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FDR's Folly: How Roosevelt and His New Deal Prolonged the Great Depression

Jim Powell (2003)


Many "progressives" visited the Soviet Union and came away more convinced than ever that a government-run economy, offered the best solution. Stuart Chase wrote A New Deal (1932), in which he said that communists didn't need "further incentive than the burning zeal to create a new heaven and a new earth." Chase closed his book by asking, "Why should Russians have all the fun of remaking a world?" (2-3)

FDR, who embraced "progressive ideas," certainly wasn't a thinker. "Roosevelt responded less to principles than to personalities, and these could be presented best in conversation," observed historian George Martin. Indeed, FDR appeared to be utterly ignorant of economics. He seemed willing to try practically anything as long as it involved more government control over the economy. He was apparently unaware that such policies had been tried before in many other countries—and failed. (5)

On June 17, 1930, Hoover signed the Smoot-Hawley tariff, which raised import duties an average of 59 percent on more than 25,000 agricultural commodities and manufactured goods. The U.S. stock market plunged, and more than sixty countries retaliated , with restrictions against whichever products would inflict the worst losses on Americans—typically products very different from those affected by Smoot-Hawley. In this way, the tariff led to random damage to economies everywhere. (43)

The best-documented tax revolt was in Chicago. On a single day, November 29, 1930, some 4,000 taxpayers filed protests with the Board of Review. Tax collections were suspended for two years, but it proved difficult to get people back in the habit of paying. (50)

Title II of FDR's Emergency Banking Act gave considerable discretionary power to the comptroller of the currency, who, as conservator of national banks, could reorganize banks without going through established bankruptcy proceedings. The Emergency Banking Act also authorized the printing of Federal Reserve notes backed not by gold but by government bonds, which meant that the government could print as much money as it wanted and wouldn't be limited by the amount of gold available. In addition, the Emergency Banking Act authorized the Fed to lend banks money against a wider range of bank assets. (54)

FDR was under considerable pressure to pursue inflation, especially from farmers who wanted higher agricultural prices. But inflation was difficult as long as the United States remained on the gold standard. The U.S. Treasury was obligated to give anybody as much gold as they wished at $20.67 per ounce. If the federal government began inflating the supply of paper dollars, people would naturally anticipate devaluation and begin turning in dollars, hoping to get as much gold as possible before the price went up. (66)

In Presidential Proclamation 2039, March 6, 1933, which declared the national "bank holiday," FDR asserted that gold "hoarding" was "unwarranted" and had brought on the "emergency." The proclamation claimed the legal authority of the Trading with the Enemy Act (October 6, 1917), which provided fines of $10,000 or as much as ten years in prison for anyone convicted of doing business with an "enemy" of the United States. A subsection of the Trading with the Enemy Act authorized the president "under such rules and regulations as he may prescribe" to ban "any transactions in foreign exchange, export or earmarkings of gold or silver coin or bullion or currency ... by any person within the United States." Presidential Proclamation 2039 made it against the law until March 9 for any bank to "pay out, export, earmark, or permit the withdrawal or transfer in any manner or by any device whatsoever of any gold." Thus did FDR make outlaws of ordinary citizens whose "crime" was to protect their assets with gold. (66)

Less than -a month later, on April 5, 1933, FDR issued Executive Order 6012, which expropriated privately owned gold. He ordered Americans to surrender their gold to the government by May , 1933. Violators would be subject to a $10,000 fine or as much as ten years in prison. (67)

What about existing contracts that people had voluntarily agreed to, specifying payment in gold? FDR persuaded Congress to overturn those contracts and wipe out the gold clause. (68)

FDR imagined he could fix the world gold price from his bedroom. Morgenthau reported that when he visited FDR on Friday, November 3, he suggested a 10- or 15-cent rise from the previous day, and FDR decided on a 21-cent rise. Morgenthau asked the rationale for 21 cents, and FDR reportedly replied that "three times seven" is a lucky number. (71-2)

Even though his gold-buying scheme failed, the government kept all the gold it had taken from private individuals. FDR ranked among history's biggest hoarders, with an estimated 190 million ounces of gold worth $7 billion after the dollar devaluation. FDR undoubtedly hoarded gold for the same reasons that the mercantilist kings of the sixteenth, seventeenth, and eighteenth centuries hoarded it: Gold was the ultimate money, and for a ruler money meant power. (74)

