FDR’s American Economic Miracle 1938-44, or the First Economic Bomb – The USA from 1938 to 1944 (Part 1)

1 Background

“Granted that the United States had peculiar advantages in the quantity of resources, in freedom of intervention from the enemy, and in the great quantity of slack which existed in the economy before 1940, it remains a logical and revealing approach to ask precisely why the productive effort in other economies fell short of that in America.”

Alan Millward, “War, Economy and Society, 1939-45”, (Harmondsworth: Penguin, 1977) p 75.

The adminstrations of President Franklin Delano Roosevelt developed two great innovations – first, the understanding about how to create an economic explosion (or an economic bomb) and second, the knowledge about how to construct atomic bombs. The first of these developments partly funded the second.

The 32nd President of the United States had started to provide investment for wartime production to supply lend-lease armaments to the UK prior to America entering the war. When the USA entered the war after the 7^thDecember 1941 attack on Pearl Harbour, Churchill certainly appreciated the enormous potential economic power of the USA and is reported as having said:

“Silly people – and there were many – might discount the force of the United States,” he mused, but America was like “a gigantic boiler. Once the fire is lighted under it, there is no limit to the power it might generate.”

Richard Parker, John Kenneth Galbraith, A 20^thCentury Life, Old Street Publishing Ltd, London, 2005, p143.

This short article is about how that “gigantic boiler” produced the first economic miracle.

Once the USA declared war, FDR was determined to use his wartime powers to create a consensus between business and government to enhance the progress of the war effort. He seemed to act to ensure that various co-opted business leaders and agencies had similar overlapping powers to provide some competition in making progress, and to guard against the possibility that any one agency could thwart his desired developments. He brought businessmen directly into government war production councils to link the power of government with the productive intelligence of the business community.

The President was also focused on doing whatever was necessary to ensure the Allies won the Second World War. A big part of that was to provide the funds to equip US industry with the plant and equipment required to win the war. FDR did everything possible to encourage patriotic saving in War Bonds, but these were not enough.

2 Necessity was the mother of the invention of Investment Credit Creation

More armaments – aircraft and ships, tanks and vehicles, rifles and ammunition – and all the other machineries of war were required. US industry needed to invest massively to produce these goods. So FDR did something unprecedented. He instructed the Federal Reserve Bank to create the Investment Credit required by US manufacturing industry to produce the goods to win the war. The Americans created large flows of investment credit – long term, low-repayment business loans – to ensure that no investment required by the war effort was held up by lack of funds. That signal and the funding went out from the Federal Reserve Bank, down through the twelve regional FRBs, through the US banking system and into private industry in all parts of the country

The great economic innovation in the wartime United States of America was the creation of an immense flow of credit to support the construction of industrial plant and equipment for the war effort. The American government willed the ends – of vast steel factories, great new production facilities for ships, aircraft, and armaments – and willed the means, by authorising the “Fed” (the Federal Reserve Bank) to create credit for business expansion. This is the heart of the secret of rapid economic development – if the power of the banks and the government to create credit is allied to the capability of businesses to invest that money then the economy will prosper.

3 The financing of the US economic miracle 1938-44

Table 1 below shows how the economic miracle of US wartime production was financed. The excess of wartime spending over tax and savings receipts was very large, however one assesses it. The extent of government deficit financing – the excess of expenditure over receipts – rose from less than $1.2 billion in 1937/8 to a peak of $57.4 billion in 1942/43. What is usually called the “deficit spending” of the American government in wartime ranged from 5.6% of GDP in 1938/39 ($3.8 billion out of a GDP of $67.3 billion) to 31.3% of GDP in 1942/43 ($57.4 billion out of a GDP of $183.8 billion). This was an impossible amount for the country to generate as national savings – it was too concentrated into the years of 1941-44. The average amount of Investment Credit Creation by the Federal Reserve Bank was about 15% of GDP throughout the 1938-44 years, but it was very “peaky” and exceeded 30% of GDP in 1942/43.

Table 1 Deficit Spending and Public Debt in the USA, 1937/8-1947/8

Source: Reproduced by permission from the United Nations Statistical Yearbook, 1949/50, Table 158, p469.

The “public debt” and investment credit created to fund these vast programs was dwarfed by the immense productivity gains made by American industry during and after the war. The results of the wartime productivity are an indelible part of the American economic record. Key data is in Table 2, which shows that during the years between 1938 and 1944:

– Productivity per head increased by about 53%, or 8.5% pa; because the working population increased by about 3.4% pa, real output increased at an average rate of about 12.2% pa;

– Output of machinery increased from an index of 65 to 352, an increase of 441%, equivalent to about 40% pa;

– Shipping launched increased by 72 fold, from 160 thousand tons to 11.58 million tons. Initially only 8% of world production in 1938, it represented 85% of world production, or over five times the output of all the rest of the world put together, in 1943;

– Industrial production went up from an index number of 79 to 212, an increase of 168% or an average rate of 21.8% pa;

– Industrial construction boomed from 2.5 million sq. metres in 1938 to 41.8 million sq. metres in 1943 (up by a factor of over sixteen!) and remained thereafter at over four times the pre-war average.

Table 2 Some indicators of US growth, 1938-4

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This post was written by George Tait Edwards