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Patrick Newman


NextImg:Cronyism in America

How many times have you seen a politician, businessman, union, or activist group clamoring for the government to do something on the grounds that it will improve the public weal? “We need higher minimum wages to benefit the working class,” a union official says. A Rust Belt politician claims, “Higher tariffs on steel goods protect American manufacturing and create jobs.” An American Medical Association spokesperson declares, “The government has a duty to increase regulatory standards on drugs and medicine to keep the public healthy.” Or perhaps, to paraphrase so many economists and Wall Street bankers, “The Federal Reserve must bail out large financial institutions during a crisis to stave off a depression.”

At face value, these are simple examples of honest people motivated to use the government for the greater good. And like all good altruistic people, they are even willing to devote considerable amounts of their own time, money, and other resources to lobby for the cause! But these are only their stated motivations. To get the public and skeptics on board with a particular intervention, advocates must dress it up in the best public-interest garb. The real motivations, the actual reasons for their outpouring of energy, are hidden and far more sinister.

Calls for minimum wages, tariffs, medical regulations, bailouts, and so on are in fact examples of cronyism: government intervention that benefits special interests at the public’s expense. Minimum wages raise the earnings of medium-skilled union workers and reduce the employment of lower-skilled workers. Tariffs encourage and favor monopolies, leading to higher prices for consumers. Safety standards erect barriers to entry that increase the profits of the largest incumbent firms and deprive consumers of product variety. Central bank bailouts enrich the financial elites and ignite inflationary booms and busts. The sad truth is that special interests lobby politicians to pass policies that give them privileges and subsidies, and politicians go along because they receive a slice of the pie. To prevent public protest, the special-interest groups say that the government intervention is designed to benefit the people. In a profound sense, then, the modern political decision-making process is something like a con game: in the name of improving the general welfare, policies are passed that hurt it.

No doubt this is a radical take. Unsurprisingly, it is quite unpopular in history books, the official records of the interventions that governments have engaged in over the years. Most of the time, the stated motivations are taken as given and the grand narrative of American history is one of public-interested servants striving to benefit the people. The Good Guys, in favor of more government, always beat out the Bad Guys, in favor of less. The story is repeated, taught in schools and universities, and promoted in the news, and it shapes our minds and makes us more supportive of the interventions of today. But what if that narrative is not true? What if instead the overarching theme of American history is cronyism, where self-interested actors push for government privileges at the public’s expense? This is the story that my book series Cronyism aims to tell.

In the first installment, Cronyism: Liberty versus Power in Early America, 1607–1849 (2021), I used Murray Rothbard’s “Liberty versus Power” theory to analyze constitutions, central banking, tariffs, territorial expansion, and other special privileges granted in the years between the founding of Jamestown and the election of 1848. In that era there were multiple political movements and parties fighting for liberty and free-market policies and against the forces of government power and favoritism. The libertarian Jacksonian Democrats and the statist Whigs were the most prominent combatants. After the election of 1848, the Liberty versus Power conditions no longer held, and cronyism has been with us ever since. There was no longer a question that cronyism should exist. The question was now what type of cronyism there should be. Since then, Republicans and Democrats have differentiated themselves only by which special interests and elites they reward with government privileges.

So what type of cronyism did special interests saddle the American people with in the post–Liberty versus Power struggle? In my forthcoming book, Cronyism: Rise of the Corporatist State, 1849–1929, I argue that the general trend was to establish government-sponsored cartels and monopolies that weakened free-market competition and enriched incumbent businesses, unions, and other interest groups. Contemporaries defined this system as corporatism and the government that administered it as the corporatist state. As the corporatist state developed, its main goal was to restrict competition. It did so largely through regulatory commissions that raised barriers to entry, increased the market share of favored groups, stifled quality innovation, and crippled price competition.