[National Recovery Administration Director Hugh] Johnson, Richberg, and their cohorts occupied offices in the Department of Commerce Building where Herbert Hoover had once worked. Johnson described his quarters as "the worst-planned and least efficient modern office building in the world." It was curious that Johnson didn't wonder how the very same government, which he believed could save the world, couldn't even get a building right. (116-17)

There were some 1,400 NRA compliance enforcers at fifty-four state and branch offices. They were empowered to recommend fines up to $500 and imprisonment up to six months for each violation. On December 11, 1933, for instance, the NRA launched its biggest crackdown, summoning about 150 dry cleaners to Washington for alleged discounting. In April 1934, forty-nine-year-old immigrant Jacob Maged of Jersey City, New Jersey, was jailed for three months and fined for charging 35 cents to press a suit, rather than the 40 cents mandated by the NRA dry cleaning code. (121)

During the 1920s, farmers had tried a number of schemes aimed at raising their incomes. They formed cooperative associations that would control the marketing of their crops in hopes of realizing higher prices than they would expect on their own, but these associations invariably failed. There were always mavericks who could make more money selling outside the associations. What farmers wanted was compulsion, some way of limiting what everybody produced, to force prices above market levels. (130)

[U.S. Supreme Court associate justice James Clark] McReynolds's opinions focused on protecting private property, freedom of contract, and freedom of speech. In Meyer v the State of Nebraska, 262 U.S. 390 (1923), he struck down a law that made it illegal to teach a foreign language prior to the ninth grade. In Farrington v T. Tokushige, 273 U.S. 284 (1927), McReynolds overturned a law that banned the teaching of the Japanese language. He was horrified at the policies of FDR, whom he called an "utter incompetent." (155)

The next big Supreme Court case involved the Agricultural Adjustment Act, which New Dealers considered as important for reviving agriculture as the National Industrial Recovery Act was thought to be for industry. As noted in chapter 10, the idea was to tax food processors and channel the proceeds to farmers who destroyed crops, thereby reducing supplies and maintaining farm prices. Raising farm prices was viewed as the way to raise farmers' income, much as high wage rates were supposed to raise the incomes of industrial workers. (168-9)

The Roosevelt administration claimed that the tax was just another tax, and taxpayers couldn't refuse to pay because they disagreed with the way it was spent. But Justice Roberts, in his majority opinion, observed, that he sole purpose of this tax was to pay farmers who reduced their cultivated acreage and destroyed crops, which meant it wasn't a legitimate tax: "A tax, in the general uderstanding of the term, and as used in the Constitution, signifies an exaction for the support of the Government. The word has never been thought to connote the expropriation of money from one group for the benefit of another."
Roberts continued, "The question is not what power the Federal Government ought to have, but what powers, in fact, have been given by the people. . . . The federal union is a government of delegated powers. It has only such as are expressly conferred upon it and such as are reasonably to be implied from those granted. In this respect, we differ radically from nations where all legislative power, without restriction or limitation, is vested in a parliament or other legislative body subject to no restrictions except the discretion of its members."
Did the Constitution delegate to the federal government power over agricultural production? Since agricultural production was a local activity, it couldn't be covered by the commerce clause. Nor was such power implied in the clause about enacting taxes for the "common Defense and general Welfare of the United States." The phrase "general welfare" couldn't reasonably be invoked when a tax benefits particular people (like farmers) rather than the general population. Roberts insisted that if "general welfare" were applied to whatever the government wanted to spend money on, it would gain unlimited power, and the primary purpose of the Constitution was to protect liberty by limiting government power. (169-70)

Roberts concluded: "From the accepted doctrine that the United States is a government of delegated powers, it follows that those not expressly granted, or reasonably to be implied from such as are conferred, are reserved to the states, or to the people. To forestall any suggestion to the contrary, the Tenth Amendment was adopted. The same proposition, otherwise stated, is that powers not granted are prohibited. None to regulate agricultural production is given, and therefore legislation by Congress for that purpose is forbidden." (170-71)

