Great Depression Timeline: No, Prof. Krugman, War Undermines an Economy; The Depression Proves It!

SUMMARY:

• Henry C. Alexander of the Morgan Guaranty Trust Corporation said, "Increased borrowing must be matched by increased ability to repay.  Otherwise we aren't growing the economy; we are merely puffing it up."
• Because most economists confuse paper money with real wealth, they don't see the truism in this transparently true statement. 
• One manifestation of the colossal ignorance of the axiom upon which credit is based, is most modern economists think war is one of the best things for an economy. 
• As history - and simple common sense - makes clear, the war debts incurred by the Allies to the United States during World War I played a huge role in the Great Depression which began eleven years after the war ended.

DISCUSSION:
Paul Krugman - with degrees from Yale and MIT (1) - famously said of the US economy and what could cure its considerable ills circa 2011, "If we discovered that space aliens were planning to attack, and we needed a massive build-up to counter the space alien threat, and inflation and budget deficits took secondary place to that, this slump would be over in eighteen months." (2)

The notion that war creates prosperity is built on the keystone fallacy of modern economics, the confusion of money with real wealth.  Real wealth is measured in productive capacity - the capacity to build the goods people want.  The weapons of war have no benefit to the average person, and the resources used to build them reduce the wealth of society; they can never increase it.  This common sense notion - which escapes virtually the entire economic community - was trenchantly expressed by President Eisenhower who famously said in his 'Cross of Iron' speech;
"Every gun that is made, every warship launched, every rocket fired signifies, in the final sense, a theft from those who hunger and are not fed, those who are cold and not clothed... This world in arms is not spending money alone.  It is spending the sweat of its laborer, the genius of its scientists, the hopes of its children... This is not a way of life at all in any true sense.  Under the cloud of threatening war, it is humanity hanging from a cross of iron." (3)

Because the economics 'profession' fails to understand the negative impact from wartime spending, it is incapable of accurately diagnosing the causes of the Great Depression and how the Depression ultimately metastasized into the enormous collapse it ultimately became.  A major driver of the Great Depression were the enormous wartime debts incurred by America's allies - England, France, Italy and Russia.  Sir John Hicks, the first Englishmen to win the Nobel Prize in economics defined 'really catastrophic depressions' as those occasions where 'the rot in the financial system goes very deep.'  The Great Depression proves the accuracy of both Hicks' insight and the fact that few things can undermine the prosperity of a country more completely and effectively than wartime spending.

Prior to World War I, the US had a very long (and correct!) policy of neutrality.  This policy of neutrality was expressed by George Washington as;
"Harmony, liberal intercourse with all nations are recommended by policy, humanity and interest.  But even our commercial policy should hold an equal and impartial hand; neither seeking, nor granting exclusive favors or preferences...The great rule of conduct for us in regard to foreign nations in extending our commercial relations is to have with them as little political connection as possible." (4)

However, with the outbreak of World War I, companies tried to work around the country's policy of neutrality.  No company was more dogged in its efforts to sell weapons to the Allies than Charles Schwab's Bethlehem Steel.  Thomas Edison called Schwab a 'master hustler,' and on no issue did Schwab hustle harder than trying to sell weapons to the Allies. However, before Schwab could sell weapons, the US needed to first change its long-standing policy of neutrality.  When war broke out Woodrow Wilson was president and William Jennings Bryan was his secretary of state.  Bryan was a deeply religious man and deeply suspicious of the motives of the men clamoring to sell weapons overseas.  He was even more suspicious of the motivations of the financiers who wanted to finance all the proposed wartime spending.  Indeed, Bryan was far more concerned about financing the combatants in a war then selling them weapons.  Bryan warned Wilson that "money is the worst of all contrabands" because it would rule everything else. (5)

"The powerful financial interest which would be connected with these loans would be tempted to use their influence through the newspapers to support the interest of the Government to which they had loaned because the value of their security would be directly affected by the result of the war.  We would thus find our newspapers violently arrayed on one side or the other, each paper supporting a financial group and pecuniary interest.  All of this influence would make it more difficult for us to maintain neutrality as our action on various questions that would arise would affect one side or the other and powerful financial interests would be thrown into the balance." (6)

