The New Vampire Economy: Banks and the Socialization of Investment

0:00Neither syndicalist rhetoric about worker-run industries nor the facade of corporatist organization under fascism could hide its essential economic character from Ludwig von Mises. As Mises recognized, quote, never was there any question of the much talked about essential feature of corporatism, self-government of the various branches of trade and industry. The fascist government clung first to the same principles of economic policies which all not outright socialist governments have adopted in our day, interventionism. Then later it turns step by step toward the German system of socialism that is all around state control of economic activities. The division of labor economy implies the interdependency of productive activity in the service of consumers and therefore cannot coexist with autonomous industries run for the benefit of an alliance of big business and big labor that constitute the corporative.

0:52Moreover, Mises demonstrated that any system dedicated to limited state intervention inevitably moves towards central planning. What distinguished the fascist variety of interventionism was its reliance on the idea of stability to justify extending state power. Big business and labor eagerly allied with the state to obtain stability against what Murray Rothbard called business fluctuations, the ups and downs of particular markets that result from shifting consumer demands. They naively thought that state power could supplant consumer sovereignty with their own producer sovereignty over their industries while maintaining the greater productivity of the division of labor. At first, the fascists used state spending mainly for war to eliminate business fluctuations. Only after they became dependent on the state did the leaders of big business and labor realize that they had merely traded consumer sovereignty for state sovereignty.

1:44and State Sovereignty. Soon after, they learned which one was the more exacting taskmaster. To extend their control, the fascists bolstered fiscal expenditures with debt and monetary inflation. Not only did they hope thereby to dominate more and more industries with their expenditures, but also to boost public support for their regimes by generating economic prosperity. Instead, their reckless spending and inflating set in motion the boom-bust cycle. They took the depression as an opportunity to extend their power further by socializing investment with regulations while claiming that such measures would stabilize the business cycle. The fascists found a ready-made theoretical justification for stabilization policies in the work of John Maynard Keynes.

2:29Keynes claimed that the instability of capitalism emanated from the free play the system gave to the animal spirits of investors. Driven by bouts of over-optimism and over-pessimism, investors alternate between bullish spending and bearish hoarding, sending the economy into fits of booms and busts. Keynes proposed to eliminate this instability with state control over both sides of the capital markets. A central bank with the power to inflate the money supply through credit expansion would determine the supply of capital funding, and the fiscal and regulatory policy would socialize the investment of capital. In an open letter to President Roosevelt, published in the New York Times on December 31, 1933, Keynes counseled this plan, quote, in a field of domestic policy, I put in the forefront a large volume of loan expenditure under government auspices.

3:18I put in the second place the maintenance of cheap and abundant credit. With these, I should expect a successful outcome with great confidence. How much that would mean, not only to the material prosperity of the United States and the whole world, but in comfort to men's minds through a restoration of their faith in the wisdom and the power of government." Keynes was even more enthusiastic for the spread of his faith in Germany. In the Preface to the German Edition of the General Theory published in 1936, Keynes wrote, quote, the theory of aggregate production, which is the point of the following book, in the book, nevertheless can be much easier adapted to the conditions of a totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire."

4:08State control of money, credit, banking and investment became the blueprint for fascist stabilization policy. Thus, the expansion of state control under fascism followed a predictable pattern. Debt and monetary inflation paid for state spending. The resulting expansion of credit led to the boom-bust cycle. The financial collapse of the bust resulted in stricter regulation of banking and socialization of investment, which permitted more monetary inflation, credit expansion, debt and spending. The consequent decline in the purchasing power of money justified price and wage controls, which became the focal point of all-around state control. In some cases more slowly and in other cases more rapidly, fascism followed this path towards central planning. The Italian fascists began spending and inflating to co-op big business soon after the March on Rome in 1922.

