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America’s Great Depression Fifth Edition America’s Great Depression Fifth Edition Murray N. Rothbard MISES INSTITUTE Copyright ?? 1963, 1972 by Murray N. Rothbard Introduction to the Third Edition Copyright ?? 1975 by Murray N. Rothbard Introduction to the Fourth Edition Copyright ?? 1983 by Murray N. Rothbard Introduction to the Fifth Edition Copyright ?? 2000 by The Ludwig von Mises Institute Copyright ?? 2000 by The Ludwig von Mises Institute All rights reserved. Printed in the United States of America.
No part of this book may be reproduced in any manner whatsoever without written permission except in the case of reprints in the context of reviews. For information write The Ludwig von Mises Institute, 518 West Magnolia Avenue, Auburn, Alabama 36832. ISBN No. : 0-945466-05-6 TO JOEY, the indispensable framework The Ludwig von Mises Institute dedicates this volume to all of its generous donors, and in particular wishes to thank these Patrons: Dr. Gary G. Schlarbaum ??? George N. Gallagher (In Memoriam), Mary Jacob, Hugh E. Ledbetter ??? Mark M. Adamo, Lloyd Alaback, Robert Blumen, Philip G.
Brumder, Anthony Deden (Sage Capital Management, Inc. ), Mr. and Mrs. Willard Fischer, Larry R. Gies, Mr. and Mrs. W. R. Hogan, Jr. , Mr. and Mrs. William W. Massey, Jr. , Ellice McDonald, Jr. , MBE, Rosa Hayward McDonald, MBE, Richard McInnis, Mr. and Mrs. Roger Milliken (Milliken and Company), James M. Rodney, Sheldon Rose, Mr. and Mrs. Edward Schoppe, Jr. , Mr. and Mrs. Robert E. Urie, Dr. Thomas L. Wenck ??? Algernon Land Co. , L. L. C. , J. Terry Anderson (Anderson Chemical Company), G. Douglas Collins, Jr. , George Crispin, Lee A. Everhart, Douglas E. French, John William Galbraith, Walker S. Green, Mr. nd Mrs. Max Hocutt, Donald L. Ifland, Joe R. Lee, Arthur L. Loeb, William R. Machgan, Dorothea H. Marica, Bernard Morton, Daniel W. Muirhead, James O’Neill, Charles H. Reeves (Reeves Family Foundation), Donald Mosby Rembert, Stephen K. Salisbury, Mr. and Mrs. Allan Sawatzky, Joseph P. Schirrick, Mr. and Mrs. Thomas W. Singleton (Nehemiah Foundation), Robert W. Smiley, Jr. (The Benefit Capital Companies), Byron L. Stoeser, Joseph J. Syslo, James E. Tempesta, M. D. , top dog???, Alex T. Van Rensselaer, Lawrence Van Someren, Sr. , Mr. and Mrs. Quinten E. Ward, David Westrate, Anne Williamson, Keith S.
Wood ??? Robert Bero, Robert J. Birnbach, Richard Bleiberg, John Hamilton Bolstad, Mr. and Mrs. Justin G. Bradburn, Jr. , David and Elizabeth Butler, John W. Carpenter, Dr. John P. Cochran, John Cooke, Henry V. Curll, James V. De Santo (DTL Inc. ), Chris A. Doose, Mr. and Mrs. Ted C. Earle, Jay Elliott, Eric Englund, Dr. Larry J. Eshelman, Lawrence N. Field, Elton B. Fox (The Fox Foundation), Capt. and Mrs. Maino des Granges, Christopher J. Hackett, John A. Halter, John R. Harper, Frank W. Heemstra, Douglas M. Joy, Michael G. Keller, D. O. , Robert N. Kennedy, Richard J. Kossmann, M. D. David Kramer, Steven R. Krause, Gary R. Letsinger, Diana Lewis, J. Edward Martin, Norbert McLuckie, Samuel Mellos, Joseph Edward Paul Melville, Robert Mish, Dr. Dorothy Donnelley Moller, Jerry W. Moore, Keith E. Moore, D. M. D. , Reed W. Mower, Brantley I. Newsom, Professor and Mrs. Stanley E. Porter, James A. Reichert, Thomas S. Ross, Conrad Schneiker, Roy Schroeder, William V. Stephens, Charles Toops, II (Mo-Ark Guide Service), Robert H. Walker (Walker Die Casting Company), Mr. and Mrs. Victor Zadikov, Jeannette Zummo Introduction v vi America’s Great Depression Acknowledgments
W hile the problem of 1929 has long been of interest to myself as well as most Americans, my attention was first specifically drawn to a study of the Great Depression when Mr. Leonard E. Read, President of the Foundation for Economic Education, asked me, some years ago, to prepare a brief paper on the subject. I am very grateful to Mr. Read for being, in this way, the sparkplug for the present book. Having written the article, I allowed the subject to remain dormant for several years, amid the press of other work. At that point, on the warm encouragement of Mr. Richard C.