Bryan's warnings fell on deaf ears and soon US banks were lending enormous volumes of money to the Allies so the Allies could take all this money - borrowed at interest - to purchase weapons from American companies.  It is hard to imagine a more explosive economic combination or one more doomed to ultimate collapse.  Some idea of the enormous sums of money loaned to the Allies and prodigious supply of armaments the Allies purchased can be gleaned from the record of Schwab's Bethlehem Steel alone.  Bethlehem produced (7);

• 65% of the finished artillery pieces produced by all the allies
• 20-million artillery rounds
• 70-million pounds of armor plate
• 1.1-billion pounds of steel for shells

Impressive figures to be sure and desperately needed by the allied armies.  However, from a purely economic perspective, the more money the allied governments borrowed, the more hopeless the financial position of France, England and Italy became.  (Germany supported all of its war needs with domestic production as the British naval blockade shut down virtually all trade.)  France, England and Italy borrowed money in a foreign currency (dollars) to purchase items (weapons) that have no real economic value.  They were all banana republics without bananas.  The only way these countries could pay for these weapons in terms of real wealth was with a reduced standard of living; not the sort of hard truth people can expect from their leaders.  (When czarist Russia fell to the Bolsheviks, the communists simply renounced their overseas debts to the US and others as the responsibility of the Czar. )

In the years immediately after the cessation of hostilities, the war debts of the Allies dominated the economic environment of the time.  France and England both expected Germany to pay for the war as German reparations were roughly four-times the Allied borrowings during the war. (8)  However, only a strong Germany could pay reparations and neither country wanted a strong Germany. With such mutually exclusive economic and strategic objectives desired, the Allied war debts began to fester as the years passed.  As nothing concrete was done to address these enormous war debts, they hung like the sword of Damocles over all sorts of economic activity.
"The time came in 1927 when the burden of debt service on the debts of Europe to private creditors in the United States was much larger than the burden of intergovernmental debts.  But there was a great difference between private debts which grew out of income-creating investments due from merchants and industries to foreign creditors, and the debts of governments, which represented the dead horse of war and which had to be paid out of the fiscal surplus, surpluses which didn't exist." (9)

The war debts alone didn't guarantee an economic cataclysm as bad as the Great Depression, but they represented an enormous economic disequilibrium.  One way or another, the debts would have to be repaid or creditors would have to be prepared to accept that some of the loans would simply default.  The longer these war debts remained unaddressed, the longer the shadow these debts would cast over economic decision making.  Either way, the transparently obvious way Word War I debts hung over commerce of the 1920s should prove, convincingly, war never advances the economic interests of society and should never be contemplated in the interest of advancing economic goals - even if the war is against fictitious aliens. 

 

Peter Schmidt
Sugar Land, TX
November 24, 2019

PS - As always, if you like what you read, please register with the site.  It just takes an e-mail address and I don't share this e-mail address with anyone.  The more people who register with the site, the better case I can make to a publisher to press on with publishing my book.  Registering with the site will give you access to the entire Confederacy of Dunces list as well as the financial crisis timeline.  

Help spread the word to anyone you know who might be interested in the site or my Twitter account.  I can be found on Twitter @The92ers

 

ENDNOTES:
(1) http://www.the92ers.com/dunce/paul-krugman

(2) Josh Sanburn, "Paul Krugman: An Alien Invasion Could Fix the Economy," Time Magazine, August 16, 2011, http://business.time.com/2011/08/16/paul-krugman-an-alien-invasion-could-fix-the-economy/

(3) https://www.youtube.com/watch?v=eGQ-wgPGTp8

(4) Ron Paul, The Revolution - A Manifesto, Grand Central Publishing, New York, 2008, p. 9

(5) Ron Chernow, The House of Morgan, Grove Press, New York, 2001, p. 186

(6) United States Hearings, 74th Congress, Second Session, "Munitions Industry Hearings," Part 25, January 7-8, 1936, p. 7665-6, Secretary of State William Jennings Bryan to President Woodrow Wilson, August 10, 1914 http://www.gwpda.org/1914/bryanloan.html

(7) David Venditta and Hilliard Ardith, editors, Forging America - The Story of Bethlehem Steel, The Morning Call, 2010

(8) German war reparations were fixed at 132-billion Goldmarks or roughly $40-billion.  (See Henry Kissinger, Diplomacy, p. 257.)  On the other hand, Allied borrowings for the years 2017-2020 were approximately $10-billion.  (See Benjamin Anderson, Economics and the Public Welfare, p. 291)

(9) Benjamin Anderson, Economics and the Public Welfare, Liberty Press, Indianapolis, 1979, p. 296