4:57Industrial profits and production jumped during the consequent boom which lasted until 1926. Protectionist measures were also enacted during the boom to give an added benefit to steel, iron, automobiles and shipbuilding. Building. Under pressure on the lira to devalue in 1926, the Bank of Italy reversed course and the boom collapsed. By 1927, prices and wages were falling, but not sufficiently to prevent widespread bankruptcy and depression. Businesses failed by the thousands in the 1930s. From 1928 to 1932, production was cut by one-fourth and national income by one-third, and by the end of 1934, one- One-third of capital capacity sat idle, and over one million workers were unemployed. The state progressively intervened to stave off the ill effects of its monetary inflation and extend its control.

5:47It bailed out big businesses and banks, fostered mergers and acquisitions, cartelized the remaining now larger enterprises, and renewed spending, mainly for war. Annual state expenditures in the early 1930s were double their levels of the early years of fascism. As tax revenues failed to keep pace, deficits ballooned. Banks also combined and associated more closely with big industrial concerns under supervision of the state. To rescue the big banks, which had accumulated significant holdings of industrial securities during the boom, the state nationalized their holdings in 1931 and issued new securities backed by the state to provide a new source of credit for the banks. Banks. The state also created new and invigorated old credit institutions outside the banking system to provide added channels for credit. It appointed a majority of the boards of these new credit institutions and provided them with their funds by direct subsidies and by guaranteeing their industrial investments with state bonds. Private parties then would invest in the state guaranteed bonds of these new institutions that would then invest the funds in favored businesses. Although the domestic purchasing power of the lira was rising in the

6:56In the early 1930s, the Italian state still overvalued it in foreign exchange. The resulting trade deficit and gold outflows led the state to limit imports and impose foreign exchange controls. When even the highest tariff rates in the world failed to close the trade deficit, the fascists adopted an import quota system by enforced licensing importers. The burgeoning state control of businesses swelled the state bureaucracy and led to widespread centralization and corruption. Small businesses were left to fail and have their assets swallowed up by big businesses and big banks. Nearly 100,000 businesses failed from 1926 to 1935 in Italy, almost four-fold the number that failed in the previous 10 years. By 1935, Mussolini boasted that fully three-fourths of Italian businesses rested on the shoulders of the state.

7:46The Ethiopian War in 1935 demonstrated the extent of fascist control. Annual war expenditures were 14 times larger during the war years than previously. To meet these extraordinary expenditures, the fascists resorted to monetary inflation and capital confiscation. Beginning in July, the gold reserves against the Bank of Italy's notes were progressively relaxed. Yet even as the gold reserve sagged from 5.25 billion lira in June of 1935 to 3.9 billion lira in October, the money stock rose to over 15.25 billion lira. In the next few years, monetary inflation accelerated as the fascists monetized the national debt which stood at 1.8 trillion lira by 1938.

8:31To curb the decline in the purchasing power of money, the fascists resorted to price and wage controls, which then paved the way for all-around planning. Confiscation of capital began in May of 1935, when banks, businesses and individuals were required to turn all their foreign issued stocks and bonds over to the Bank of Italy. By September, the state had compelled renters in cities and towns over a certain size to buy state bonds in amounts proportionate to their rents. All Italians to exchange their foreign credits for state bonds, businesses to invest all profits in excess of 6% in state securities, and investors holding heavily depreciated state bonds to exchange them plus liquid capital for a new issue of bonds at par value. Carl Schmitt in 1939 summarized Italian fascism with these words, Quote, fascism arose to power as a preventative reaction, defending the pecuniary and sentimental interests of the property and quasi-property groups of towns and country from the specter of revolution.

9:33It not only sought to safeguard existing property rights, but also fostered further industrialization and concentration of business enterprise. If fascism could not solve the basic difficulties of Italian capitalism, The deepening economic crisis in later years forced business enterprise to rest more and more on the support of the state. As the economic role of the state grew, a subtle shift of spirit and purposes took place. Governmental support of the ongoing economic order called for an increasing army of intruding officials, for a bureaucratic formalization of business affairs, and the bureaucracy developed ends of its own, associated with holding and enlarging its security and power. Thus, despite all form of pronouncements, fascism seemed to be evolving into a tyranny over all but a very few of the Italian people.