Cornuelle, now of the Foundation for Voluntary Welfare, I proceeded on the task of expansion to the present work, an expansion so far-reaching as to leave few traces of the original sketch. I owe a particular debt to the Earhart Foundation, without whose aid this study could never have been written. My supreme debt is to Professor Ludwig von Mises, whose monumental theory of business cycles I have used to explain the causes of the otherwise mysterious 1929 depression. Of all Professor Mises’s notable contributions to economic science, his business cycle theory is certainly one of the most significant.
It is no exaggeration to say that any study of business cycles not based upon his theoretical foundation is bound to be a fruitless undertaking. The responsibility for this work, of course, is entirely my own. vi Introduction vii viii America’s Great Depression Contents Introduction to the Fifth Edition………………………………………………… xi Introduction to the Fourth Edition………………………………………….. xvii Introduction to the Third Edition……………………………………………. xxv Introduction to the Second Edition…………………………………………. xxi Introduction to the First Edition……………………………………………. xxxv PART I: BUSINESS CYCLE THEORY 1 THE POSITIVE THEORY OF THE CYCLE……………………. 3 Business cycles and business fluctuations…………………………………….. 4 The problem: the cluster of error……………………………………………….. 8 The explanation: boom and depression……………………………………….. 9 Secondary features of depression: deflationary credit contraction……………………………………………………………………….. 4 Government depression policy: laissez-faire………………………………. 19 Preventing depressions……………………………………………………………. 23 Problems in the Austrian theory of the trade cycle…………………………………………………………………………. 29 2 KEYNESIAN CRITICISMS OF THE THEORY……………… 37 The liquidity “trap”………………………………………………………………… 39 Wage rates and unemployment………………………………………………… 2 3 SOME ALTERNATIVE EXPLANATIONS OF DEPRESSION: A CRITIQUE……………………………………………. 55 General overproduction………………………………………………………….. 56 Underconsumption…………………………………………………………………. 57 The acceleration principle……………………………………………………….. 60 viii Introduction ix Dearth of “investment opportunities”……………………………………….. 68 Schumpeter’s business cycle theory…………………………………………… 2 Qualitative credit doctrines……………………………………………………… 75 Overoptimism and overpessimism……………………………………………. 80 PART II: THE INFLATIONARY BOOM: 1921???1929 4 THE INFLATIONARY FACTORS……………………………………. 85 The definition of the money supply…………………………………………… 87 Inflation of the money supply, 1921???1929…………………………………. 91 Generating the inflation, I: reserve requirements……………………….. 5 Generating the inflation, II: total reserves……………………………….. 101 Treasury currency………………………………………………………………….. 116 Bills discounted…………………………………………………………………….. 117 Bills bought???acceptances……………………………………………………….. 126 U. S. government securities…………………………………………………….. 133 5 THE DEVELOPMENT OF THE INFLATION ……………. 137 Foreign lending…………………………………………………………………….. 37 Helping Britain…………………………………………………………………….. 142 The crisis approaches…………………………………………………………….. 159 6 THEORY AND INFLATION: ECONOMISTS AND THE LURE OF A STABLE PRICE LEVEL……………………. 169 PART III: THE GREAT DEPRESSION: 1929???1933 7 PRELUDE TO DEPRESSION: MR. HOOVER AND LAISSEZ-FAIRE………………………………………………………. 185 The development of Hoover’s interventionism: unemployment………………………………………………………………… 88 The development of Hoover’s interventionism: labor relations………………………………………………………………….. 199 8 THE DEPRESSION BEGINS: PRESIDENT HOOVER TAKES COMMAND………………. 209 The White House conferences……………………………………………….. 210 Inflating credit……………………………………………………………………… 214 Public works…………………………………………………………………………. 216 The New Deal Farm Program……………………………………………….. 17 Contents x 9 1930……………………………………………………………………………………. 239 More inflation………………………………………………………………………. 239 The Smoot???Hawley Tariff……………………………………………………… 241 Hoover in the second half of 1930…………………………………………… 243 The public works agitation…………………………………………………….. 250 The fiscal burdens of government…………………………………………… 53 10 1931???”THE TRAGIC YEAR”…………………………………………. 257 The American monetary picture…………………………………………….. 260 The fiscal burden of government……………………………………………. 263 Public works and wage rates…………………………………………………… 264 Maintaining wage rates………………………………………………………….. 267 Immigration restrictions………………………………………………………… 70 Voluntary relief…………………………………………………………………….. 271 Hoover in the last quarter of 1931…………………………………………… 272 The spread of collectivist ideas in the business world………………… 277 11 THE HOOVER NEW DEAL OF 1932……………………………. 285 The tax increase……………………………………………………………………. 286 Expenditures versus economy…………………………………………………. 288 Public works agitation……………………………………………………………. 92 The RFC……………………………………………………………………………… 296 Governmental relief………………………………………………………………. 