winning countries, things weren't easy. Politicians didn't want to be seen as incompetent leaders who had led their people into a pointless war. So they told their people they had "won" and were now free to enjoy the benefits.
They demanded that Germany "repair" the damage done. But how was Germany supposed to do that? If they shipped goods to Britain and France, that would hurt British and French industries. And there was also a third reason that Europe embraced nationalism instead of moving away from it. Woodrow Wilson had said that postwar borders should follow "historically established lines of allegiance and nationality." But people weren't divided along those lines. Every European state ended up with a discontented minority.
If the Allied politicians had been smart, they would have lowered expectations at home. They would have drawn a line between the warmongers and the people of the Central Powers. As John Maynard Keynes said, the warmongers had been "moved by insane delusion and reckless self-regard." But even Keynes, who was sympathetic to the Germans, blamed "the German people" for the war.
Still, he believed that the Allies needed to forget about it and let bygones be bygones. If they tried to make Germany pay too much, they would ruin the whole European economy. He went to the Paris Peace Conference and was horrified by how much the Allies wanted to get out of Germany.
As Prime Minister Jan Christian Smuts of South Africa wrote in a letter, "Poor Keynes often sits with me at night after a good dinner and we rail against the world and the coming flood." Herbert Hoover, who had been working to fight famine in Belgium during the war, warned that thirty million people could die if nothing was done.
Hoover shipped food. Keynes wrote a book, The Economic Consequences of the Peace, in which he criticized the politicians. He said that if the Allies impoverished Germany, it would lead to more conflict and destroy civilization.
The postwar trouble started with inflation. You see, market economies rely on prices to tell people what to do. But if prices are wrong, it's hard to make good decisions. And that is what Lenin said when he declared that "the best way to destroy the capitalist system was to debauch the currency." Inflation, then, isn't just a small increase in prices. It’s a way for governments to confiscate wealth secretly. It creates "profiteers" who are hated by everyone. It messes up all the relationships between lenders and borrowers. As Keynes said, "There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency."
SO WHY THEN WOULD governments cause high inflation?
Well, imagine a government that has promised more than it can afford. One way to deal with that is to borrow money by issuing bonds. The government asks people to give up spending now, and promises them more money in the future. But what if the people who buy the bonds – mostly financiers – don't trust the government? Then they'll demand high interest rates. Economists use a one-equation model called the fiscal theory of the price level to demonstrate this, that is:
Price Level = (Nominal Debt) × (Interest Rate) / (Real Debt Service Limit)
Let's say that France in 1919 had a national debt of ₣200 billion, on which it owed 4 percent interest per year. If the real resources the French government and electorate could mobilize to pay the interest on its debt were equal to ₣8 billion per year at average 1919 prices, the equation would have balanced and France would not have experienced inflation in the 1920s. But it turned out that the real resources the French government and electorate could mobilize to pay the interest on its debt amounted to only ₣3.2 billon (at average 1919 prices). And financiers demanded 6 percent interest. To keep equilibrium, the average level of prices in France needed to triple. That meant a value of the French franc was no longer ₣1 = US$0.15 but rather of ₣1 = US$0.04. The result? 20 percent average inflation for seven years. That can really throw off economic planning.
And worse outcomes came when financier’s trust broke down completely. Then the money and bonds are worthless. This first happened in the countries that used to be part of the Austro-Hungarian Empire. After the war, the empire was split into seven countries, each with its own currency and tariffs. The old regional economy fell apart.
Joseph Schumpeter was the finance minister of the new Austrian Republic. He wanted to tax wealth to pay off the debt. But the rest of the government wanted to use the money to take over Austrian companies and make them more efficient. Schumpeter said that if the companies were actually efficient, they wouldn't need the tax money.
Schumpeter was fired. The government fell apart. And they started printing money. The Austrian crown used to be worth almost 20 US cents. By 1922, it was worth 0.01 of a cent. The League of Nations gave Austria a loan, but only if the government gave up control of its currency and finances. They cut spending and raised taxes, and Austria stayed poor for years.