[Justice] Cardozo acknowledged that Social Security wasn't legitimate insurance. As he explained in Steward Machine, "The proceeds, when collected, go into the Treasury of the United States like internal revenue collections generally. They are not earmarked in any way." In other words, even after an individual has paid Social Secuity taxes for decades, he or she doesn't have a contractual claim to specific benefits. Congress could change the benefits formula at any time, and it has. By contrast, a private insurance policy is a contract specifying what premiums the insured will pay and what benefits the insured or heirs will get. If an insurance company defaults, it can be taken into court for breach of contract. Surely millions of Americans would feel more secure if their Social Security taxes bought a contractual right to collect a specific package of benefits, but they never got this from a Supreme Court that had done so much to trash freedom of contract. This position,. that a taxpayer doesn't have a contractual right to collect specific Social Security benefits, was affirmed by the Supreme Court decades later, in Flemming v Nestor, 363 U.S. 603 (1960). (219)

Because a disproportionate number of black workers were in the South, they were the principal losers from this minimum wage law. As George Mason University law professor David E. Bernstein noted, "labor union leaders, who by the late 1930s were an integral part of the New Deal coalition, supported a high, uniform national minimum wage partly out of labor solidarity, but also to limit competition between unskilled nonunionized southern workers and unskilled union members. (229)

Personal income tax rates hit 91 percent, and corporate excess profts taxes hit 95 percent.
Meanwhile, on April 27, 1942, FDR issued a message to Congress in which he declared, "No American citizen ought to have a net income, after he has paid his taxes, of more than $25,000 a year." The Treasury Department submitted to the House Ways and Means Committee a memorandum calling for a 100 percent tax on incomes over $25,000. (245)

The idea that the government had the power to set an income limit is disturbing, particularly since the trend has been for high tax rates to affect people with lower and lower incomes. Middle-class people are hit with tax rates originally aimed at the rich, simply because there are far more middle-class people. The government, like bank robbers, goes where the money is. (245-6)

Taxes made it almost impossible for living standards to recover from the Great Depression, but there wasn't much to buy anyway. Consumer goods factories had converted to producing war goods, and empty store shelves were commonplace. Practically everything was scarce. Despite the paper shortage, the government printed longer and more complicated tax forms. (246)

Tax withholding would have an unintended consequence: dramatic expansion of the Internal Revenue Service. Commissioner Guy Helvering estimated that to administer withholding for some 30 million wage earners would require hiring an estimated 11,000 more IRS agents, finding more office space, and increasing the IRS budget by about $24 million. He acknowledged, too, that the law would impose substantial costs on employers who did the government's work of collecting and remitting taxes.
The World War II tax regime, supposedly "temporary," remained largely intact afterwards. It continued to be a mass tax—there was no going back to the days when only a few people had to worry about the IRS. Federal income as well as Social Security taxes continued to be withheld from paychecks. While President Truman signed the Revenue Act of 1945, which cut the top federal income tax rate from 94 percent to 86.45 percent, and there were additional modest tax reductions in the Revenue Act of 1948, taxes went up again during the Korean War. Concerned about high levels of Cold War defense spending, President Eisenhower opposed tax cuts. Social Security taxes, which especially hit lower incomes, were increased. (247)

New Deal farm programs have backfired just as Social Security has done, and they have been as tenaciously defended. Washington channeled hundreds of billions of taxpayer dollars to farmers who agreed not to grow certain crops. Marketing orders, authorized by the Agricultural Marketing Agreement Act of 1937 as amended, continue to restrict production and marketing. They are the most blatant type of interference with U.S. agricultural markets, a throwback to medieval times when guilds determined who could work in various trades, how much they could charge, and how much they could produce. (255)

Recalling Henry Wallace's policy of destroying food during the Great Depression, the kind of thing that had outraged novelist John Steinbeck, the Department of Agriculture still enforces orders that ood food be left to rot when officials decide too much has been produced. This sort of thing has been going on so long it isn't news anymore, but New York Times reporter Ann Crittenden filed a vivid report about consequences of the New Deal in our time: "Stretching in all directions are millions and millions of navel oranges all abandoned to rot under the California sun. The oranges have been dumped under what is known as a Federal marketing order." (256)

New Deal farm laws, still in effect, continue to benefit big farmers, because the programs are based on the amount of acreage a farmer has or the quantities of crops produced. As investigative reporter James Boyard observed, in a 1989 study, "the USDA gave, in direct payments to the 29,000 largest farms, an average of $46,073—an amount that exceeded the net worth (including the value of house and cars) of over half the families in America." (256-7)

On President Nixon's second inaugural," [New Orleans investor James U.] Blanchard recalled, "we hired a World War I-style biplane to carry a 50-foot sign: LEGALIZE GOLD!" People smuggled gold bars into the United States and displayed these publicly, daring Treasury officials to enforce the relic of law. But times had changed, and President Gerald Ford gave Americans back an important part of their economic liberty by legalizing private gold ownership on December 31, 1974, for the first time in forty years. (262)