300 The inflation program…………………………………………………………… 301 The inflation agitation…………………………………………………………… 308 Mr. Hoover’s war on the stock market……………………………………… 316 The home loan bank system…………………………………………………… 317 The ankruptcy law……………………………………………………………….. 318 The fight against immigration………………………………………………… 319 12 THE CLOSE OF THE HOOVER TERM……………………………. 321 The attack on property rights: the final currency failure……………. 323 Wages, hours, and employment during the depression………………. 330 Conclusion: the lessons of Mr. Hoover’s record……………………….. 336 APPENDIX: GOVERNMENT AND THE NATIONAL PRODUCT, 1929???1932…………………………………………………………. 39 INDEX………………………………………………………………………………… 349 xi TABLES America’s Great Depression TABLE 1: Total Money Supply of the United States, 1921???1929………………………………………………………………. 92 TABLE 2: Total Dollars and Total Gold Reserves………………………. 94 TABLE 3: Member Bank Demand Deposits………………………………. 98 TABLE 4: Demand and Time Deposits…………………………………….. 99 TABLE 5: Time Deposits……………………………………………………….. 00 TABLE 6: Member Bank Reserves and Deposits………………………. 102 TABLE 7: Changes in Reserves and Causal Factors . . . 1921???1929…………………………………………………………………….. 109 TABLE 8: Per Month Changes in Reserves and Causal Factors . . . 1921???1929…………………………………………………….. 110 TABLE 9: Factors Determining Bank Reserves July???October 1929………………………………………………………….. 166 TABLE I: National Product……………………………………………………. 41 TABLE II: Income Originating in Government……………………….. 342 TABLE III: Private Product……………………………………………………. 342 TABLE IV: Government Expenditures……………………………………. 343 TABLE V: Expenditures of Government Enterprises………………… 345 TABLE VI: Expenditures of Government and Government Enterprises…………………………………………………. 345 TABLE VII: Receipts of Government and Government Enterprises…………………………………………………. 46 TABLE VIII: Government and the Private Product…………………. 347 xii America’s Great Depression Introduction to the Fifth Edition T he Wall Street collapse of September???October 1929 and the Great Depression which followed it were among the most important events of the twentieth century. They made the Second World War possible, though not inevitable, and by undermining confidence in the efficacy of the market and the capitalist system, they helped to explain why the absurdly inefficient and murderous system of Soviet communism survived for so long.
Indeed, it could be argued that the ultimate emotional and intellectual consequences of the Great Depression were not finally erased from the mind of humanity until the end of the 1980s, when the Soviet collectivist alternative to capitalism crumbled in hopeless ruin and the entire world accepted there was no substitute for the market. Granted the importance of these events, then, the failure of historians to explain either their magnitude or duration is one of the great mysteries of modern historiography. The Wall Street plunge itself was not remarkable, at any rate to begin with.
The United States economy had expanded rapidly since the last downturn in 1920, latterly with the inflationary assistance of the bankers and the federal government. So a correction was due, indeed overdue. The economy, in fact, ceased to expand in June, and it was inevitable that this change in the real economy would be reflected in the stock market. The bull market effectively came to an end on September 3, 1929, immediately the shrewder operators returned from vacation and looked hard at the underlying figures. Later rises were merely xii Introduction xiii iccups in a steady downward trend. On Monday October 21, for the first time, the ticker tape could not keep pace with the news of falls and never caught up. Margin calls had begun to go out by telegram the Saturday before, and by the beginning of the week speculators began to realize they might lose their savings and even their homes. On Thursday, October 24, shares dropped vertically with no one buying, and speculators were sold out as they failed to respond to margin calls. Then came Black Tuesday, October 29, and the first selling of sound stocks to raise desperately needed liquidity.
So far all was explicable and might easily have been predicted. This particular stock market corrective was bound to be severe because of the unprecedented amount of speculation which Wall Street rules then permitted. In 1929 1,548,707 customers had accounts with America’s 29 stock exchanges. In a population of 120 million, nearly 30 million families had an active association with the market, and a million investors could be called speculators. Moreover, of these nearly two-thirds, or 600,000, were trading on margin; that is, on funds they either did not possess or could not easily produce.