The most influential special interests that wanted to clamp down on competition were the nation’s big businesses—Wall Street banks, industry, railroads, and food and drug producers— who paid intellectuals eager for prestige and influence to craft the necessary public-interest propaganda and rhetoric. However, due to the lobbying influence of rival bankers, smaller businesses, unions, merchants, and other special-interest groups, politicians created compromise regulatory commissions and policies. It was only after the legislative process that big business captured the compromise policies by lobbying for the appointment of personnel that would interpret the legislative mandates in its favor. Due to changing personnel, laws, and rules, the corporatist state went through alternating periods of capture by various special interests until big business reigned supreme. Through the creation of a dizzying array of regulatory agencies and appointments of favorable personnel, big business successfully established a network of government-mandated cartels and monopolies that protected its interests.

The most notable example of a regulatory agency captured by big business is precisely the institution that advocates of government intervention exalt as being immune to special-interest influence: our nation’s central bank, the Federal Reserve System. The truth about the Fed is precisely the reverse. Wall Street spearheaded the drive for a central bank and afterward captured the Fed by handpicking the man who would run the New York branch. Through this appointment, Wall Street used the Fed to increase New York City banks’ market share and elevate the dollar into a world reserve currency through credit expansion.

Like many other big businesses at the turn of the twentieth century, Wall Street faced a crisis: new competition was eroding the monopoly privileges it had received from a previous government intervention, the National Banking Acts of 1863 and 1864, which had created the National Banking System and made New York City the only central reserve city in the country. The rise of Chicago and St. Louis from interior agriculture and livestock hubs into serious financial competitors with their own special interests and politicians led to legislation that cost New York City its privileged status in the National Banking System.

Wall Street desperately sought not only to stem the erosion of its domestic power, but also to ascend to unquestioned supremacy internationally, envying the status of the pound sterling and of London and other European financial centers. “Something radical is going to be necessary in order to meet the banking competition that we are facing,” wrote Frank Vanderlip, vice president of National City Bank (yes, the precursor to today’s Citibank). He and other Wall Street bankers, particularly those affiliated with J. P. Morgan & Co. (that’s right, the precursor to modern-day JPMorgan Chase), decided to get ahead not by becoming more efficient compared to rivals in a deregulated market, but through the time-honored method of acquiring new regulatory privileges from Congress. This time, they wanted regulations that would cartelize the banking sector and aggressively promote New York finance around the world.

In 1910 Wall Street banks and allied economists concocted their radical proposal at a secluded resort on Jekyll Island in Georgia. They drafted a plan to create a single central bank whose personnel would be appointed by Wall Street and other large banks. But anti–big business Populists in Congress, beholden to smaller bankers fearful of concentrated power in New York, were not about to take the bait. Instead, in 1913 they passed the Federal Reserve Act, which created a system of regional central banks monitored by a presidentially appointed board in Washington, DC.

This new regulatory machinery had the power to increase Wall Street’s market share and promote its financial services abroad, but only if Wall Street controlled its money-printing capabilities. To control the money machine, Wall Street needed one of its elite bankers to become governor of the regional Federal Reserve Bank of New York and work around the Federal Reserve Board in Washington to funnel credit to Wall Street institutions. They turned to Benjamin Strong, the new president of the Morgan-affiliated Bankers Trust Company. Initially he did not want the job, believing that the Federal Reserve failed to grant big bankers enough power. But Wall Street counseled that he could “frame the by-laws so as to give [him]- self sufficient power as Governor,” interpreting the statute’s vague authorities in a way that enhanced the New York Fed’s power relative to the Federal Reserve Board. Convinced, Strong accepted the position. A certified Morgan man thus became head of the New York Fed.

With Strong as governor of the New York Fed and positioned to become the de facto head of the whole system, Wall Street achieved its corporatist goals. After World War I broke out in Europe in 1914, Strong organized an extralegal Federal Reserve governors’ council to co-opt monetary policy. He assumed control of the council and coordinated regional central bank purchases of bank assets, much to the consternation of the Federal Reserve Board. Against his skeptics, Strong purchased warrelated acceptances, financial instruments that facilitated the exportation of munitions and whose purchase pushed the country closer to war, from New York City banks. When the United States formally entered the conflict in 1917, Strong continued to benefit Wall Street by aiding in wartime finance, loaning money to New York City banks to buy war bonds. His actions increased Wall Street’s market share and transformed the city into one of the world’s leading financial capitals.