In Germany, prices rose a trillionfold. In 1914, what had cost 4 Reichsmarks cost 4 trillion by the end of 1923. Again, the Allies imposed reparations on Germany at the Treaty of Versailles. And it was electoral poison for any politician wanting to work out a plan to actually pay them.
France and Britain could have bought shares of German companies with their reparations money, but they didn't want to wait. The German government preferred to resist over figuring out a way to pay. The bulk of the reparations burden was never paid, instead financed by American investors. They made loans to Germany that Germany then transferred to the Allies. The German reparations burden was forgiven during the Great Depression.
The imposition of those reparations turned out to be a costly political decision, for it set off a chain of events that ultimately led to the Depression.
By the end of 1919, the Reichsmark was worth just 1 cent. It then recovered somewhat. But the government kept spending and printing, and by the end of 1921, the mark was back down to 0.33 of a cent, an inflation rate of 500 percent per year. And it kept getting worse from there.
For a while the government welcomed the inflation. Industrial and mercantile interests also benefited, as did labor. But in January 1923 the French government sent in its army to occupy the Ruhr Valley and collect commodities at gunpoint. The German government and people responded with passive resistance. The inhabitants of the Ruhr went on strike. And the German government printed even more money to try to maintain the incomes of the passive resisters. By the end of 1923, the mark was worth 0.000000000025 of a cent, an inflation rate of 9,999,999,900 percent per year.
Of the countries that experienced post–World War I inflation, Germany was hit the worst. But a number of other countries also saw inflation climb to devastating levels. In Russia prices rose four billionfold. In Poland they rose two and a half millionfold. In Austria, prices rose two thousandfold.
This wave of inflation was because of governments trying to appease the people who had just lived through World War I: the maimed, the starved, and those grieving for lost brothers, fathers, husbands, and sons. Political leaders tried to create a "land fit for heroes." This meant social welfare programs, infrastructure projects, and giving voting rights to the working class and women.
There followed disability insurance for war veterans, unemployment insurance, mammoth government expenditures, and, even more, mammoth government expenditures to pay off the war debts. Voters and heroes demanded that governments compensate them for their property that had been destroyed or that had lost its value from war-induced dislocations. And they demanded their Polanyian rights. Old-age pensions, public housing, and public health insurance moved onto the agenda. Satisfying these demands would take vast resources. The world’s governments were all poorer than they had been in 1914, but the urge to spend was strong. The right did not dare resist it. The left did not have enough of an electoral mandate to make the rich pay. The result was inflation.
From a narrow economists' perspective, inflation is simply a tax, a rearrangement, and a confusion. It is a tax on cash, because your cash becomes worth less between when you acquire it and when you spend it. It is a rearrangement, as those who have borrowed pay back their loans in depreciated currency, while those who have lent have to accept the depreciated currency. And it is a source of confusion, because it is difficult to calculate whether what you're doing makes economic sense when the numbers correspond to different amounts of real purchasing power.
All of these elements of inflation are destroyers of trust in the economy, society, and governments. According to Keynes, this destruction of trust was "fast rendering impossible a continuation of the social and economic order of the nineteenth century. But [European leaders had] no plan for replacing it."
NEARLY EVERYONE WITH POWER or property sought a return to what US president Warren G. Harding called "normalcy." And for many, that meant fixing the gold standard – the half-century-long general commitment of all the largest trading countries to buy and sell their currencies for gold at a fixed price. In the immediate aftermath of World War I, countries agreed that they had to peg their currencies back to gold, and eventually they did. That pleased the rich because it would guard against further inflation.
Only Britain got to raise and lower interest rates at home. This seemed a good system both for Britain and for world trade. After all, the pre–World War I gold standard had supported the fastest and broadest half century of economic growth of any era up until then.