The danger of this growth in margin trading was compounded by the mushrooming of investment trusts which marked the last phase of the bull market. Traditionally, stocks were valued at about ten times earnings. With high margin trading, earnings on shares, only one or two percent, were far less than the eight to ten percent interest on loans used to buy them. This meant that any profits were in capital gains alone. Thus, Radio Corporation of America, which had never paid a dividend at all, went from 85 to 410 points in 1928.
By 1929, some stocks were selling at 50 times earnings. A market boom based entirely on capital gains is merely a form of pyramid selling. By the end of 1928 the new investment trusts were coming onto the market at the rate of one a day, and virtually all were archetype inverted pyramids. They had “high leverage”???a new term in 1929???through their own supposedly shrewd investments, and secured phenomenal stock exchange growth on the basis of a very small plinth of real growth. United Founders Corporation, for instance, had been created by a bankruptcy with
Introduction to the Fifth Edition xiv an investment of $500, and by 1929 its nominal resources, which determined its share price, were listed as $686,165,000. Another investment trust had a market value of over a billion dollars, but its chief asset was an electric company which in 1921 had been worth only $6 million. These crazy trusts, whose assets were almost entirely dubious paper, gave the boom an additional superstructure of pure speculation, and once the market broke, the “high leverage” worked in reverse.
Hence, awakening from the pipe dream was bound to be painful, and it is not surprising that by the end of the day on October 24, eleven men well-known on Wall Street had committed suicide. The immediate panic subsided on November 13, at which point the index had fallen from 452 to 224. That was indeed a severe correction but it has to be remembered that in December 1928 the index had been 245, only 21 points higher. Business and stock exchange downturns serve essential economic purposes. They have to be sharp, but they need not be long because they are self-adjusting.
All they require on the part of the government, the business community, and the public is patience. The 1920 recession had adjusted itself within a year. There was no reason why the 1929 recession should have taken longer, for the American economy was fundamentally sound. If the recession had been allowed to adjust itself, as it would have done by the end of 1930 on any earlier analogy, confidence would have returned and the world slump need never have occurred. Instead, the stock market became an engine of doom, carrying to destruction the entire nation and, in its wake, the world.
By July 8, 1932, New York Times industrials had fallen from 224 at the end of the initial panic to 58. U. S. Steel, the world’s biggest and most efficient steel-maker, which had been 262 points before the market broke in 1929, was now only 22. General Motors, already one of the best-run and most successful manufacturing groups in the world, had fallen from 73 to 8. These calamitous falls were gradually reflected in the real economy. Industrial production, which had been 114 in August 1929, was 54 by March 1933, a fall of more than half, while manufactured durables fell by 77 percent, nearly four-fifths.
Business construction fell from $8. 7 billion in 1929 to only $1. 4 billion in 1933. Introduction xv Unemployment rose over the same period from a mere 3. 2 percent to 24. 9 percent in 1933, and 26. 7 percent the following year. At one point, 34 million men, women, and children were without any income at all, and this figure excluded farm families who were also desperately hit. City revenues collapsed, schools and universities shut or went bankrupt, and malnutrition leapt to 20 percent, something that had never happened before in United States history???even in the harsh early days of settlement.
This pattern was repeated all over the industrial world. It was the worst slump in history, and the most protracted. Indeed there was no natural recovery. France, for instance, did not get back to its 1929 level of industrial production until the mid-1950s. The world economy, insofar as it was saved at all, was saved by war, or its preparations. The first major economy to revitalize itself was Germany’s, which with the advent of Hitler’s Nazi regime in January, 1933, embarked on an immediate rearmament program.
Within a year, Germany had full employment. None of the others fared so well. Britain began to rearm in 1937, and thereafter unemployment fell gradually, though it was still at historically high levels when war broke out on September 3, 1939. That was the date on which Wall Street, anticipating lucrative arms sales and eventually U. S. participation in the war, at last returned to 1929 prices. It is a dismal story, and I do not feel that any historian has satisfactorily explained it. Why so deep? Why so long? We do not really know, to this day.
But the writer who, in my judgment, has come closest to providing a satisfactory analysis is Murray N. Rothbard in America’s Great Depression. For half a century, the conventional, orthodox explanation, provided by John Maynard Keynes and his followers, was that capitalism was incapable of saving itself, and that government did too little to rescue an intellectually bankrupt market system from the consequences of its own folly. This analysis seemed less and less convincing as the years went by, especially as Keynesianism itself became discredited.
In the meantime, Rothbard had produced, in 1963, his own explanation, which turned the conventional one on its head. The severity of the Wall Street crash, he argued, was not due to the unrestrained license of a freebooting capitalist system, but to government Introduction to the Fifth Edition xvi insistence on keeping a boom going artificially by pumping in inflationary credit. The slide in stocks continued, and the real economy went into freefall, not because government interfered too little, but because it interfered too much.
