(B.2) An American love for printing money

(B.2.a) FDR (Franklin Delano Roosevelt) says no deflation, and so does Ben Bernanke

When most people think of FDR they think of World War II and the New Deal. His contribution to how government works was not just to make it bigger by spending more money, but by also printing more money.

Roosevelt frankly had little idea how to respond to the Great Depression. He promised voters he would actively experiment, and that he did, but his experiments were often contradictory and without a clear purpose. We think of FDR creating the FDIC bank insurance (next time you are in the bank, notice all the stickers advertising the FDIC) and being a free-spender of government money, but in reality he opposed FDIC and was often more concerned with balancing the budget than spending money. His campaign against Herbert Hoover promised to be a different President, but in many ways he simply proceeded with what Hoover was already doing, with the novelty of also doing other things that contradicted it.

There were two, but only two goals of FDR's presidency. One was the idea of promoting security, consisting of programs like Social Security and unemployment insurance. His only other consistent objective was his desire for inflation, not for inflation itself, but to counteract deflation. Leading up to the stock market crash of 1929, farmers were locked into loans requiring them to pay the same number of dollar bills each year while the price they received for their crops declined. Deflation (where the general price level of goods and services falls) was bankrupting farm after farm.

Consider some numbers. In the 1920's there was basically no inflation, meaning the inflation rate was zero. In 1929, when farmers and lenders negotiated interest rates which would specify the number of dollar bills farmers would pay each year for a number of years, they did so thinking the value of the dollar would be about the same in 1935 as it was in 1929. They were wrong. Between 1930 and 1933 prices in general were falling by about 8% each year, for an annual inflation rate of -8%. This means each dollar could purchase more in 1933 than it could in 1930. Meanwhile, farmers were receiving lower prices for their crops. At the same time they earned less dollars farming, each dollar the farmers paid on their loans was valued much higher, which means in reality farmers paying a much higher interest rate than they planned. Farmers who thought they would pay a 4% interest rate between 1930 and 1933 actually ended up paying a real rate of 13%. This was too much for many farmers, causing them to go bankrupt, leading to an exodus of farm families much like those you read about in The Grapes of Wrath.

Roosevelt wanted inflation, hoping that it could cause crop and livestock prices to rise along with everything else, giving farmers more dollar bills to repay their debts. He knew inflation would occur if there were more dollar bills floating around. The problem was that the U.S. was on a Gold Standard, where all money was backed by a certain amount of gold, and FDR could not create more gold. His response, then, was to go off the Gold Standard in 1933—not completely; a dollar bill not backed by any gold wouldn't take place until 1971.

Roosevelt decided that for now on he would be in charge of determining the amount of gold each dollar bill would represent (if you think this is arrogant, don't forget that Ben Bernanke is in charge of setting interest rates today!). In that past this price was fixed, and agreed upon by a collection of nations. Now Roosevelt would decide the price of gold himself, often over breakfast and with no real justification other than his whims. These whims generally implied a higher price of gold, though, which meant that the same amount of gold owned by the U.S. Treasury could now support more dollar bills. This allowed more dollar bills to circulate, hoping to achieve the inflation that would increase crop prices.^(K1)

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One morning, FDR told his group he was thinking of raising the gold price by twenty-one cents. Why that figure? his entourage asked. “It’s a lucky number,” Roosevelt said. “because it’s three times seven.” As Morgenthau later wrote, “If anybody knew how we really set the gold price through a combination of lucky numbers, etc., I think they would be frightened.

—Shales, Amity. 2007. The Forgotten Man. Harper Perennial: NY, NY.

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Roosevelt's action was fervently opposed by many, but he stuck to his guns and consistently sought more inflation by allowing more dollar bills to circulate throughout the economy. It worked. The graph below shows the CPI during the Great Depression, where a falling CPI represents deflation and a rising CPI signifies inflation. The CPI fell from 1930 to 1933, then once off the gold standard, it began to rise, allowing farmers to pay back loans in devalued dollars, thus paying back loans at a lower real interest rate (to the chagrin of lenders). What is important to recognize is that it wasn't so much inflation that FDR wanted but to avoid deflation, and all the farm bankruptcies that accompanies deflation.

Figure 3—The CPI During The Great Depression ^(A1)
(The Consumer Price Index (CPI) measures the general level of prices in the economy)

This created a new responsibility for government that has maintained to this day: setting the number of dollar bills that can circulate. When the U.S. government encountered the Financial Crisis of 2008, one of the first thing the government did was print tons and tons of money, and the major goal was to prevent deflation. As such, FDR's only consistent objective became one of the most revolutionary changes in how the government operates. The President is no longer in charge of determining the money supply. That is now the Federal Reserve's job, an agency which in 2008 was run by Ben Bernanke, but the President still gets to pick who runs the Fed. The number of dollar bills in existence is referred to formally as the Federal Reserve's Balance Sheet, and the number of bills it created out of thin air since 2008 is astonishing, as shown below.

Figure 4—Printing Money in 2008-2012