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Deliberate Deficits

June 2024
3min read

The country that elected Franklin D. Roosevelt President in 1932 was a very different place from the one that had elected Herbert Hoover four years earlier. The severity of the Depression that had engulfed it had overwhelmed the mostly informal social services that were available to deal with poverty. And that poverty was everywhere. The homeless threw up ramshackle collections of huts, known as Hoovervilles, in places as visible as New York’s Central Park. Furthermore, the traditional government fiscal policies of avoiding deficits and paying down the debt had not only been impossible to achieve as the economy spiraled downward, but the pursuit of those policies had greatly worsened the situation.

These new realities produced a fundamental change in American politics. Before the Depression, a balanced budget had always been the number-one goal of government fiscal policy; ever since, the goal has been to avoid a new Great Depression. In the years before 1930, the government had an annual surplus twice as often as it ran a deficit. In the years since, it has run deficits seven times as often as surpluses, despite the return of prosperity.

ROOSEVELT MADE DEFICITS A MATTER OF GOVERNMENT POLICY FOR THE FIRST TIME.

Indeed, Roosevelt made deficits a matter of deliberate policy for the first time, instituting an array of projects, collectively known as the New Deal, to get people back to work. These programs, often known by their initials—CCC5WPA—inundated Washington with what came to be called alphabet soup and, in a wartime mutation, gave rise to the acronym (the word entered the language only in 1943, by which time the military had created hundreds of them). But these programs couldn’t end hard times. Unemployment, which reached a staggering 24.9 percent in 1933, was still at 17.2 percent as late as 1939, higher by far than it has ever been since.

Federal spending more than doubled between 1933 and 1940, from $4.6 billion to $9.6 billion (and the debt nearly doubled to finance it). Federal revenues as a percentage of the gross national product rose sharply as well. Revenues were only 3.6 percent of the gross national product in 1933. By 1940, they were 6.9 percent. This was the start of a continuing trend in which a nearly constantly increasing share of the nation’s wealth would pass through the budget of the federal government every year. Whatever the politics this change engendered, the economic effect has been to make the federal budget act more and more like a fiscal flywheel, automatically supplying stimulus to the economy when it slows down.

The other great change brought about by the Depression and the New Deal was in the area of regulation. The banking system was overhauled. The Federal Reserve, which had failed to act as the Depression deepened, and in many cases couldn’t have because of restrictions in the law, was reorganized and given broad new powers to oversee credit and the money supply. Learning from its mistakes, the Fed was to use these powers very effectively in the stock market crash of 1987. That is why today, only 14 years later, that crash is nearly forgotten.

The national banks lost their power to issue notes, and the Federal Reserve became the sole supplier of paper money—except for the Treasury’s onedollar silver certificates, circulated until the 1960s. The Fed was also given increased power to regulate interest rates, including margin requirements on Wall Street.

The Glass-Steagall banking act of 1933 forced the great Wall Street banks, which were often conveniently blamed for all the economic troubles, to become either depository banks or investment banks. In other words, it separated the banking business from the securities business. J. P. Morgan and Company, which remained a depository bank, was forced to spin off Morgan Stanley as an independent investment bank and would never again have the extraordinary power it had possessed.

And Glass-Steagall established the Federal Deposit Insurance Corporation, to insure bank deposits up to $5,000 (now $100,000). The purpose was to remove any incentive for depositors to panic and suddenly withdraw funds based on rumors of impending bank failures. It has certainly been a success—the country has not experienced a serious banking panic since. But it also, in the long term, made banks less cautious about where and to whom they loaned money. This would have severe consequences half a century later, when the savingsand-loan industry vanished in a sea of red ink, and the federal government had to pay depositors billions.

Wall Street brokerage firms as well came under federal regulation for the first time, with the establishment of the Securities and Exchange Commission, intended to curb the excesses that had plagued Wall Street in the 1920s. The New York Stock Exchange had become one of the most important financial institutions in the country, but it had remained, in both form and substance, a private organization, run for the benefit of its members.

This had led to many abuses, as the members, operating on the floor of the exchange, formed pools and otherwise manipulated stocks at the expense of the general public. Roosevelt appointed Joseph P. Kennedy, himself a major stock speculator in the 1920s, as the SEC’s first chairman. Many thought this meant the fix was in, but Kennedy proved an able choice and got the SEC off to a good start. It was the commission’s third chairman, however, William O. Douglas (who later sat on the Supreme Court for more than 30 years), who instituted major reforms and persuaded the Stock Exchange to write a new constitution. That transformed it into a quasi-public institution, one far better able to meet the public needs than ever before.

The labor movement was also transformed by the New Deal. In the prosperous 1920s, membership in labor unions had shrunk considerably. Then, as the Depression deepened, the conflict between labor and capital intensified. The Roosevelt administration was strongly on the side of organized labor, and in 1935 the National Labor Relations Act reshaped the situation.

It guaranteed the right to organize and bargain collectively and outlawed many practices companies had been using to prevent union activity. The country’s largest industries were unionized in the late 1930s, although not without considerable resistance and some real violence. On Memorial Day 1937, police fired on demonstrators outside the Republic Steel plant in Chicago, killing 10 and wounding 84.

By the end of the New Deal era, organized labor had become a major part of the economy, with political influence to match. By the 1940s, more than a third of America’s workers would be unionized.

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