Rothbard was the first to make the point, in this context, that the spirit of the times in the 1920s, and still more so in the 1930s, was for government to plan, to meddle, to order, and to exhort. It was a hangover from the First World War, and President Hoover, who had risen to worldwide prominence in the war by managing relief schemes, and had then held high economic office throughout the twenties before moving into the White House itself in 1929, was a born planner, meddler, orderer, and exhorter. Hoover’s was the only department of the U. S. ederal government which had expanded steadily in numbers and power during the 1920s, and he had constantly urged Presidents Harding and Coolidge to take a more active role in managing the economy. Coolidge, a genuine minimalist in government, had complained: “For six years that man has given me unsolicited advice???all of it bad. ” When Hoover finally took over the White House, he followed his own advice, and made it an engine of interference, first pumping more credit into an already overheated economy and, then, when the bubble burst, doing everything in his power to organize government rescue operations.
We now see, thanks to Rothbard’s insights, that the Hoover??? Roosevelt period was really a continuum, that most of the “innovations” of the New Deal were in fact expansions or intensifications of Hoover solutions, or pseudo-solutions, and that Franklin Delano Roosevelt’s administration differed from Herbert Hoover’s in only two important respects???it was infinitely more successful in managing its public relations, and it spent rather more taxpayers’ money. And, in Rothbard’s argument, the net effect of the Hoover???Roosevelt continuum of policy was to make the slump more severe and to prolong it virtually to the end of the 1930s.
The Great Depression was a failure not of capitalism but of the hyperactive state. I will not spoil the reader’s pleasure by entering more deeply into Rothbard’s arguments. His book is an intellectual tour de force, Introduction xvii in that it consists, from start to finish, of a sustained thesis, presented with relentless logic, abundant illustration, and great eloquence. I know of few books which bring the world of economic history so vividly to life, and which contain so many cogent lessons, still valid in our own day.
It is also a rich mine of interesting and arcane knowledge, and I urge readers to explore its footnotes, which contain many delicious quotations from the great and the foolish of those days, three-quarters of a century ago. It is not surprising that the book is going into yet another edition. It has stood the test of time with success, even with panache, and I feel honored to be invited to introduce it to a new generation of readers. PAUL JOHNSON 1999 Introduction to the Fourth Edition T here seems to be a cycle in new editions of this book. The second edition was published in the midst of the 1969???71 inflationary recession, the third in he mighty inflationary depression of 1973???75. The economy is now in the midst of another inflationary depression at least as severe, and perhaps even more so, than the 1973???75 contraction, which had been the worst since the 1930s. The confusion and intellectual despair we noted in the introduction to the third edition has now intensified. It is generally conceded that Keynesianism is intellectually bankrupt, and we are treated to the spectacle of veteran Keynesians calling for tax increases during a severe depression, a change of front that few people consider worth noting, much less trying to explain.
Part of the general bewilderment is due to the fact that the current, severe 1981???83 depression followed very swiftly after the recession of 1979???80, so that it begins to look that the fitful and short-lived recovery of 1980???81 may have been but an interlude in the midst of a chronic recession that has lasted since 1979. Production has been stagnating for years, the auto industry is in bad shape, thrift institutions are going bankrupt by the week, and unemployment has reached its highest point since the 1930s.
A notable feature of the 1981???83 depression is that, in contrast to 1973???75, the drift of economic thought and policy has not been toward collectivist planning but toward alleged free-market policies. The Reagan administration began with a fanfare of allegedly drastic budget and tax cuts, all of which lightly masked massive xviii Introduction xix increases in taxes and spending, so that President Reagan is now presiding over the largest deficits and the highest budgets in American history.
If the Keynesians and now the Reagan administration are calling for tax increases to narrow the deficit, we find the equally bizarre spectacle of veteran classical liberal economists in the early days of the same administration apologizing for government deficits as being unimportant. While it is theoretically true that deficits financed by sale of bonds to the public are not inflationary, it is also true that the huge deficits (a) exert enormous political pressure on the Fed to monetize the debt; and (b) cripple private investment by crowding out private savings and channeling hem into unproductive and wasteful government boondoggles which will also impose higher taxes on future generations. The twin hallmarks of “Reaganomics” so far have been huge deficits and remarkably high interest rates. While deficits are often inflationary and always pernicious, curing them by raising taxes is equivalent to curing an illness by shooting the patient. In the first place, politically higher taxes will simply give the government more money to spend, so that expenditures and therefore deficits are likely to rise still further.
