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[EOR]
[BOC]
On the Soviet side, the Bolsheviks had been engaged in extremely distorted propaganda since before even the 1905 revolt against the Czar.  The SR's (Social Revolutionaries) learned quite a bit from dealing with Okhrana, and Stalin's time at Pravda didn't help the organization's desire to live up to its name much.  Lenin preferred the "dictatorship" part of the "dictatorship of the proletariat," quickly resorting to Vanguardism led by Sovnarkom, the Council of People's Commissars, and similar organizations.  Stalin ruthlessly purged the Red Army and "kulaks," wreckers, traitors, social undesirables, "workshy elements," after the declaration of support for Sergei Kirov at the 17th Party Congress.  His 5 Year Plans had been...unpopular, and the passport system and "Socialist Realism" movements coincided with the rise of Sociology, Edward Bernays, psychoanalysis, Walter Lippmann, Wilfred Bion and others, who coined terms like "the manufacture of consent" and "engineering consent."  

Governments came to learn more and more about their citizens throughout the 30's, while citizens knew increasingly less beyond the scope of which they were intended to learn.  Goebbels, Streicher, and Rosenberg were certainly not exempt from this desire to have the public learn the "truth" rather than the truth of any given thing.  The techniques of war propaganda pioneered in World War I to keep men charging into death at the Somme, Belleau Wood, Passchendaele, and so forth were being perfected by the 40's.  The massacre in Katyn Forest, an NKVD massacre of Polish army officers (largely by Vasili Blokhin, the most prolific personal killer of all time), became a Nazi atrocity.  The Trial of the Twenty One in Moscow and other show trials convicted Lev Kamenev, Grigorii Zinoviev, Karl Radek, and other leading Bolsheviks, with eventually even the NKVD chiefs Genrikh Yagoda and Nikolai Yezhov themselves being killed.  This was the way of Soviet information.  Doing his own part, FDR relentlessly slammed the Third Reich to drag his reluctant country kicking and screaming into the war with the Atlantic Charter, lend-lease, the embargo on Japan, and other provocations.  His ambassador to the Soviet Union even produced "Mission to Moscow," a film lauding the Soviet Union; they were very close ideologically.
The crowds at these trials were typically frothing at the mouth to "get the traitor!  kill him!  kill him!" in a kind of demonizing depersonalization which would come into play later.

Naturally, all this combined well with the international news of Kristallnacht, and Jewish rumors which began spreading early during the war.  Just as with Khmelnitskii's uprising against the arendators centuries before, they tended to take very real and terrible suffering and inflate it to enormous levels.  Neurotic people, whose civilizational identity revolves around being in constant danger, in great fear, will tend to do such things.  Killings such as at Jozefow, the rather ruthless campaigns to stamp out partizans and supporters, lent some viability to the rumors.  Jews, like other groups the war touched, indeed suffered terribly.  It was the worst war in human history, by far, that's really no surprise.

Despite what the U.S. Holocaust Museum in D.C. claims, the Allies didn't suppress Jewish rumors, but arrived in Europe fully ready to document them.  Dwight Eisenhower had a great fondness for psychological operations, and between USIA and massive retaliation at the Formosa Strait Crises, made it central to his later foreign policy as president.  After the bridge at Remagen was seized and the Western Allies poured into Germany, he arrived with psy ops crews, and showbiz types like William Paley and Billy Wilder, ready to document the Ohrdruf, then Buchenwald "death camps" once he realized he'd made a mistake.  This was the first time the German civilians were marched out to witness the shrunken heads, tattooed skin, lampshades, and other "Ripley's Believe it or Not" stuff he'd set up.  Alfred Hitchcock also filmed footage at Bergen-Belsen.  These claims of German death camps were quietly dropped, and the Dachau gas chamber became a gas chamber disguised as a shower which was never used as a gas chamber.  The Soviets, with their penchance for thinly veiled deceit, were more than willing to portray Majdanek's Bath and Disinfection chambers as gas chambers.  This was followed by "death marches" in other Polish camps, where the delousing chambers were often destroyed, which was later used in a common "the only reason we don't have evidence for gas chambers is because they destroyed the evidence," no win kind of situation.

So it's really a combination of the rise of mass psychology in the social sciences, more efforts at revising and expanding World War I propaganda, Soviet totalitarian information control, Churchill and FDR needing to justify continuing the fight after the Fall of France, an attempt to discredit Germany to prevent further world wars, rumors among frightened prisoners, justification for Israel which coincided with calling in the Balfour Declaration debt and a terrorist campaign in Israel by Lehi, and the fact that the international reputation of the Third Reich, Hitler's bombastic speeches, actual German atrocities which occurred and are committed by just about every army in every war, heightened general violence on the Eastern Front given the implications and brutality of the conflict, and a simple case that victors will always try to portray themselves as good guys who fought evil.  Dean Irebodd also has a "Shrunken Heads: Lies which Justify War" video which makes a pretty good case that it was a setup for further warmaking, this tendency to bandy lies to the public about the evil bad guy they have to vanquish so they'll go along with elites' war agendas.
[EOC]

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