10:24Fascist Italy defined the fascist style of interventionism, state control of the economy by fiscal and monetary policy and regulation. Nazi Germany, in contrast, illustrates not so much the fascist style, but how the fascist episode culminates in all around state control of the economy. Concerning the socialization of investment under Nazi Germany, Günter Reimann, whose real name, by the way, is Hans Steinecke, And as an aside, Heinz Thonica passed away in March of this year at the age of 100 after pioneering the international independent financial analysis market. So a great economist and a great practitioner of economics.

11:12Anyway, Reimann wrote in 1939, quote, Backed by the general staff of the army, Nazi bureaucrats have been able to embark upon schemes which compel the most powerful leaders of business and finance to undertake projects which they consider both risky and unprofitable. The building up of the German war economy takes precedent over everything, including the opinions of private capitalists and their scientific research staffs. The viewpoint of private investors and industrialists who think of the ultimate safety and soundness of investments has been disregarded. This is particularly true of the big industrialists who earned huge profits from the armament boom and who have large amounts of capital to invest. Their liquid funds do not escape the attention of state commissars who are searching for means to finance new state-sponsored plants.

12:00Lured by enormous profits in war production, big businessmen in one industry after another came under state control. Neither political connections nor social status protected industrialists from state predation. The Nazis coerced them into investing war profits to build factories for unprofitable projects, such as synthetic rubber, low-grade iron ore and other aerosols production. State and Army commissars insisted on rapid expansion of plant capacity, ancillary investments related to war production, and the use of obsolete discarded machinery. Along with directing investment at the point of bayonet, the Nazis confiscated the profits of industrialists and directed them to new construction.

12:45In addition to malinvesting capital, these policies retarded maintenance of the existing capital capacity. The state even forbade private investment to increase or replace existing profitable capital. Prohibitions against new entry were enacted, as well as closing down existing plants. And in the shrinking realm of private investment, the capriciousness of state bureaucrats could throw investment plans into disarray. The myopia of state planners led to the neglect of investment to maintain and improve what would become important wartime industries like the railroads. Riemann summarizes the situation with these words, quote, The flow of capital is no longer regulated by a capital market which directs it into industries that are particularly profitable. The state has supplanted the capital market. It compels private capitalists to make investments in a future wartime economy and creates economic conditions which cause old investments to decline in value, close quote.

13:41Faced with a dearth of profitable opportunities in the shrinking market economy, investors turned to what they thought would be safe havens from state power, such as real estate and precious metals and gems. Thus, even the capital not consumed by the state was directed away from the capital structure. As part of the drive to bring capital markets under their control, the Nazis made bankers mere functionaries. Like their counterparts in industry, big bankers eagerly entangled themselves in the web of state power by accepting bailouts to avoid bankruptcy during the banking crisis in 1931. By the time the Nazis came to power, the state owned a majority of shares of the big banks. In 1933, the state declared its, quote, control of all credit institutions, close quote, and began to license banks, collect information on debtors, and scrutinize banking operations.

14:32The state dictated to them what investments they were permitted to recommend to investors, namely government bonds and bonds of enterprises subsidized by the state. Bankers were forbidden to express less than optimistic assessments of the state's financial condition. For investors who refused such advice and withdrew their capital from banks to invest on their own initiative, bankers were obligated to report their activity to the state. A large bureaucracy was formed to oversee banking centered into Reich Bank. By 1935, state spending had ballooned to the point that private investment decisions had been supplanted and banking was under the full sway of the state. State power was extended to the entire economy in Germany in the form of wage and price controls. Wage controls were imposed in 1933 with the purpose of holding down labor costs to boost profits during the Depression.

