Central bankers around the world nowadays may not know about Marriner S Eccles. The second phase of the Great Depression can be blamed on the early policies of the Federal Reserve under Eccles (November 15, 1934-January 31, 1948). Eccles, the president of tiny First National Bank of Ogden, Utah, became nationally famous through his successful effort to save his bank from collapse in the late summer of 1931.
Eccles defused depositors’ panic outside of his bank by announcing that his bank would stay open until all depositors were paid. He also instructed his tellers to count every small bill and check every signature to slow the prospect of his bank running out of cash. A mostly empty armored car carrying all First National’s puny reserves from the Federal Reserve Bank in Salt Lake City arrived conspicuously while Eccles announced that there was plenty of money left (which was true except for the fact that none of it belonged to First National). The crowd’s confidence in First National was re-established and Eccles’ bank survived on a misleading statement that would have been considered criminally fraudulent in a vigorous investigation.
Eccles was a quintessential frontier entrepreneur of the US West and politically a Western Republican. Beginning with timber and sawmill operations, his family’s initial capital came in the form of labor and raw material. He learned from his father, an illiterate who immigrated from Scotland in 1860, that the way to remain free was to avoid becoming indebted to the Northeastern banks, which were in turn much indebted to British capital. Among Eccles’ assets of railroads, mines, construction companies and farm businesses was a chain of local banks in the West.
Immersed in an atmosphere of US populism that was critical of unregulated capitalism and Northeastern “money trusts”, Eccles viewed himself as an ethical capitalist who succeeded through his hard works and wits, free of oppression from big business trusts and government interference.
A Mormon polygamist, the elder Eccles had two wives and 21 children, which provided him with considerable human capital in the labor-short West. The young Eccles, at age 22 and with only a high-school education, had to assume the responsibilities of his father when the latter died suddenly. The Eccles construction company built the gigantic Boulder Dam, begun in 1931 and completed in 1936, renamed from Hoover Dam in the midst of the Depression and re-renamed Hoover Dam in 1941.
The market collapse of 1929 caught the inner-directed Eccles in a state of bewilderment and despair. Through eclectic reading based on common sense, he came to a startling awareness: that despite his father’s conservative Scottish teachings on the importance of saving, individuals and companies and even banks, ever optimistic in their own future, tended to contribute to aggregate supply expansion to end up with overcapacity through excessive savings for investment. Eccles’s conclusion that we needed an income policy was the diametric opposite of Hayek’s market fundamentalism, which claimed that each market participant acting independently to maximize his individual interest represents the most efficient allocation of resources.
It was obvious to Eccles that the problem of the 1930s was that too much money had been channeled into savings and too little into spending. This new awareness, albeit not early enough to save him from policy error made in the first two years as Fed Chairman, led Eccles like Saint Paul’s vision on the way to Damascus to a radical conclusion that contradicted all that his conservative father had taught him.
From direct experience, Eccles realized that bankers like himself, by doing what seemed sound on an individual basis, by calling in loans and refusing new lending in hard times, only contributed to the financial crisis. He saw from direct experience the evidence of market failure. He concluded that to get out of the depression, government intervention, something he had been taught was evil, was necessary to place purchasing power in the hands of the public. In the industrial age, the mal-distribution of income (which was hugely unequal) and the excessive savings for capital investment always lead to the masses exhausting their purchasing power, unable to sustain the benefits of mass production that such savings brought.
Mass consumption is required by mass production. But mass consumption requires a fair distribution of new wealth as it is currently produced (not accumulated wealth) to provide mass purchasing power. By denying the masses necessary purchasing power, capital denies itself of the very demand that would justify its investment in new production. Credit can extend purchasing power but only until the credit runs out, which would soon occur without the support of adequate income.
Eccles’ epiphany was his realization that Calvinist thrifty individualism does not work in a modern industrial economy. Eccles rejected the view of his fellow bankers that depressions are natural phenomena, in the long run the destruction they wreak is healthy and government intervention only postpones the needed elimination of the weak and unfit, thereby weakening the whole system through the support of the unfit.
