Friday, June 28, 2019

Lessons from the Great Depression: What Really Ended the Great Depression? (Part 2 of 3)

Click here to read the original Cautious Optimism Facebook post with comments

6 MIN READ - FDR realizes he must end his war on business if America is to win the war against Hitler.

A contemporary editorial cartoon that reflected perfectly
 FDR's change of strategy abandoning the New Deal.

Dismissing Keynesian claims crediting massive government deficit spending for the recovery of 1940, the COCEA credits the one person most responsible—with the possible exception of Adolf Hitler—for finally getting America out of the Great Depression: General Motors President William S. Knudsen.


Free market economists such as those in the Austrian School or supply-siders espouse a different explanation than the Keynesians for the sudden economic recovery that began in May of 1940, and their version actually aligns correctly with the World War II timeline.

Far from the rebound being the consequence of massive wartime government spending that didn't begin until 1942, it was the prospect of fighting a world war that forced FDR to free American industry from the most radical and destructive policies of the New Deal.

The story goes as follows:

When Germany and the Soviet Union simultaneously invaded Poland in September of 1939 Franklin Roosevelt sensed the United States might soon be dragged into the war. He also knew America’s army was tiny and ill-prepared; a paltry 18th largest in the world and slightly smaller than Holland’s.

FDR called his new Army Chief of Staff George C. Marshall for an assessment who replied if Hitler landed five divisions on American shores that there would be nothing to stop him. As FDR pondered how to reconstitute America’s neglected military his economic adviser Bernard Baruch suggested he consult General Motors President and managerial genius William Knudsen.

In May of 1940 Roosevelt asked Knudsen to take a leave of absence from GM and oversee military production from Washington, even though the United States had not yet entered the war. After a series of discussions Knudsen, representing American industry in general, worked out a deal with Roosevelt.

In short, he reminded Roosevelt that he was going to need a vibrant business sector to produce his "arsenal of democracy" (a phrase Knudsen himself created) which would require him to scrap the most radical New Deal regulations that had been strangling the same business sector he was going to need. In return, the private sector would deliver FDR an outpouring of tanks, ships, and warplanes the likes of which the world had never seen.

In the words of “Freedom’s Forge” author Arthur Herman, Knudsen’s advice to FDR “was to clear away antiquated antibusiness tax laws and regulations.”

Also according to Herman, far from the government centrally planning war production…

“Knudsen… …insisted on keeping the process voluntary and decentralized, so that companies would be free to decide on their own which war materiel they were best suited to bid on, and how to produce it. The point was to reduce Washington's interference in the production process to a minimum.”


“This proposal was in effect Roosevelt's first introduction to supply-side economics. To arm the nation for war, Roosevelt not only had to agree to set aside his own ideological misgivings but almost a decade of his own failed economic policies.”

General Motors President and
Army Lieutenant General William S. Knudsen

This was not an easy pill for Roosevelt to swallow. He had publicly lambasted American industry and businessmen for most of his presidency, blaming them for worsening the Great Depression. But now he needed them, because there was no one else to turn to for the massive war materiel he needed to fight an enemy like Nazi Germany.

Roosevelt agreed to the deal. His public anti-business rhetoric ended. During his second term he had demonized businessmen as “economic royalists… …the privileged princes of these new economic dynasties, thirsting for power” and “this new industrial dictatorship… tyranny such as this.” But this sort of vitriol and disdain abruptly halted in mid-1940.

The capital gains tax rate was reduced. The undistributed profits tax, which had punished companies that wanted to reinvestment profits back into their operations to expand production, had already been dropped in late 1939 by veto-proof Congressional vote.

FDR instructed his Justice Department’s antitrust division head, Yale professor Thurman Arnold to end his precocious harassment and prosecution of big business.

Arnold, who his entire career had crusaded against successful companies in industries ranging from milk, tobacco, school supplies, and fertilizers to typewriters, oil, fire insurance, and tires and condemned their managers in the courtroom as “the biggest men,” “grasping men,” and “malefactors of great wealth” reluctantly complied. However his continued protests at being abandoned caused him to fall out of favor and FDR eventually offered Arnold a judgeship on the circuit court of appeals—”kicking him upstairs” to get him out of the way.

Years after the President's death Arnold wrote an article complaining that “FDR recognizing that he could have only one war at a time, was content to declare a truce in the fight against monopoly.”

Another change: Since the 1935 passage of the Wagner Act labor unions had gone on strike at more than double the prior rate. And worse still, many engaged in so-called “sit in strikes” where workers physically blocked factory entrances, impeded the use of capital equipment, and even lived and slept on the workfloor in order to prevent replacement workers or management from operating machinery. Until 1940 Roosevelt, sympathetic to labor and trying to artificially boost worker wages to increase aggregate demand, told arbitrators in his National Labor Relations Board to look the other way from such illegal offenses.

But once the country was committed to a military buildup everything changed.