During World War I, finance ministers discovered the benefits of inflation, finding it to be a necessity. But you could not inflate if you kept your promise to buy and sell your currency for its fixed gold parity. So countries had dropped the gold standard during the war. And afterward, countries seeking normalcy sought to return to it.
Much easier sought than done. Wartime and postwar inflation had tripled prices worldwide. Banks and governments made sure that their transactions stayed greased by holding a constant fraction of their payments flow in the form of gold assets, gold as reserves. Triple prices and you triple the nominal value of transactions. Triple the nominal value of transactions, and you triple the gold you need to hold unless you are willing to change the equivalency scale between gold bars and your currency.
After wartime and postwar inflations and hyperinflations, the interwar gold standard was attempting to run itself with only one-third of the gold-as-reserves ratio of asset holdings to transaction amounts that had been needed for even semismooth functioning before the war.
One place where it did not work was Britain. Even though wartime and postwar inflation was smallest in Britain, Britain found itself facing a fraught situation. It had seen a currency depreciation. Instead of the pegged value of GB£1 = $4.86 that had existed in July 1914, the market seemed to want to settle the value of the British pound at slightly less than $4.00. In advising British officials on how to respond, the financiers assured them that the government would win a great deal of long-term market trust by enacting austerity measures to restore the £1 = $4.86 pre–World War I parity. The result, the financiers said, would be increased stability, lower interest rates, and faster growth. All the financiers sounded confident and credible.
The ruling politicians chose to follow their financiers’ advice. But in an economy where the market wanted a pound to be valued at $3.80, the austerity measures needed to follow through on their plan required a 30 percent reduction in the average value of all wages and prices. In other words, deflation, which quickly led to high unemployment, bankruptcy driven by foreign competition, and an unrealistic exchange rate.
The decider in Britain in the mid-1920s was the finance minister – chancellor of the exchequer – Winston Churchill. One guest at a dinner in 1924 hosted by Churchill painted a grim picture of hobbled exports, unemployment, substantial downward pressure on wages, and waves of strikes. The guest was John Maynard Keynes.
He had attained a stature that meant he floated across even burned bridges. The Economic Consequences of the Peace had made Keynes famous. The economist spoke "like an angel with the knowledge of an expert." Keynes was propelled by "passion and despair" and showed an extraordinary mastery not just of economics but also of the words that were needed to make economics persuasive.
Keynes felt compelled to use what power he could command to restore civilization. But simply winding back the clock to the 1914 exchange-rate parity of GB£1 = US$4.86 would not do the job. Fundamentals had changed profoundly. But Keynes was not sufficient to nudge history, or, more precisely, politicians – or, more precisely still, Churchill.
In 1919 the economic risks of returning to the prewar parity of pound to gold and dollar seemed vague, distant, and uncertain. The benefits of setting out on a path of further experimentation seemed unnecessary. The political risks of postponing the return, of continuing the experimentation, seemed large and immediate. The decision was made to return Britain to the gold standard.
Great Britain returned to the gold standard in 1925. British industries found themselves facing severe competitive difficulties. This resulted in unemployment in export industries and a push for wage reductions to make domestic industry more competitive. Speculators began to pull their money out of Britain. In order to balance its payments, the Bank of England had to keep British interest rates above American interest rates. Higher interest rates depressed investment, further increasing unemployment.
Social conflict broke out in Britain over the distribution of the adjustment burden, ultimately leading to a general strike in 1926. As a result, the British government began to subsidize its declining and uncompetitive industries.
At the end of the 1920s, citizens and voters in Western Europe at least could look back on not one but two low and dishonest decades. Because of World War I, the 1910s had been the last gasp of the age in which emperors, aristocrats, generals, politicians, and soldiers had been in the saddle – and the result had been a near-complete human catastrophe. Then, in the aftermath of the war, came the 1920s, a decade in which calculators, economists, and politicians were in the saddle. While their policies had not killed ten million people, they had failed to bring rapid growth, stable incomes, stable prices, and full-enough employment.
