The Crash of 1929 ushered in a new era of misunderstanding of the role of the State, especially the degree to which government can or should directly control economic and social life by infringing on the natural rights of liberty and property. The New Deal, characterized by rapid, almost explosive growth of government through manipulation of the financial, tax and monetary systems (see Harold G. Moulton, The New Philosophy of Public Debt. Washington, DC: The Brookings Institution, 1943) was the logical end of the decayed populism of the 1890s, and the derailed progressivism of 1900-1912.
The new understanding of private property embodied in the New Deal was a direct result of the distortions forced on the Constitution in the Slaughterhouse Cases, integrated into government monetary and fiscal policy largely through the work of Adolph Berle and Alvin Hansen. To a significant degree, the economic policies of the New Deal were determined by the fixed — and erroneous — belief that the only way to finance new capital formation is to cut consumption, accumulate money savings and invest.
Analysts operating within this "currency principle" framework were baffled by the causes of the Crash and the Great Depression of the 1930s. As Moulton made clear in a number of his books (most in-depth in The Recovery Problem in the United States, 1936, in which he accurately predicted the "Depression within the Depression" of 1937-1938), by assuming that the only source of financing for anything is existing accumulations of savings, the presumed experts could not understand why, at one and the same time, there was plenty of money for capital expansion and speculation on Wall Street.
Under the currency principle common to Keynesian, Monetarist and Austrian economics, the allocation of credit, presumed fixed by the Production Possibilities Curve that in turn is determined by the amount of existing savings, is an "either/or" situation, "guns or butter," as it is usually expressed. On the contrary, as Moulton pointed out, because commercial and central banks have the power to issue promissory notes in exchange for accepted bills of exchange, i.e., by discounting and rediscounting eligible paper, it is possible to create as much money as necessary to finance all feasible capital projects in the economy by the expansion of bank credit without upward pressure on the price level.
The problem in the 1920s, similar to the situation that prevailed in 1873 and 1893, was that by 1929 productive capacity had temporarily outstripped the capacity of consumers to absorb the new production. Business had more capacity to produce than consumers had the capacity (effective demand) to consume — a discontinuity that led to the non-functioning of Say's Law of Markets: that we can only consume if we produce, and that we can only obtain what others produce by offering what we produce in exchange.
Thus, as wage labor became less productive relative to advancing technology (Moulton noted that the number of jobs in direct manufacturing actually declined in the United States between 1919 and 1929), wage workers became less able to consume what was being produced. (The solution to this, as Louis Kelso explained a generation later, is to make "every worker an owner," ideally, every person, so that replacing labor with capital in the production process will no longer result in a discontinuity between production and consumption.)
If, at the same time, money is being created for speculation in secondary equity issues — as it was in the 1920s at a tremendous rate — then the prices of shares on the secondary market will reflect the influx of money and rise accordingly. Many people in the 1920s and even today failed to realize that purchasing equity shares and debt on the secondary market is not investment in new capital, but the purchase of existing capacity. When the purchaser buys and sells secondary issues in the hope of realizing a gain from a change in the value per share or the price of the bond instead of for the stream of dividends or interest to be paid in the future out of profits generated by the production of marketable goods and services, it must be classified as "speculation," not investment.
Consistent with the "banking principle," money for speculation, consumption and government expenditures must come out of existing accumulations of savings. Unfortunately, the Keynesian policies implemented in the New Deal assumed as a given that all expenditures for any purpose come out of existing accumulations of savings. Per the currency principle, increasing the money supply simply divides the savings accumulation into smaller and smaller pieces.
Issuing new money thus presumably only redistributes existing wealth, so that the amount of government debt issued is irrelevant as long as the debt is held within the domestic economy. To retire excess debt, it is only necessary to drain excess money out of the economy by taxation. If additional money is needed for consumption or investment, it is only necessary to increase outstanding government debt.
Keynesian monetary and fiscal theory — an application of Georg Friedrich Knapp's "chartalism" (now called "Modern Monetary Theory," or "MMT") — is thus based on the utterly false assumption that government debt — and thus the money supply — represents the present value of existing wealth in the economy. On the contrary, as has been graphically demonstrated by the colossal sovereign debt burdens of many countries today, the issuance of government securities to finance the modern Welfare State can rapidly outstrip the ability of the economy to be taxed and repay the debt. Many modern governments have made, and continue to make promises they cannot possibly keep.
This is because what is being monetized by the issuance of government debt is not limited to the quantifiable present value of existing wealth in an economy. To this must be added the present value of future tax collections based on the unquantified present value of marketable goods and services to be produced in the future, limited only by what politicians can spend, not what the private sector can produce. Governments are not only redistributing existing wealth through inflation by deficit spending monetized by their central banks. They are mortgaging future production that does not yet exist, and which may never exist if the capacity of the private sector to produce is destroyed or damaged beyond recovery.
To allow governments to take over money and credit and control the economy required a fundamentally different conception not only of natural rights, but of the source of those rights. The architects of the New Deal, principally Adolph Berle and Alvin Hansen, found this different conception in the devolution of natural law theory and the growth of legal positivism that began in the United States with the effective nullification of the U.S. Constitution by the Supreme Court in the Dred Scott decision, and was congealed into amorphous dogma in the opinion in the Slaughterhouse Cases. The demand for increased government control of the economy could be justified by the new conceptions of property and freedom of association (liberty) implied in Slaughterhouse, which due to the vagueness of the Court's opinion could be used to make the Constitution mean anything the government or the Court found useful or expedient.
Underlying the new conceptions of property and liberty, however, was an even more dangerous idea: that rights such as life, liberty (freedom of association/contract) and property are not inherent in the human person, but are a grant from the State. By changing the orientation of the Constitution away from natural law, the idea that every human being is by nature automatically a person having inherent or inalienable rights was utterly abolished.
Within the framework dictated by adherence to Keynesian economics, the State assumes absolute power; man becomes "a mere creature of the State." In fulfillment of Walter Bagehot's idea of "democracy" expressed in The English Constitution (1867), the transformation of the American system from the vision of the Founding Fathers to a government of the State, by the State, and for the State was complete.