15:26and comprehensive price controls were added in 1936 to hide the effects of monetary inflation. Hans Sennholz reports that by 1945 the right bank's note issue was 16 times larger than it was in 1933. And bank credit had increased nearly sevenfold from July of 1936 to September of 1944. By 1939, state debt had risen to 16 billion marks and the deficit had come to exceed the entire funds available in the capital markets. By 1935, war expenditures were more than half the total budget and by 1939 they exceeded 75% of the total. The price and wage controls enacted in response to the decline in purchasing power of the mark formed an integral part of the Nazi system of total command over the economy.

16:15When debt and monetary inflation proved insufficient to feed its spending, the state freed itself from financial limitations by decree. It refused to make payments on its debt, confiscated funds from individuals and groups, canceled private debts, and reduced interest rate on private loans and transferred the resulting funds to the state. As financial pressures from war expenditures mounted during 1938 and investors fled from banks to invest with other financial intermediaries, the state compelled all credit intermediaries, banks, insurance companies and saving banks as well as municipalities to buy its debt. The stock market too was controlled by the state through the dominant position that banks came to hold in it after its collapse during the Depression.

17:00Riemann estimated that by 1938, 80 to 90 percent of the new capital in the market was absorbed by the state. Thus, the Nazis built their war economy by consuming the capital stock constructed by preceding generations of German savers and investors. The fascist form of interventionism in America was built on the rump of state corporatism that emerged during the progressive era and the experience of state planning during the First World War. The former culminated in the establishment of the Federal Reserve System to fully centralize state control of banks and monetary inflation, and the latter set precedence for New Deal programs. With the Fed in full swing, the Italian pattern during the Great Depression was seen in America also.

17:48Monetary inflation and credit expansion during the 20s led to the bust, which was used to justify greater state control of investment through fiscal expenditures and regulation. Like Mussolini, Hoover used protectionism to favor certain producers, increased funding for public works programs and bailed out key businesses. Federal spending more than doubled from 1929 through 1934 and nearly tripled for the decade between 1929 and 1939. From a modest surplus in 1930, the federal budget was in deficit in every one of the next 15 years. In 1932, the deficit was 142% of tax revenue and in 1933 it was 130%. In four of the five years between 1932 and 1936, the budget deficit was more than 100% of tax revenues.

18:40After the stock market crash in October of 1929, the Fed tried unsuccessfully to reinflate and bolster the credit markets. When its effort failed, Hoover strong-armed big banks into establishing the National Credit Corporation as a bailout to banks. Capitalized with $500 million from the banks and the power to borrow up to a billion dollars from the Fed, Instead, the NCC operated as a stopgap measure until the rebirth of the War Finance Corporation from the First World War as the Reconstruction Finance Corporation. Born in January of 1932, the RFC was chartered to issue one and a half billion in debt and to lend to distressed businesses. The first billion was dispensed by June and 80% of it went to banks and railroads.

19:26In July, the RFC was authorized by the Emergency Relief and Construction Act to extend its credit to $3.8 billion, and it dispensed $2.3 billion for the year, $300 million of which was lent to the states for relief programs. Hoover also induced insurance companies to put off foreclosing mortgages by subsidizing them through the federal farm loan banks. Authorized by the first Glass-Steagall Act in February of 1932, the Fed stepped up its purchases of treasury securities in what proved to be another vain attempt to reinflate the economy. Despite a 35% rise in bank reserves during 1932, the money stock actually fell by $3.5 billion. In July of 1932, Hoover added the Federal Home Loan Bank with 125 million of capital from mortgage loans.

20:17But at least Hoover did not embrace the Swope Plan, which called for the forced cartelization of the economy under the direction of the Federal Government. That would have to wait for his successor. While accelerating expansionary fiscal and monetary policy, Roosevelt conducted a regulatory blitz. The Emergency Banking Act of 1933 further cartelized banks, brought them under stricter federal regulation and provided bailouts. The state eliminated competition among banks and from non-banking institutions by reserving to banks a uniform set of practices. The Banking Act of 1935 insulated the banking cartel by closing entry to unapproved competitors. The Federal Deposit Insurance Corporation slowed the liquidation process of the Depression and froze malinvestments in banking in the capital structure.