AMERICAN ISOLATIONISM IN THE 1920s was not limited to avoiding foreign diplomatic and military entanglements. Commercial globalization went into reverse – and not just in the United States, either. Up until 1950, globalization went into recession and retreat worldwide.
Some of it was that in times of unemployment nations jealously guarded their markets, reserving them for their own production. Some of it was that nations and their rulers feared that interdependence could be weaponized. More of it was that interests that were being outcompeted and impoverished by globalization gained a greater political voice in polities that were increasingly democratic or demagogic. But most of it was that domestic manufacturing productivity levels themselves leaped ahead so rapidly without diverging substantially across countries. The coming of mass production and the assembly line meant that come 1950 international trade was back to the 9 percent of global economic activity that it had been in 1800. The globalization cycle had been fully reversed.
Furthermore, many influential Americans felt that curbing immigration should be an urgent priority.
There had been resistance to free immigration and open borders long before World War I. US senator Henry Cabot Lodge – a nativist Boston Brahmin and a Republican – had long beaten the drum, as had Progressive Woodrow Wilson, seeking to avoid social Darwinist corruption of the American race, by which they meant white people, a category they defined very narrowly.
Between 1900 and 1930 the economic and social position of America’s Black middle class was reduced to rubble. Hollywood reinvigorated the Ku Klux Klan. It was the left-of-center president Woodrow Wilson, too, who segregated the federal civil service and set personnel management to downgrading Black workers.
And by the mid-1920s, immigration restrictions against eastern and southern Europeans took hold. Back in 1914, more than 1.2 million immigrants had come to the United States. By the mid-1920s, however, the immigration restrictions had fixed the number of immigrants allowed in each year at only 160,000 or so. Moreover, there were fixed quotas for each nation. The quotas for northern and western Europe were more than sufficient for the demand. The far lower quotas for immigrants from southern and eastern Europe were decidedly not. By 1930, there were 7 million missing Americans – people who would have immigrated were it not for Henry Cabot Lodge and company’s legislative success in 1924. But America had kept building houses as though those 7 million had arrived and were living in them. And it was valuing houses and apartment buildings as though those 7 million were purchasing them or paying rent.
Truth be told, many Americans were not alarmed by the turn inward. The United States of the 1920s had plenty to do, very much including becoming a middle-class economy of radios, consumer appliances, automobiles, and suburbs. The utopian qualities of the Jazz Age weren’t even sobered by the prohibition of the sale of alcohol. Nearly thirty million motor vehicles, one for every five Americans, were on the road by 1929. Assembly lines powered by electric motors in factories arranged for the convenience of workers made the post–World War I United States the richest society the world had ever seen.
In the middle of the 1800s, English engineers had spied some regularities in the way Americans seemed to do things. American manufacturing industries made simpler and rougher goods. American manufactures used much less skilled labor. American manufactures used up lots of raw materials. American manufacturers paid their workers much better than did the British.
This “American system of manufactures” was the brainchild of Eli Whitney. The idea was that American manufacturers could make the pieces of their goods to better, tighter specifications in order to make parts interchangeable – the barrel of one firearm would fit the trigger mechanism of another. The diffusion of American-system techniques played a substantial part in the late nineteenth-century growth of American manufacturing.
Economizing costs, certainly, held the attention of nineteenth-century manufacturers. But more was needed: they aimed at also producing a higher-quality product than would otherwise be possible, which they could then sell for a premium price.
The key difference between Henry Ford and his predecessors in using the “American system” for metalworking was that Ford’s focus was not always on making a superior product, but rather on making a low-priced product he could sell to as many people as possible.
Ford minimized his costs by building a capital-intensive plant that was very good at building automobiles, but not at building anything else. This capital intensity carried risk. The productivity and profitability of the Ford plant depended on a high rate of production. This was achieved in part by “moving the work to the men” by means of the assembly line. The pace of work could be increased. The monitoring of the worker could be increased. Unskilled workers could be substituted for skilled ones. Fixed overhead costs were spread out over larger and larger volumes of production, and thus lower and lower prices became possible.
