" At the time (1991), the U.S. Warfare State’s budget— counting the pentagon, spy agencies, DOE weapons, foreign aid, homeland security and veterans—-was about $500 billion in today’s dollars. Now, a quarter century on from the Cold War’s end, that same metric stands at $900 billion. This near doubling of the Warfare State’s fiscal girth is a tad incongruous. After all, America’s war machine was designed to thwart a giant, nuclear-armed industrial state, but, alas, we now have no industrial state enemies left on the planet."

Keynesian Myths, Monetary Central Planning and The Triumph of The Warfare State

By David Stockman

Flask in hand, Boris Yelstin famously mounted a tank outside the Soviet Parliament in August 1991. Presently, the fearsome Red Army stood down—an outcome which 45 years of Cold War military mobilization by the West had failed to accomplish.

At the time, the U.S. Warfare State’s budget— counting the pentagon, spy agencies, DOE weapons, foreign aid, homeland security and veterans—-was about $500 billion in today’s dollars. Now, a quarter century on from the Cold War’s end, that same metric stands at $900 billion.

This near doubling of the Warfare State’s fiscal girth is a tad incongruous. After all, America’s war machine was designed to thwart a giant, nuclear-armed industrial state, but, alas, we now have no industrial state enemies left on the planet.

The much-shrunken Russian successor to the Soviet Union, for example, has become a kleptocracy run by a clever thief who prefers stealing from his own citizens rather than his neighbors.

Likewise, the Red Chinese threat consists of a re-conditioned aircraft carrier bought second-hand from a former naval power—-otherwise known as the Ukraine. Its bubble-ridden domestic economy would collapse within six weeks were China to actually bomb the 4,000 Wal-Mart outlets in America on which its mercantilist export machine utterly depends.

On top of that, we’ve been fired as the world’s policeman, al Qaeda has essentially vanished and during last September’s Syria war scare the American people even took away the President’s keys to the Tomahawk missile batteries. In short, the persistence of America’s trillion dollar Warfare State budget needs some serious “splainin”.

The Great War and Its Aftermath

My purpose tonight is to sketch the long story of how it all happened, starting precisely 100 years ago in 1914.

In that year the Fed opened-up for business just as the carnage in northern France closed-down the prior magnificent half-century era of liberal internationalism and honest gold-backed money.

The Great War was self-evidently an epochal calamity, especially for the 20 million combatants and civilians who perished for no reason that is discernible in any fair reading of history, or even unfair one.

Yet the far greater calamity is that Europe’s senseless fratricide of 1914-1918 gave birth to all the great evils of the 20th century— the Great Depression, totalitarian genocides, Keynesian economics, permanent warfare states, rampaging central banks and the exceptionalist-rooted follies of America’s global imperialism.

Indeed, in Old Testament fashion, one begat the next and the next and still the next.

This chain of calamity originated in the Great War’s destruction of sound money, that is, in the post-war demise of the pound sterling which previously had not experienced a peacetime change in its gold content for nearly two hundred years.

Not unreasonably, the world’s financial system had become anchored on the London money markets where the other currencies traded at fixed exchange rates to the rock steady pound sterling—which, in turn, meant that prices and wages throughout Europe were expressed in common money and tended toward transparency and equilibrium.

This liberal international economic order—that is, honest money, relatively free trade, rising international capital flows and rapidly growing global economic integration—-resulted in a 40-year span between 1870 and 1914 of rising living standards, stable prices, massive capital investment and prolific technological progress that was never equaled—either before or since.

During intervals of war, of course, 19th century governments had usually suspended gold convertibility and open trade in the heat of combat. But when the cannons fell silent, they had also endured the trauma of post-war depression until wartime debts had been liquidated and inflationary currency expedients had been wrung out of the circulation.

This was called “resumption” and restoring convertibility at the peacetime parities was the great challenge of post-war normalizations.

The Great War, however, involved a scale of total industrial mobilization and financial mayhem that was unlike any that had gone before. In the case of Great Britain, for example, its national debt increased 14-fold, its price level doubled, its capital stock was depleted, most off-shore investments were liquidated and universal wartime conscription left it with a massive overhang of human and financial liabilities.

Yet England was the least devastated. In France, the price level inflated by 300 percent, its extensive Russian investments were confiscated by the Bolsheviks and its debts in New York and London catapulted to more than 100 percent of GDP.

Among the defeated powers, currencies emerged nearly worthless with the German mark at five cents on the pre-war dollar, while wartime debts—especially after the Carthaginian peace of Versailles—–soared to crushing, unrepayable heights.