Now, the interesting thing is that Eccles, who never attended university or studied economics formally, articulated his pragmatic conclusions in speeches a good three years before Keynes wrote his epoch-making The General Theory of Employment, Interest, and Money (1936). John Galbraith, in his book Money: Whence It Came, Where It Went (1975), explained: “The effect of The General Theory was to legitimize ideas that were in circulation.” With scientific logic and mathematic precision, Keynes made crackpot ideas like those promoted by Eccles respectable in learned circles, (even though Keynes himself was considered a crackpot by New York Fed president Benjamin Strong as late as 1927).
In one single testimony in 1933, in his salt-of-the-earth manner Eccles convinced an eager US Congress of his new economic principle. He outlined a specific agenda for how the federal government could save the economy by spending more money on unemployment relief, public works, agricultural allotment, farm-mortgage refinancing, settlement of foreign war debts, etc.
Eccles also proposed structural systemic reform for achieving long-term stability: federal insurance for bank deposits, minimum wage standards, compulsory retirement pension schemes — in fact, the core program that came to be known as the New Deal.
Eccles also helped launch the era of liberal credits through government guarantee mortgages and interest subsidies, making middle-class and low-income home ownership a reality. It was not a plan to do away with capitalism as much as it was to save capitalism from itself. Eccles’ plan was to give the masses high income on which liberal credits can finance a nation of homeowners. It was fundamentally different from the neoliberal program of depressing worker income through cross-border wage arbitrage while financing homeownership with subprime mortgages.
Eccles also rescued the Federal Reserve System from institutional disgrace. For this, the Fed building in Washington has since been named after him. The evolution of political economy models in the early 1930s, a crucial period of change in the supervision and regulation of the financial sector, can be clearly seen in the opposing policies of the Hoover and Roosevelt administrations. It resulted in a change of focus in the Federal Reserve Board from orthodox sound money initiatives to a heterodox Keynesian outlook, which was reversed by the monetarism of Milton Friedman. Under Eccles, the push toward centralizing the monetary powers of the Federal Reserve System at the Board, away from the regional Federal Reserve Banks, was implemented.
With support from Roosevelt, despite bitter opposition from big money center banks, Eccles personally designed the legislation that reformed the Federal Reserve System, the central bank of the United States founded by Congress in 1913 (Glass-Owen Federal Reserve Act), to provide the nation with a safer, more flexible, and more stable monetary and financial/banking system. An important founding objective of the original Federal Reserve System had been to fight inflation by controlling the money supply through setting the short-term interest rate, known as the Fed Funds Rate (FFR), and bank reserve ratios. By 1915, the Fed had regulatory control over half of the nation’s banking capital and by 1928 about 80 percent.
The Banking Act of 1935, designed by Eccles, modified the Federal Reserve Act by stripping the 12 district Federal Reserve Banks of their autonomous privileges and veto powers and concentrated monetary policy power in the seven-member Board of Governors in Washington. Eccles served as chairman for 14 years while he continued to function as an inner-circle policy maker in the White House. The Fed under Eccles had no pretension of political independence. Galbraith described the Fed under Eccles as “the center of Keynesian evangelism in Washington.”
Eccles’ transformation from a businessman, brought up to believe in survival of the fittest, to his belief in government spending on the neediest can teach us many lessons today. He pragmatically saw that money is not neutral, and it has an economic function independent of ownership. Money serves a social purpose if it circulates widely through transactions and investments, and is socially harmful if it is hoarded in idle savings, no matter who owns it. Liquidity is the only measure of the usefulness of money. The penchant for capital preservation on the part of those who have surplus money has a natural tendency to reduce liquidity in times of deflation and economic slowdown.
The solution is to start the money flowing again by directing it not toward those who already have a surplus, but to those who have not enough. Giving more money to those who already have too much would take more money out of circulation into idle savings and prolong the depression.
The solution is to give money to the most needy, since they will spend it immediately. The only institution that can do this transfer of money for the good of the system is the federal government, which can issue or borrow money backed by the full faith and credit of the nation and put it in the hands of the masses, who would spend it immediately, thus creating needed demand. Transfer of money through employment is not the same of transfer of wealth. Deficit financing of fiscal expenditure is the only way to inject money and improve liquidity in a stalled economy. Thus Eccles promoted a limited war on poverty and unemployment, not on moral but on utilitarian grounds.
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Henry C.K. Liu is an independent commentator on culture, economics and politics.