What is confidence and why is it missing? The concept seems to be driving Treasury Secretary Timothy Geithner crazy this summer. You can hear that when you listen to him talk about the poor quality of the current recovery. Last week, on PBS's "NewsHour," for example, he said the administration was working hard to restore "a basic sense of confidence to American businesses and American families."
Mr. Geithner is gradually discovering that to recover, the market needs a specific kind of confidence. It is not something Washington can hand down. It is not even demand confidence—the confidence of the consumer who wants to shop. The confidence relevant to recovery is the confidence of the investor and the saver. It comes only when an administration in Washington demonstrates reliability and restraint.
Unfortunately the importance of this specific version of confidence tends to take a while to sink in. And that in turn tends to delay general recovery. This is what the painfully halting education of another U.S. Treasury secretary long ago, Henry Morgenthau Jr., makes clear.
Morgenthau started out in government with no notion of confidence at all. It was 1933, and President Franklin Delano Roosevelt knew he confronted an economic crisis. But the president didn't feel like working with the critical old Wall Street crowd. His first Treasury secretary, an establishment businessman named William Woodin, fell ill. Woodin's withdrawal did not upset Roosevelt, who liked to pilot the national ship himself. "I think father wanted to be his own Secretary of the Treasury," James Roosevelt would later write.
Over the summer of 1933, FDR found himself relying increasingly on someone he was sure would say "yes"—Morgenthau, his timid old Dutchess County neighbor who held a post at the Farm Credit Administration. With the aid of his "yes" man, Roosevelt launched a novel gold purchase program. The plan was to drive up the general price level by buying gold. Each morning, FDR set the gold price target, personally. This in turn was supposed to help farmers, who would get higher prices for commodities.
But the exposure to investors that Morgenthau was getting through the gold purchase project of 1933 was already teaching him something. Investors didn't like the arbitrariness. It took away their confidence. One day Morgenthau asked FDR why the president had chosen to drive up the price of gold by 21 cents. The president cavalierly said he'd done that because 21 was seven times three, and three was a lucky number. "If anyone ever knew how we really set the gold price through a combination of lucky numbers etc., I think they would be frightened," Morgenthau wrote in his diary. And they were: In the second half of 1933 a powerful stock rally flattened.
Morgenthau was named acting Treasury secretary and then, in December 1933, Treasury secretary. The gentleman farmer was terrified. He knew he was underqualified. The Treasury post, after all, had been held by great figures, most notably by the budget-balancing, tax-cutting Andrew Mellon. Loyal to Roosevelt, Morgenthau believed it was his job to defend the president whenever necessary. That was often.
For example, when an old professor of Roosevelt's, the much esteemed Oliver Sprague, resigned his post at Treasury because he disapproved of Roosevelt's effort to push up prices by buying gold, Morgenthau testily told the press that "It's a free country." Morgenthau added that "the Sun will rise in the morning," meaning the departure of Sprague was in the scheme of things insignificant.
FDR also wanted Treasury to investigate Mellon's tax returns and prosecute him for tax fraud. Morgenthau enthusiastically sicced the attorneys on the septuagenarian even after they advised him that there was no case.
Yet over time Morgenthau internalized several principles. One was the old gold-standard principle that a balanced federal budget is basic to market confidence. Another was the market's conviction that government consistency is mandatory too. FDR liked to bait and attack business. Morgenthau's diaries show that in the mid-1930s Morgenthau started to fight back. He also began to quarrel with Federal Reserve Chairman Marriner Eccles.
Some of these Treasury-Fed squabbles were personal. Morgenthau and Eccles behaved in an undiplomatic fashion that both Mr. Geithner and Chairman Bernanke would know better than to adopt. "There's never any use talking to you, Marriner," Morgenthau exploded at Eccles in one meeting. "You get irritated every time I come over and present anything," Eccles snapped back, threatening to leave.
But there were also policy components to the tension. Eccles was becoming what today we call a "Keynesian," a disciple of demand-side economist John Maynard Keynes. He wanted the government to put more money in the downturn of 1937. Then consumers would have the confidence to shop. Eccles also favored government discretion—a banker, he had himself crafted the modern Fed and its license to tinker with the dollar. Morgenthau was becoming a grotesque of his predecessor, Mellon. He sought a balanced budget and wanted to improve business confidence.
Scholars have spotlighted the monetary tension, arguing that in 1937 or 1938 Eccles was essentially right—taken together, the federal government was "too tight." But the second tension, the tension between activism and a stable environment, was just as important.
The battle came to a head in that 1937 downturn, so much mentioned today. Morgenthau, like Mr. Geithner now, found himself with the awkward duty of presenting this bad news to his president. But the timorous Morgenthau pulled himself together and spoke truth to power about confidence. "You can do something about public utilities," he said. "You can do something about the railroads. You could do something about housing. Above all, you must do something to reassure business." In public, Morgenthau likewise made his view clear: "We want to see private business expand. We believe that much of the remaining unemployment will disappear as private capital funds are increasingly employed."
Wall Street laughed at the Roosevelt flunky. But Morgenthau found an unlikely supporter for this concept in Keynes, who wrote to FDR the next year that he couldn't understand FDR's desultory persecution of utilities: "What's the object of chasing them around the lot every other week?"
Morgenthau remained torn between loyalty to FDR and loyalty to office. But from then on, he expressed his disgust for arbitrary intervention. Referring to an agriculture department program that killed swine in order to reduce supply and drive up prices, Morgenthau once commented, "I think from the day we started killing pigs there has been a curse on this administration."
The recovery that followed the 1937-38 depression within the Depression is often credited to expansionary policy—monetary, especially. But the evidence suggests that a new respect for market confidence also helped. Sensing that the U.S. would engage in battles overseas, FDR called off his attack on companies at home and made them allies.
To attribute this shift to the flawed Morgenthau alone would be silly. But the vacillating Treasury secretary played a role in exposing what was wrong. We are left to wonder what the mid-1930s recovery would have done had there been a conservative, market-oriented secretary in office. The pity was that the lesson took half a decade. Perhaps Mr. Geithner might like to read up on Morgenthau's progress. Treasury secretaries who forget the past condemn us all to repeat it.
This article appears in full on CFR.org by permission of its original publisher. It was originally available here.