In short, the bow-wave of debt, currency inflation and financial disorder from the Great War was so immense and unprecedented that the classical project of post-war liquidation and “resumption” of convertibility was destined to fail. In fact, the 1920s were a grinding, sometimes inspired but eventually failed struggle to resume the international gold standard, fixed parities, open world trade and unrestricted international capital flows.

Only in the final demise of these efforts after 1929 did the Great Depression, which had been lurking all along in the post-war shadows, come bounding onto the stage of history.

I.

The Great Depression’s tardy, thoroughly misunderstood and deeply traumatic arrival happened compliments of the United States.

In the first place, America’s wholly unwarranted intervention in April 1917 prolonged the slaughter, doubled the financial due bill and generated a cockamamie peace, giving rise to totalitarianism among the defeated powers and Keynesianism among the victors. Choose your poison.

Even conventional historians like Niall Ferguson admit as much. Had Woodrow Wilson not misled America on a messianic crusade, the Great War would have ended in mutual exhaustion in 1917 and both sides would have gone home battered and bankrupt but no danger to the rest of mankind.

Indeed, absent Wilson’s crusade there would have been no allied victory, no punitive peace, and no war reparations; nor would there have been a Leninist coup in Petrograd or Stalin’s barbaric regime.

Likewise, there would have been no Hitler, no Nazi dystopia, no Munich, no Sudetenland and Danzig corridor crises, no British war to save Poland, no final solution and holocaust, no global war against Germany and Japan and no incineration of 200,000 civilians at Hiroshima and Nagasaki.

Nor would there have followed a Cold War with the Soviets or CIA sponsored coups and assassinations in Iran, Guatemala, Indonesia, Brazil, Chile and the Congo, to name a few.

Surely there would have been no CIA plot to assassinate Castro, or Russian missiles in Cuba or a crisis that took the world to the brink of annihilation. There would have been no Dulles brothers, no domino theory and no Vietnam slaughter, either.

Nor would we have launched Charlie Wilson’s War to arouse the mujahedeen and train the future al Qaeda. Likewise, there would have been no shah and his Savak terror, no Khomeini-led Islamic counter-revolution, no US aid to enable Saddam’s gas attacks on Iranian boy soldiers in the 1980s.

Nor would there have been an American invasion of Arabia in 1991 to stop our erstwhile ally Hussein from looting the equally contemptible Emir of Kuwait’s ill-gotten oil plunder—or, alas, the horrific 9/11 blowback a decade later.

Most surely, the axis-of-evil—-that is, the Washington-based Cheney-Rumsfeld-neocon axis—- would not have arisen, nor would it have foisted a $1 trillion Warfare State budget on 21st century America.

II.

But….I digress!

The real point is that the Great War enabled the already rising American economy to boom and bloat in an entirely artificial and unsustainable manner for the better part of 15 years. The exigencies of war finance also transformed the nascent Federal Reserve into an incipient central banking monster in a manner wholly opposite to the intentions of its great legislative architect—the incomparable Carter Glass of Virginia.

The 1914-1929 Boom Was An Artifact of War and Money Printing

In the first stage, America became the granary and arsenal to the European Allies—-triggering an eruption of domestic investment and production that transformed the nation into a massive global creditor and powerhouse exporter virtually overnight.

American farm exports quadrupled, farm income surged from $3 billion to $9 billion, land prices soared, country banks proliferated like locusts and the same was true of industry—where steel production, for example, rose from 30 million tons annually to nearly 50 million tons.

Altogether, in six short years $40 billion of money GDP became $92 billion in 1920—a sizzling 15 percent annual rate of gain.

Needless to say, these fantastic figures reflected an inflationary, war-swollen economy—-a phenomena that prudent finance men of the age knew was wholly artificial and destined for a thumping post-war depression. This was especially so because America had loaned the Allies massive amounts of money to purchase grain, pork, wool, steel, munitions and ships. This transfer amounted to nearly 15 percent of GDP or $2 trillion equivalent in today’s economy, but it also amounted to a form of vendor finance that was destined to vanish at war’s end.

As it happened, the nation did experience a brief but deep recession in 1920, but this did not represent a thorough-going end-of-war “de-tox” of the historical variety. The reason is that America’s newly erected Warfare State had hijacked Carter Glass “banker’s bank” to finance Wilson’s crusade.

Indeed, when Congress acted just six months before Archduke Ferdinand’s assassination, it had provided no legal authority whatsoever for the Fed to buy government bonds or undertake so-called “open market operations” to finance the public debt. In part this was due to the fact that there were precious few Federal bonds to buy. The public debt then stood at just $1.5 billion, which is the same figure that had pertained 51 years earlier at the battle of Gettysburg, and amounted to just 4 percent of GDP or $11 per capita.