Work on Ford’s emerging assembly line was brutal. In one year, 1913, Ford had an average annual labor force of 13,600, and yet 50,400 people quit or were fired. Ford’s workers seemed like obvious fodder for recruitment into the Industrial Workers of the World, and Ford’s profits were very vulnerable to IWW-style wildcat strikes.
Ford’s solution was a massive increase in wages: to $5 a day for unskilled workers, so long as their family circumstances and deportment satisfied Ford. By 1915, annual turnover was down from 370 percent to 16 percent.
In the highly unequal, highly stratified America of the 1910s and 1920s, the idea that a high-paid, blue-collar, semiskilled worker could be well in the upper half of the income distribution seemed radical. Yet it was happening in Detroit. For all of this Ford became a celebrity, and a symbol. The extraordinary productivity of mass production offered the prospect of a ride to utopia via technology alone. Between the world wars, Henry Ford was – as Aldous Huxley made him out to be in his ambiguously dystopian novel Brave New World – a legend, a mythical figure, a near-Moses to the world.
Not everyone was convinced, and a few were outright suspicious. Huxley’s Brave New World was still clearly dystopian. Fordism as fictionalized by Huxley gave rise to a world not everyone would, or should, wish to live in.
Like many of the long century’s most prominent figures, Ford managed to retain much of the world’s regard even as his ideas became wilder, crankier, crueler, and more prejudiced. His brave new world of mass production was certainly a shock to all who thought, as Polanyi had, that they deserved stability. But it brought wonderful new, visible, and tangible things, including radios, cars, and square footage. A little instability could then be dealt with, and some of the wild and cranky and cruel could then be overlooked. All in all, America’s mass-produced future looked bright.
Increasingly, America’s decision makers believed that the key to the modern business enterprise lay in creating enormous economies of scale that could be realized by a large, vertically integrated organization able to plan the flow of raw materials into the factory and the flow of finished goods out into distribution channels. The realization of these economies of scale required the highest output, as well as the lowest practicable prices to make sure that the output could be sold. But corporations like Ford’s were proving this formula to be practical, or at least practical enough.
Theodore N. Vail, president of American Telephone and Telegraph in the early twentieth century, distinguished two different strategies for generating net revenue: “by a large percentage of profit on a small business, or a small percentage of profit on a large business.” And in America, the second was best.
Manufacturers of mass-produced items, however, faced a problem literally of their own creation. Once the market had been saturated, replacement demand of the same product dropped considerably. Producers needed consumers who would not simply “replace” but would “upgrade.” This was a big problem for Ford.
What Ford wrestled with, Alfred P. Sloan, at General Motors, embraced. Make the guts of the cars the same, put the guts in differently colored boxes, and rely on advertising to create different auras surrounding different lines of cars. Some psychology was certainly involved, but sophisticated? No.
It is natural to be of two minds about this surge of product differentiation. It seems wasteful and deceptive. Yet product differentiation, monopolistic competition, and even advertising are all genuinely popular. Mass production plus mass consumption is what made the creation of America as a middle-class society possible. A whole host of inventions and technologies that greatly transformed the part of economic life that takes place within the household became interwoven with the public’s understanding of Polanyian rights.
Back before World War I, the United States had had the most virulent business cycle in the industrialized part of the world. The United States got a central bank in 1913, the Federal Reserve, tasked with keeping the financial system sound and liquid so that the wheels of commerce and industry could turn smoothly. And so, after World War I, for about a decade, for most Americans, the market gaveth and rarely tooketh, so blessed be the market. And all this was achieved without the bother of taking on hegemonic responsibility for stabilizing the world as a whole. It was enough to stabilize the United States.