Wartime success begot postwar gains: Strong positioned himself to reconstruct the worldwide financial system in New York’s favor and continue the expansionary parade. He slashed interest rates to “facilitate foreign borrowing in this country.” This helped create the global gold-exchange standard, wherein many European and Latin American currencies became redeemable for dollars instead of gold. Morgan partner Russell Leffingwell approvingly wrote that “the job we did in the reconstruction of currencies all over the world was a good one.”

Through Strong, Wall Street’s plans came to fruition. By 1929, New York City banks had regained much of the market share they had lost to Chicago and St. Louis, and the dollar had surpassed the pound as a global reserve currency. Wall Street banks were reaping the profits of cronyism. The three largest banks, National City Bank, Guaranty Trust, and Chase National Bank, reached roughly $2 billion in assets apiece. J. P. Morgan partners collected $1 million dollars a year on average—massive sums at the time—with Jack Morgan, J. P. Morgan’s son and heir, receiving a lofty $5 million. It is all too clear, then, that it was in the years following the passage of the Federal Reserve Act—and not before, as is commonly proclaimed—that Wall Street became the Money Trust pulling the strings of the American financial system, with dire consequences for the US and global economies to come.

Wall Street was not the only interest to profit from the corporatist state. Corporations used the Federal Trade Commission and the Department of Commerce to enforce anticompetitive trade agreements and promote export cartels. The railroads secured freight rate minima and favorable Interstate Commerce Commission rules through the Transportation Act. Health interests acquired their own privileges from the Food and Drug Administration, the Department of Agriculture, and the original National Institute of Health. In each case politicians, lobbyists, bankers, industrialists, bureaucrats, and intellectuals always advocated crony policies in the name of the public interest. But the real intent was to monopolize profits. These regulatory captures were the fruit of decades-long efforts to reduce business entry and innovation in the marketplace.

Mainstream historians say that the Federal Reserve and other interventions helped the public. They call the early twentieth century the Progressive Era for this reason. But if there was one group that lost out in the rise of the corporatist state, it was precisely the American people, the men and women who consumed and worked and belonged to no special-interest group. Free enterprise tends to satisfy consumer desires. Consumers learn from experimentation, networks, reputations, advertising, and other sources about the goods and services that best suit their ends. Businesses, big or small, that produce what consumers value earn profits, while those that fail to do so suffer losses. Increased savings and technological innovation grow the supply and types of capital goods, which in turn raises the quality of consumer goods, workers’ real wages, and living standards. These free-market forces were responsible for the massive economic gains that occurred from 1849 to 1929.

On the contrary, the new network of corporatist regulations inhibited, delayed, and distorted progress. Inflationary bank credit from the Federal Reserve redistributed income to the government’s favorites and misallocated resources through artificially low interest rates, propelling an unsustainable boom that crashed in 1929. In other sectors of the economy, barriers to entry and compliance costs privileged the largest corporations while burdening small and medium-sized firms and their workers and hurting upstart companies’ ability to innovate and compete. Consequently, the supply of products and laborers was restricted, leading to higher prices, less variety, and less innovation. The increasing restriction of price and wage competition resulted in growing rigidities, making markets less responsive to changes in supply and demand. Dynamic competition gave way to ossification.

Cronyism: Rise of the Corporatist State, 1849– 1929, documents all of this and more. It reveals the great political con game as it actually played out, exposing the actual motivations behind and the actual consequences of government activity—not the sanitized versions so commonly presented to us. It shows that there was no such thing as the Progressive Era in America, only the rise of the corporatist state, a tectonic expansion in the history of cronyism. The result has not been progress but higher prices, lower quality, reduced variety, and a persistent inequality between those who are favored by the government and those who are not. This was the system that the corporatists thrusted upon the American people, and it is still alive and kicking to this very day.