Cutting taxes, on the other hand, puts great political pressure on Congress and the administration to follow suit by cutting spending. But more directly, it is absurd to claim that a tax is any better from the point of view of the consumer???taxpayer than a higher price. If the price of a product rises due to inflation, the consumer is worse off, but at least he still enjoys the services of the product. But if the government raises taxes in order to stave off that price rise, the consumer is getting nothing in return.
He simply loses his money, and obtains no service for it except possibly being ordered around by government authorities he has been forced to subsidize. Other things being equal, a price rise is always preferable to a tax. But finally, inflation, as we point out in this work, is not caused by deficits but by the Federal Reserve’s increase of the money supply. So that it is quite likely that a higher tax will have no effect on inflation whatsoever. Deficits, then, should be eliminated, but only by cutting government spending. If taxes and government spending are both
Introduction to the Fourth Edition xx slashed, then the salutary result will be to lower the parasitic burden of government taxes and spending upon the productive activities of the private sector. This brings us to a new economic viewpoint that has emerged since our last edition???”supply-side economics” and its extreme variant, the Laffer Curve. To the extent that supply-siders point out that tax reductions will stimulate work, thrift, and productivity, then they are simply underlining truths long known to classical and to Austrian economics.
But one problem is that supply-siders, while calling for large income-tax cuts, advocate keeping up the current level of government expenditures, so that the burden of shifting resources from productive private to wasteful government spending will still continue. The Laffer variant of the supply-side adds the notion that a decline in income tax rates will so increase government revenues from higher production and income that the budget will still be balanced.
There is little discussion by Lafferites, however, of how long this process is supposed to take, and there is no evidence that revenue will rise sufficiently to balance the budget, or even will rise at all. If, for example, the government should now raise income tax rates by 30 percent, does anyone really believe that total revenue would fall? Another problem is that one wonders why the overriding goal of fiscal policy should be to maximize government revenue. A far sounder objective would be to minimize the revenue and the resources siphoned off to the public sector.
At any rate, the Laffer Curve has scarcely been tested by the Reagan administration, since the much-vaunted income tax cuts, in addition to being truncated and reduced from the original Reagan plan, were more than offset by a programmed rise in Social Security taxes and by “bracket creep. ” Bracket creep exists when inflation wafts people into higher nominal (but not higher real) income brackets, where their tax rates automatically increase. It is generally agreed that recovery from the current depression has not yet arrived because interest rates have remained high, despite the depression-borne drop in the rate of inflation.
The Friedmanites had decreed that “real” interest rates (nominal rates Introduction xxi minus the rate of inflation) are always hovering around 3 percent. When inflation fell sharply, therefore, from about 12 percent to 5 percent or less, monetarists confidently predicted that interest rates would fall drastically, spurring a cyclical recovery. Yet, real interest rates have persisted at far higher than 3 percent. How could this be? The answer is that expectations are purely subjective, and cannot be captured by the mechanistic use of charts and regressions.
After several decades of continuing and aggravated inflation, the American public has become inured to expect further chronic inflation. Temporary respites during deep depressions, propaganda and political hoopla, can no longer reverse those expectations. As long as inflationary expectations persist, the expected inflation incorporated into interest rates will remain high, and interest rates will not fall for any substantial length of time. The Reagan administration knew, of course, that inflationary expectations had to be reversed, but where they miscalculated was relying on propaganda without substance.
Indeed, the entire program of Reaganomics may be considered a razzle-dazzle of showmanship about taxes and spending, behind which the monetarists, in control of the Fed and the Treasury Department, were supposed to gradually reduce the rate of money growth. The razzle-dazzle was supposed to reverse inflationary expectations; the gradualism was to eliminate inflation without forcing the economy to suffer the pain of recession or depression. Friedmanites have never understood the Austrian insight on the necessity of a recession to liquidate the unsound investments of the inflationary boom.
As a result, the attempt of Friedmanite gradualism to fine-tune the economy into disinflation-without-recession went the way of the similar Keynesian fine-tuning which the monetarists had criticized for decades. Friedmanite fine-tuning brought us temporary “disinflation” accompanied by another severe depression. In this way, monetarism fell between two stools. The Fed’s cutback in the rate of money growth was sharp enough to precipitate the inevitable recession, but much too weak and gradual to bring inflation to an end once and for all. Instead of a sharp but short recession to liquidate the malinvestments of the preceding boom,
Introduction to the Fourth Edition xxii we now have a lingering chronic recession coupled with a grinding, continuing stagnation of productivity and economic growth. A pusillanimous gradualism has brought us the worst of both worlds: continuing inflation plus severe recession, high unemployment, and chronic stagnation. One of the reasons for the chronic recession and stagnation is that the market learns. Inflationary expectations are a response learned after decades of inflation, and they place an inflationary premium on pure interest rates.