The New Deal did plenty to prolong high unemployment. New Deal policies were dubious when considered from the standpoint of their effects. After Americans had suffered through a catastrophic contraction for three years (1929-1933), FDR supported policies like the National Industrial Recovery Act that promoted further contraction. His executive orders helped enforce higher consumer prices when millions of Americans were unemployed and needed bargains. FDR approved the destruction of food when people were hungry. FDR signed into law higher taxes for everybody, so consumers had less money to spend, and employers had less money with which to hire people—during the worst depression in American history. New Deal labor laws empowered the most racist unions to exclude blacks and had the effect of making it illegal for many employers to hire blacks. The power of the Federal Reserve became more centralized, but this meant that the mistakes of a few people (members of the Federal Reserve Board) were likely to harm millions across the United States; and indeed the Fed's mistakes were a major cause of the depression of 1938 as well as the monetary contraction of 1929-1933. After having throttled competition with the National Industrial Recovery Act, Agricultural Adjustment Act, Bituminous Coal Conservation Act, Robinson-Patman Act, Retail Price Maintenance Act, Federal Communications Act, Civil Aeronautics Act, high corporate taxes, and other measures, New Dealers posed as defenders of competition and filed a record number of antitrust lawsuits against private employers, one effect of which was to further discourage investment needed for growth and jobs. (263-4)

Sophisticated New Dealers dismissed as simplistic those who defended individual rights, private property, and economic liberty, yet experience has revealed New Deal policies to be quite simplistic. FDR believed that if the federal government bought all the gold in the United States and as much of the gold as it could get overseas, he could push up farm prices. FDR imagined that government spending programs would end the agony of high unemployment, but he ignored the fact that government spending comes directly or indirectly from taxation, and people taxed have less money to spend or invest, offsetting the effect of spending programs. FDR assumed that taxes could be increased repeatedly without undermining incentives for people to produce, but he was mistaken. New Deal efforts to force wages above market levels made it more expensive for employers to hire people and contributed to chronic high levels of unemployment. Pro-FDR intellectuals assumed that government officials work selflessly for the public good, but as we now know, the self-interest of government officials, particularly their concern to win the next election, had a major impact on New Deal spending. FDR touted the Tennessee Valley Authority as proof that government could work wonders with electric power, ignoring subsidies from the 98 percent of American taxpayers who didn't live in the Tennessee Valley (and, as it turned out, the TVA didn't work wonders, since non-TVA southern states grew faster than TVA states).
New Dealers were naive to assume that dictatorial power would enable them to stabilize the American economy and bring about recovery. FDR was hailed when, in his first inaugural address, he asked for "broad Executive power to wage a war against the emergency, as great as the power that would be given to me if we were in fact invaded by a foreign foe." Hugh S. Johnson, when he headed the National Recovery Administration, exercised unprecedented arbitrary power over American industry. Henry Wallace was virtually the dictator of American agriculture, dispensing subsidies, setting prices, and issuing regulations that favored some interests over others; and he went on to become FDR's running mate in 1940.
Yet what dictator ever brought prosperity by interfering with the economy? History is littered with catastrophes that occurred because dictators couldn't keep their hands off the economy. (265)

FDR, Louis Brandeis, and other "progressives" liked to talk about their "experiments" with the economy, but these turned out to be the same types of restrictions, like medieval guild regulations, that had blocked progress for ages. More than two centuries ago in The Wealth of Nations, the savvy Scotsman Adam Smith had exposed the folly of mercantilists, those who imagined that taxes, trade restrictions, government spending, and government gold hoarding would bring prosperity. Such policies were "experiments" only to the degree that New Dealers were ignorant about what had been tried and failed before. (267)

Why did the smart, well-educated, well-intentioned New Dealers back policies that prolonged the Great Depression? How could they have gone so wrong? Most of the New Dealers, as noted, were lawyers. Few among them, including FDR, had any practical business experience. They certainly seem to have overestimated the importance of their knowledge, as opposed to the knowledge of millions of ordinary people spending their own money and running their businesses. The New Dealers really came to believe that their knowledge, combined with political power, could cure the problems of the world. They thought that by issuing executive orders, passing laws, raising taxes and redistributing money, they could make society better. (270)

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