Recession Repeat Lurks Without White House Truce

Dec. 15 (Bloomberg) — "Fat cats" is what President Barack Obama just called bankers. He also invited them to the White House this week.

The reason for the mixed message is that the president is cross with banks: they have refused to heed his orders to lend. The dynamic of preachy executive and elusive lenders recalls the mid-1930s, when a petulant Franklin Roosevelt gave a label to banks' puzzling behavior: "capital strike."

In the 1930s, the capital strike was followed by the depression of 1937-38 within the Depression. Today too, capital ponders going on strike. And without big policy changes the economy will face similar consequences.

Consider the parallels. In 2009 government seems to be spending enough for the cash to flow all around. The scope of this effort to drown the nation in money is unprecedented. In the mid-1930s Washington was also dumping dollars around in a then-unprecedented fashion. In 1936, federal outlays outpaced state and local spending for the first time with the nation not at war.

Another similarity: a government that won't say when the spending will stop. The Obama administration is generous with timetables when it comes to foreign policy, but withholds them when it comes to domestic budgeting.

Withholding was also a feature of the mid-1930s. In a comment reminiscent of presidential adviser Lawrence Summers, Senator Robert Wagner of New York told citizens in 1935 that that the U.S. would "maintain our public efforts until private businesses take up the slack."

A third big parallel is exceedingly low interest rates.

Flawed Assumption

What causes the strike? For one thing, White House assumptions that the banks are the same institutions that they were at the start of the economic crisis. Bear Stearns, Lehman Brothers and Countrywide Financial may be gone, but the bitterness of their experience has been internalized by commercial and investment banks alike. So they hesitate.

Observing that banks maintained what had once been considered ample reserves, 1930s monetary authorities reasoned that increasing reserve requirements on paper would have little effect: their increase was merely a de facto recognition of an accumulation that had already occurred.

The authorities forgot these bankers had been burned. The wary banks reacted by stashing away yet more cash. The result was an unforeseen tightening and less cash in the economy.

Election cycles also contribute to capital strikes. Banks today know that whatever the White House says, it has to stop pouring out the cash eventually, probably after midterms. Banks in the 1930s held onto cash because they knew Roosevelt would stop spending after the 1936 election, and he did.

House Winnings

High taxes, or the prospect of tax increases, do damage as well. In 1937, a tire company executive explained the effect of Roosevelt's confiscatory rates upon the investor: "He will not risk financing new ventures if the government take is greater than that of the average gambling house."

Infantilizing the private sector also makes it shut down. In the 1930s, Roosevelt, like Obama, alternated between coddling banks and companies and giving them the equivalent of a good spanking. Both can be counterproductive. The editors of Time magazine formally recognized that by printing a regular rubric over its weekly reports: "Last week the U.S. Government did the following for and to U.S. Business…"

The insistence on executive discretion is a real killer as well. Adolf Berle, Roosevelt's assistant secretary of state, sounded for all the world like Hank Paulson or Timothy Geithner when he argued in the late 1930s for a "modern financial tool kit." Tool kit means "let me fiddle around" and not "let us agree together on rules and abide by them, together."

Dow's Retreat

The results of the 1930s capital strike were wicked. The Dow Jones Industrial Average erased two years worth of gains, heading to Hoover-era levels. Unemployment, in the lower teens, leapt to almost 20 percent.

What stops a strike? Not the too-big-to-fail doctrine. Then and now, it is better to make clear the private sector is responsible for itself. That's what current calls for return to the old Glass-Steagall Act separation of the banking and brokerage businesses are about.

Business wants autonomy and respect. In a February 1939 New York Times article, a writer, Howard C. Calkins, gave voice to the longing for White House consistency: "By 'following through' its apparently revised attitude toward business generally the government would be going a long way toward rebuilding the confidence of business men, in the opinion of many in Wall Street."

In the late 1930s the government finally did back off. That was in part because of New Deal fatigue. Roosevelt critics made gains in the 1938 midterms. But it was also because the White House needed a partner, an equal, to prepare for World War II. Companies that had recently been in court fighting the administration for their lives now were winning enormous Lend-Lease contracts from that same administration.

Traditional explanations for the Depression's end focus on war spending or monetary easing. It is this truce, however, that is relevant today.

(Amity Shlaes, senior fellow in economic history at the Council on Foreign Relations, is a Bloomberg News columnist. The opinions expressed are her own.)

© Copyright 2009 Bloomberg

Available for order:

To book Amity Shlaes for a speaking engagement, contact Jamie Brickhouse at the Red Brick Agency, 646.281.9041.
Recent Articles
Free Markets Can Appeal to the Working Class
National Review
December 3, 2020
Biden's Dangerous Central-Planning Ambitions
National Review
November 24, 2020
Episode 41: Coolidge Not Silent Any More
National Review
October 28, 2020