As a result, the time-honored method of lowering interest rates???the Fed’s expanding the supply of money and credit???cannot work for long because that will simply raise inflationary expectations and raise interest rates instead of lowering them. We have gotten to the point where everything the government does is counterproductive; the conclusion, of course, is that the government should do nothing at all, that is, should retire quickly from the monetary and economic scene and allow freedom and free markets to work. It is, furthermore, too late for gradualism.
The only solution was set forth by F. A. Hayek, the dean of the Austrian School, in his critique of the similarly disastrous gradualism of the Thatcher regime in Great Britain. The only way out of the current mess is to “slam on the brakes,” to stop the monetary inflation in its tracks. Then, the inevitable recession will be sharp but short and swift, and the free market, allowed its head, will return to a sound recovery in a remarkably brief time. Only a drastic and credible slamming of the brakes can truly reverse the inflationary expectations of the American public.
But wisely the public no longer trusts the Fed or the federal government. For a slamming on of the brakes to be truly credible, there must be a radical surgery on American monetary institutions, a surgery similar in scope to the German creation of the rentenmark which finally ended the runaway inflation of 1923. One important move would be to denationalize the fiat dollar by returning it to be worth a unit of weight of gold. A corollary policy would prohibit the Federal Reserve from lowering reserve requirements or from purchasing any assets ever again; Introduction xxiii etter yet, the Federal Reserve System should be abolished, and government at last totally separated from the supply of money. In any event, there is no sign of any such policy on the horizon. After a brief flirtation with gold, the Presidentially appointed U. S. Gold Commission, packed with pro-fiat money Friedmanites abetted by Keynesians, predictably rejected gold by an overwhelming margin. Reaganomics???a blend of monetarism and fiscal Keynesianism swathed in classical liberal and supply-side rhetoric???is in no way going to solve the problem of inflationary depression or of the business cycle.
But if Reaganomics is doomed to be a fiasco, what is likely to happen? Will we suffer a replay, as many voices are increasingly predicting, of the Great Depression of the 1930s? Certainly there are many ominous signs and parallels. The fact that Reaganomics cannot bring down interest rates for long puts a permanent brake on the stock market, which has been in chronic trouble since the mid-1960s and is increasingly in shaky shape. The bond market is already on the way to collapse. The housing market has at last been stopped short by the high mortgage rates, and the same has happened to many collectibles.
Unemployment is chronically higher each decade, and is now at the highest since the Great Depression, with no sign of improvement. The accelerating inflationary boom of the three decades since the end of World War II has loaded the economy with unsound investments and with an oppressive mountain of debt: consumer, homeowner, business, and international. In recent decades, business has in effect relied on inflation to liquidate the debt, but if “disinflation” (the lessening of inflation in 1981 and at least the first half of 1982) is to continue, what will happen to the debt?
Increasingly, the answer will be bankruptcies, and deeper depression. The bankruptcy rate is already the highest since the Great Depression of the 1930s. Thrift institutions caught between high interest rates to their depositors and low rates earned on long-time mortgages, will increasingly become bankrupt or be forced into quasi-bankrupt mergers with other thrifts which will be dragged down by the new burdens. Even commercial banks, Introduction to the Fourth Edition xxiv protected by the safety blanket of the FDIC for half a century, are now beginning to go down the drain, dragged down by their unsound loans of the ast decade. Matters are even worse on the international front. During the great credit boom, U. S. banks have recklessly loaned inflated dollars to unsound and highly risky governments and institutions abroad, especially in the Communist governments and the Third World. The Depository Control Act of 1980, which shows no signs of being repealed by the Reagan administration, allows the Federal Reserve to purchase unlimited amounts of foreign currency (or any other assets) or to lower bank reserve requirements to zero. In other words, it sets the stage for unlimited monetary and credit inflation by the Fed.
The bailing out of the Polish government, and the refusal by the U. S. to declare it bankrupt so that the U. S. taxpayer (or holder of dollars) can pick up the tab indefinitely, is an omen for the future. For only massive inflation will eventually be able to bail out foreign debtors and U. S. creditor banks. Since Friedmanite gradualism will not permit a sharp enough recession to clear out the debt, this means that the American economy will be increasingly faced with two alternatives: either a massive deflationary 1929-type depression to clear out the debt, or a massive inflationary bailout by the Federal Reserve.
Hard money rhetoric or no rhetoric, the timidity and confusion of Reaganomics make very clear what its choice will be: massive inflation of money and credit, and hence the resumption of double-digit and perhaps higher inflation, which will drive interest rates even higher and prevent recovery. A Democratic administration may be expected to inflate with even more enthusiasm. We can look forward, therefore, not precisely to a 1929-type depression, but to an inflationary depression of massive proportions.