Thus, in an age of balanced budgets and bipartisan fiscal rectitude, the Fed’s legislative architects had not even considered the possibility of central bank monetization of the public debt, and, in any event, had a totally different mission in mind.

The new Fed system was to operate decentralized “reserve banks” in 12 regions—most of them far from Wall Street in places like San Francisco, Dallas, Kansas City and Cleveland. Their job was to provide a passive “rediscount window” where national banks within each region could bring sound, self-liquidating commercial notes and receivables to post as collateral in return for cash to meet depositor withdrawals or to maintain an approximate 15 percent cash reserve.

Accordingly, the assets of the 12 reserve banks were to consist entirely of short-term commercial paper arising out of the ebb and flow of commerce and trade on the free market, not the debt emissions of Washington. In this context, the humble task of the reserve banks was to don green eyeshades and examine the commercial collateral brought by member banks, not to grandly manage the macro economy through targets for interest rates, money growth or credit expansion—to say nothing of targeting jobs, GDP, housing starts or the Russell 2000, as per today’s fashion.

Even the rediscount rate charged to member banks for cash loans was to float at a penalty spread above money market rates set by supply and demand for funds on the free market.

The big point here is that Carter Glass’ “banker’s bank” was an instrument of the market, not an agency of state policy. The so-called economic aggregates of the later Keynesian models—-GDP, employment, consumption and investment—were to remain an unmanaged outcome on the free market, reflecting the interaction of millions of producers, consumers, savers, investors, entrepreneurs and even speculators.

In short, the Fed as “banker’s bank” had no dog in the GDP hunt. Its narrow banking system liquidity mission would not vary whether the aggregates were growing at 3 percent or contracting at 3 percent.

What would vary dramatically, however, was the free market interest rate in response to shifts in the demand for loans or supply of savings. In general this meant that investment booms and speculative bubbles were self-limiting: When the demand for credit sharply out-ran the community’s savings pool, interest rates would soar—thereby rationing demand and inducing higher cash savings out of current income.

This market clearing function of money market interest rates was especially crucial with respect to leveraged financial speculation—such as margin trading in the stock market. Indeed, the panic of 1907 had powerfully demonstrated that when speculative bubbles built up a powerful head of steam the free market had a ready cure.

In that pre-Fed episode, money market rates soared to 20, 30 and even 90 percent at the peak of the bubble. In short order, of course, speculators in copper, real estate, railroads, trust banks and all manner of over-hyped stock were carried out on their shields—-even as JPMorgan’s men, who were gathered as a de facto central bank in his library on Madison Avenue, selectively rescued only the solvent banks with their own money at-risk.

Needless to say, these very same free market interest rates were a mortal enemy of deficit finance because they rationed the supply of savings to the highest bidder. Thus, the ancient republican moral verity of balanced budgets was powerfully reinforced by the visible hand of rising interest rates: deficit spending by the public sector automatically and quickly crowded out borrowing by private households and business.

And this brings us to the Rubicon of modern Warfare State finance. During World War I the US public debt rose from $1.5 billion to $27 billion—an eruption that would have been virtually impossible without wartime amendments which allowed the Fed to own or finance U.S. Treasury debt. These “emergency” amendments—it’s always an emergency in wartime—enabled a fiscal scheme that was ingenious, but turned the Fed’s modus operandi upside down and paved the way for today’s monetary central planning.

As is well known, the Wilson war crusaders conducted massive nationwide campaigns to sell Liberty Bonds to the patriotic masses. What is far less understood is that Uncle Sam’s bond drives were the original case of no savings? No credit? No problem!

What happened was that every national bank in America conducted a land office business advancing loans for virtually 100 percent of the war bond purchase price—with such loans collateralized by Uncle Sam’s guarantee. Accordingly, any patriotic American with enough pulse to sign the loan papers could buy some Liberty Bonds.

And where did the commercial banks obtain the billions they loaned out to patriotic citizens to buy Liberty Bonds? Why the Federal Reserve banks opened their discount loan windows to the now eligible collateral of war bonds.

Additionally, Washington pegged the rates on these loans below the rates on its treasury bonds, thereby providing a no-brainer arbitrage profit to bankers.

Through this backdoor maneuver, the war debt was thus massively monetized. Washington learned that it could unplug the free market interest rate in favor of state administered prices for money, and that credit could be massively expanded without the inconvenience of higher savings out of deferred consumption. Effectively, Washington financed Woodrow Wilson’s crusade with its newly discovered printing press—-turning the innocent “banker’s bank” legislated in 1913 into a dangerously potent new arm of the state....

Read the rest here:
http://www.lewrockwell.com/2014/03/david-stockman/the-warfare-state%E2%80%A8-rules-the-us/