Now it wasn’t just greedy capitalists but also Roosevelt himself who was obsessed with meeting production quotas and timelines. Disruptive sit-in strikes weren’t tolerated by the federal government. Unruly strikers were seen as an impediment to delivering the tanks, planes, ships, and ammunition that the White House demanded to win a prospective war. FDR finally ordered the sit-in strikes halted even though the law had already required it since 1935.

Labor leaders nevertheless continued to order strikes, even during wartime when stoppages would interrupt military production. But by now FDR’s attitude towards militant labor had so changed that he threatened to cancel the unions’ draft deferments in order to commandeer their members and order them back to work. Facing public outrage and the prospect of worker conscription the union bosses backed down.

As the war began FDR also dismantled many of the New Deal’s most famous programs. Today history students are taught about 1930’s federal relief programs like the Civilian Conservation Corps (CCC), Works Progress Administration (WPA), National Youth Administration (NYA), and Public Works Administration (PWA), but they’re rarely told what ultimately became of those programs.

FDR quietly dissolved them all.

And finally Roosevelt diminished the most radical pro-New Deal voices in his administration. His combative Interior Secretary Harold Ickes while retained in his position lost influence during the war. Major New Deal architect Harry Hopkins, who had been head of the Works Progress Administration and then Secretary of Commerce, was reassigned as wartime emissary to Winston Churchill in 1940 effectively ending his involvement in domestic economic affairs. FDR’s Vice President Henry Wallace, a socialist progressive who had been unpalatable to Congressional Republicans and even some Democrats, was dropped when Roosevelt ran for re-election in 1944 for the more moderate Harry Truman.

During a White House press meeting journalists asked Roosevelt why he had abandoned so many of his New Deal economic policies and his response (paraphrasing) was “Dr. New Deal must make way for Dr. Win the War.”


William Knudsen began working on the industrial wartime production problem in mid-1940, leaving one of the highest paying jobs in America to take a government salary of one dollar. Cooperating with his contacts in the steel, chemicals, and manufacturing sectors Knudsen quickly launched a campaign to ramp up industrial output. But he didn't act as the "War Production Czar" that New Dealers and even Elanor Roosevelt had called for. Instead he simply got Roosevelt's most strangling policies removed and then stepped aside to allow those firms best suited for making whatever war materiel they felt suited to to offer their services. As Herman says "No one told anyone else what to make." It was a decentralized bottom-up, not top-down enterprise.

The furthest direct involvement Knudsen had was with the sector he had just left: the automobile industry which was the largest employer in America. For example, Ford Motor Company ultimately produced more war materiel than all of Mussolini's Italy.

However it’s important to note that even before the federal government began spending in earnest on war materiel, terminating the New Deal’s most antibusiness policies nurtured a more favorable backdrop for all private commerce to hire, invest, and conduct business, not just defense-related manufacturing. Knudsen’s deal with FDR was a blessing for the entire business sector.

Thus explains the rapid fall in unemployment between the summers of 1940 and 1941: FDR abandoned much of the New Deal and for the first time in a decade American businesses were free to operate without crushing interference from Washington DC.

And how did military production in particular fare? According to Arthur Herman by the end of 1942 American companies were producing more tanks, planes, and ships than all the Axis powers combined, and by the end of 1943 more than Germany, the Soviet Union, and Great Britain combined. As the author writes:

“After years of bashing business, it was a valuable learning experience for FDR. World War II taught him that there was a reason the United States had the most productive economy in the world.”

Knudsen himself was appointed Chairman of the newly created Office of Production Management in January of 1941. A year later he received a commission with the U.S. Army as a Lieutenant General, the highest rank ever assigned to a new entrant in the armed forces.

Four years later as the war drew to a close FDR began attacking business again in his speeches. In his 1944 State of the Union Roosevelt cited revitalized American industry providing a golden opportunity to reestablish the New Deal and transform the flourishing industrial sector into the collective top-down economy he had long so coveted. To the relief of businessmen such a U-turn would not take place as FDR wouldn’t get the chance. He died in April of 1945, one month short of Nazi Germany’s surrender.

Harry Truman, a moderate Democrat with less interest in reviving the most radical elements of Roosevelt’s agenda, did attempt more modest New Deal measures with his own “Fair Deal,” but it was watered down by Congressional Republicans who took control of both houses of Congress in 1946. In fact the 1947 Taft-Hartley Act retracted some of the government powers granted to labor unions in 1935, and Truman dramatically slashed government spending at war’s end despite warnings against doing so by prominent Keynesian economists. He even signed a comprehensive tax cut, America's first after 17 years of relentless tax hikes. Thus the American economy was assured never to return to FDR-era Great Depression conditions.

We will discuss Truman’s war drawdown and the 1946 postwar boom in the final installment.

Note: If you have an account, the Wall Street Journal has a particularly excellent piece on Knudsen's Arsenal of Democracy.

If you don’t have a subscription to the Journal, Herman’s similar AEI and National Review columns can be found at

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