21:05To pave the way for more monetary inflation, Roosevelt abandoned the gold standard, abrogated gold contracts and confiscated gold holdings. The Civilian Conservation Corps, the Emergency Relief Act and the Works Progress Administration subsidized unemployment and misallocation of labor and distorted private charitable efforts. The Agricultural Adjustment Acts put crop planting decisions in the hands of the state and subsidized disinvestment and malinvestment in agricultural production. The Tennessee Valley Authority, malinvested capital, destroyed natural resources and distorted energy markets. The Federal Securities Act, put stock markets, the pinnacle of capital allocation in the market under the regulatory arm of the federal government. The National Industrial Recovery Act, cartelized and bureaucratized the economy under federal control.

21:54The Homeowners Loan Act, the National Housing Act and the Rural Electrification Administration, malinvested capital in housing and electricity. The National Labor Relations Act and the Fair Labor Standards Act distorted labor costs leading to malinvestments and fostered unemployment. The Social Security Act forced people to invest in federal trust fund bonds. As the fascists had done, Roosevelt built public support for state intervention as necessary for stability and made war preparation the main outlet for the state's stabilizing expenditures. While New Deal agencies owe much to their First World War predecessors, both in form and in personnel, it took the Second World War to bring all around state planning. The Selective Training and Service Act of 1940 empowered Roosevelt to conscript labor and confiscate goods and factors for the war effort.

22:46In mid-1940, the Reconstruction Finance Corporation was authorized to issue debt and to use it to purchase and operate production facilities, Invest in equipment and machinery and buy land for war production. The First and Second War Powers Act in 1941 invested broad powers in the President to seize production facilities, regulate industries, purchase goods and factors, stipulate terms of contracts, allocate resources and expand Fed inflationary potential by authorizing it to purchase debt directly from the Treasury. The Office of Price Administration was charged with setting price and wage controls in the wake of the Fed's massive monetary inflation. Its general maximum price regulation, issued in April of 1942, resulted in widespread shortages and rationing.

23:33Not content with the unsystematic application of controls, Roosevelt pushed through the Economic Stabilization Act in October of 1942. The Office of Economic Stabilization was charged to develop a, quote, comprehensive national economic policy relating to control of civilian purchasing power, prices, rents, wages, profits, rationing, subsidies and all related matters, close quote. From 1940 to 1945, federal expenditures increased nearly tenfold and tax revenue rose nearly sevenfold. By 1942, the budget deficit was more than double all federal expenditures in 1940. In 1943, the deficit was two and a half times the deficit in 1942 and double the amount of 1943 tax revenues.

24:21The federal debt rose fivefold during the war and the Fed nearly doubled the money stock. State power was rolled back after the war. After the war, federal expenditures were cut in half and many agencies were disbanded and some of their functions ceased, while others were merely transferred to remaining agencies, but the state assumed the role of stabilizing the economy. The Employment Act of 1946 pledged the federal government to, quote, use all practicable means to promote maximum employment, production and purchasing power, close quote. In other words, to prevent downturns. To stabilize the economy, the state then has been working to restore the power exercised during the war. Let me conclude by recounting how far down the fascist path we have traveled.

25:09The fascists used state spending and regulation to direct investment into state-approved lines of production, war being the chief among them. The Federal Government has 165 primary agencies, 141 of which have significant effect on investment in the economy. 66 of these impact investment by fiscal expenditures. The departments of agriculture, commerce, defense, education, energy, health and human services, homeland security, housing and urban development, transportation and interior are among the major sources of such federal control. In 2005, the federal government spent approximately $1.3 trillion in these areas. And from 1945 to 2005, the federal government has spent $9.5 trillion on defense, $6.5 trillion on health care, $1.4 trillion on education, $1.2 trillion on transportation, $0.8 trillion on energy and natural resources, has six-tenths of a trillion on agriculture, half a trillion on science, space and technology, a third of a trillion on community and regional development, and three-tenths of a trillion on commerce and housing.