One substantial cheerleader and bridge builder for the rapid buildout of American industrialization in the 1920s was Herbert Hoover. Congress in 1919 gave Hoover $100 million to spend – and he raised another $100 million – to pay for postwar food relief. With the change of administration from Democrats back to Republicans in 1921, President Warren Harding made a concession to bipartisanship by naming Hoover secretary of commerce, a job he held from 1921 to 1928.
Hoover thought the secretary of commerce ought to be the management consultant for every single company in America, and the person who drove the other departments to cooperate and aid American industry. He promoted aviation. He promoted radio. He ran for and got the Republican presidential nomination in the summer of 1928, and then beat Democrat Al Smith in the 1928 presidential election.
At the end of 1928, in his last State of the Union message to Congress, President Calvin Coolidge began with, “No Congress of the United States ever assembled, on surveying the state of the Union, has met with a more pleasing prospect than that which appears at the present time.” And indeed, nearly everyone in America in the 1920s had good reasons to be optimistic.
Automobiles and other consumer durables, especially radios, became leading sectors. The electric motor and electricity became prime movers in industrial production. The growth of the utilities sector was interlinked with these. The clear utilities strategy was to use the underlying soundness of the industry as collateral to borrow money from banks, use that money to purchase more utilities, take advantage of engineering economies of scale to lower costs, reap the profits, and make sure the profits were shared with the right people, in order to keep potential regulators sweet on the industry.
Not that there was no malcontent. In the United States the rising concentration of wealth provoked a widespread feeling that something had gone wrong. Still, the managers who ran America’s firms and the politicians who got elected were not oblivious to the Progressive challenge. Scared of what unionization or a shift to left-wing politics might bring, and concerned about the welfare of their workers, American business leaders in the 1920s developed “welfare capitalism.”
As the 1920s proceeded, Americans forgot about the deep recessions of the pre–World War I period and began to accept that they were living in a “new era” of faster economic growth and general prosperity. The recently established Federal Reserve had the tools to calm the business cycle. Why shouldn’t people in America in the 1920s have expected prosperity to continue, and economic growth to accelerate?
One consequence of this seemingly permanent “new era” was that financial asset prices went up. The result was widespread faith in the permanent “new era” of low risks, low-interest rates produced by successful macroeconomic stabilization, rapid growth produced by new technology, and confidence that in the future, depressions would be few and small. Monetary economist Irving Fisher ruined his reputation as an economic forecaster for all time with his late-1929 declaration that “stock prices have reached what looks like a permanently high plateau.”
That the US stock market did go off its rails is clear. A host of anomalies in stock market values indicate that those who were paying for stocks in the summer and early fall of 1929 had not the slightest rational clue of what they were doing. By the fall of 1929 closed-end investment funds were selling at a 40 percent premium relative to their net asset values.
According to the “rules of the game” of the gold standard, a country that receives an inflow of gold is supposed to use it to back an expansion of its money stock, which in turn triggers inflation. But neither the United States nor France was willing to tolerate domestic inflation. They squirreled the gold away in their government vaults. Both began to view their gold reserves not as shock absorbers but rather as national treasures, to be defended and hoarded – and any outward flow would be viewed a defeat. The United States and France held more than 60 percent of the world’s monetary gold by 1929. As a consequence, a single gold coin or gold bar had to do more than five times the work that it normally would have of cushioning shocks, providing liquidity, and creating trust.
After the fact, economists Friedrich von Hayek and Lionel Robbins blamed the Great Depression that started in 1929 on the Federal Reserve’s unwillingness to raise interest rates earlier.
Economists such as Milton Friedman make a more convincing case, claiming that the Federal Reserve was not too expansionary but too contractionary in the run-up to the 1929 stock market crash. They worried that gold might start flowing out if they did not raise interest rates. They also worried that stock prices were too high, that they might end in a crash, and that such a crash might bring on a depression. So they took measures to try to choke off both gold outflows and stock market speculation by making it more expensive to borrow money.
The US economy entered a cyclical downturn in June 1929. By that time, the German economy had already been in recession for almost a year. The Great Depression had begun.