26:21These expenditures have malinvested entire sections of the capital structure. The other 75 federal agencies that affect investment do so by regulation. Examples here include the Departments of Labor, Justice and Treasury, the Environmental Protection Agency, the Federal Trade Commission, the Federal Communication Commission, the Federal Deposit Insurance Corporation and the Fed. The cost of compliance with federal regulation has been estimated at $1 trillion a year. This is without the Patriot Act and Sarbanes-Oxley. The impact of the Federal Government's fiscal and regulatory policies is $2.3 trillion this year. This is nearly 20% of gross domestic product and over 40% of private product remaining.

27:08The fascists used a central bank and cartelized the banking system under its regulation for the purpose of monetizing their debt and expanding the supply of credit. The Fed owns $736 billion of the federal debt, and depository institutions own another $1.4 trillion. Together they hold 27% of the $7.9 trillion federal debt. Of the $4.6 trillion of the federal debt owned by the public, depository institutions hold 30%. The fiduciary component of checkable deposits issued by depository institutions is approximately $582 billion, which is 8% of the total credit of $7 trillion, intermediated by depository institutions. As Joseph Salerno has pointed out, monetary inflation and credit expansion cloaked the capital consumption of state intervention and thus quelled public outcry against it.

28:02The fascists closed the windows of opportunity for investors to escape state control. As restrictions on banking mounted in the 1960s and 70s, investors sought alternatives and entrepreneurs provided them. From 1950 to 1980, the share of total assets of all financial intermediaries held by banks fell from 52 percent to 36. And the share of short-term credit market held by banks fell from 91 percent to 71 percent. In response to the financial services revolution, the federal government moved to consolidate its control over financial intermediaries. The Monetary Control Act of 1980 brought all financial institutions that offer checkable deposits under the regulatory authority of the Fed and imposed on them the uniform practices of all member banks.

28:47All depository institutions in America are regulated by three federal agencies, the Fed, the FDIC and the Comptroller of the Currency. of the Currency. Combined, they enforce more than 150 different categories of regulation. The fascists used banks to collect information on clients' financial activity. Since the Bank Secrecy Act of 1970, the federal government has enacted eight additional anti-money laundering laws expanding its power to collect financial information on Americans. Banks must now form financial profiles of their customers and file suspicious activities reports to the state when they deviate deviate from these patterns. The fascists dictated acceptable lines of investment. The Federal Government compels banks to make certain types of loans, as with the Community Reinvestment Act, and businesses to make certain types of investments, as with the Americans with Disabilities Act, environmental laws and Sarbanes-Oxley. In other cases, the Federal Government coercively changes incentives banks have to lend in certain lines of production, as with Fannie Mae and Freddie Mac. The fascists confiscated capital when fiscal The pressures mounted. The confiscatory power of the Federal Government has so far been directed at drug war and RICO cases.

30:03The Patriot Act, however, increased asset confiscation to abate money laundering and made anti-money laundering measures uniform across financial institutions. Faced with a fiscal crisis and price inflation from their fiscal and monetary policies, The fascist stepped up dictatorial and confiscatory powers and resorted to price and wage controls. Extraordinary federal expenditures for the Vietnam War and the Great Society programs, coupled with monetary inflation, led to our last imposition of price and wage controls in the early 1970s. Certainly, the federal government will resort to greater dictatorial and confiscatory powers and stricter price and wage controls in the wake of the next fiscal and monetary crisis.

30:48A political class that is willing to throw $150 billion into rebuilding a single city in the face of massive federal deficits is oblivious to the looming fiscal danger. As always, however, war spending is the biggest threat to the fiscal integrity of the state. If these fascist trends in America are not checked, they will lead to net capital consumption and the end of economic progress in America, not to mention curtailing what remains of our liberties. The Mises Institute is one of the precious views standing against these trends. We must redouble our efforts if we value liberty and prosperity.