Until then, the Austrian program of hard money, the gold standard, abolition of the Fed, and laissez-faire, will have been rejected by everyone: economists, politicians, and the public, as too harsh and Draconian. But Austrian policies are comfortable and moderate compared to the economic hell of permanent inflation, stagnation, high unemployment, and inflationary depression that Keynesians and Friedmanite neo-Keynesians have gotten us into. Perhaps, this present and Introduction xxv future economic holocaust will cause the American public to turn away from failed nostrums and toward the analysis and policy conclusions of the Austrian School.
MURRAY N. ROTHBARD Stanford, California September 1982 Introduction to the Third Edition A merica is now in the midst of a full-scale inflationary depression. The inflationary recession of 1969???71 has been quickly succeeded by a far more inflationary depression which began around November 1973, and skidded into a serious depression around the fall of 1974. Since that time, physical production has declined steadily and substantially, and the unemployment rate has risen to around 10 percent, and even higher in key industrial areas.
The desperate attempt by the politico-economic Establishment to place an optimistic gloss on the most severe depression since the 1930s centers on two arguments: (a) the inadequacy of the unemployment statistics, and (b) the fact that things were much worse in the post-1929 depression. The first argument is true but irrelevant; no matter how faulty the statistics, the rapid and severe rise in the unemployment rate from under 6 percent to 10 percent in the space of just one year (from 1974 to 1975) tells its own grisly tale.
It is true that the economy was in worse shape in the 1930s, but that was the gravest depression in American history; we are now in a depression that is certainly not mild by any pre-1929 standards. The current inflationary depression has revealed starkly to the nation’s economists that their cherished theories???adopted and applied since the 1930s???are tragically and fundamentally incorrect. For forty years we have been told, in the textbooks, the economic journals, and the pronouncements of our government’s economic advisors, that the government has the tools with which it can easily abolish inflation or recession.
We have been told that by xxvi Introduction xxvii juggling fiscal and monetary policy, the government can “finetune” the economy to abolish the business cycle and insure permanent prosperity without inflation. Essentially???and stripped of the jargon, the equations, and the graphs???the economic Establishment held all during this period that if the economy is seen to be sliding into recession, the government need only step on the fiscal and monetary gas???to pump in money and spending into the economy???in order to eliminate recession.
And, on the contrary, if the economy was becoming inflationary, all the government need do is to step on the fiscal and monetary brake???take money and spending out of the economy???in order to eliminate inflation. In this way, the government’s economic planners would be able to steer the economy on a precise and careful course between the opposing evils of unemployment and recession on the one hand, and inflation on the other. But what can the government do, what does conventional economic theory tell us, if the economy is suffering a severe inflation and depression at the same time?
Now can our self-appointed driver, Big Government, step on the gas and on the brake at one and the same time? Confronted with this stark destruction of all their hopes and plans, surrounded by the rubble of their fallacious theories, the nation’s economists have been plunged into confusion and despair. Put starkly, they have no idea of what to do next, or even how to explain the current economic mess. In action, all that they can do is to alternate accelerator and brake with stunning rapidity, hoping that something might work (e. . , President Ford’s call for higher income taxes in the fall of 1974, only to be followed by a call for lower income taxes a few months later). Conventional economic theory is bankrupt: furthermore, with courses on business cycles replaced a generation ago by courses on “macroeconomics” in graduate schools throughout the land, economists have now had to face the stark realization that business cycles do exist, while being in no way equipped to understand them.
Some economists, union leaders, and businessmen, despairing of any hope for the free-market economy, have in fact begun to call for a radical shift to a collectivized economy in America (notably, the Initiative Committee for National Economic Planning, which includes in its ranks Introduction to the Third Edition xxviii economists such as Wassily Leontief, union leaders such as Leonard Woodcock, and business leaders such as Henry Ford II).
In the midst of this miasma and despair, there is one school of economic thought which predicted the current mess, has a cogent theory to explain it, and offers the way out of the predicament???a way out, furthermore, which, far from scrapping free enterprise in favor of collectivist planning, advocates the restoration of a purely free enterprise system that has been crippled for decades by government intervention. This school of thought is the “Austrian” theory presented in this book.
The Austrian view holds that persistent inflation is brought about by continuing and chronic increases in the supply of money, engineered by the federal government. Since the inception of the Federal Reserve System in 1913, the supply of money and bank credit in America has been totally in the control of the federal government, a control that has been further strengthened by the U. S. repudiating the domestic gold standard in 1933, as well as the gold standard behind the dollar in foreign transactions in 1968 and finally in 1971.
With the gold standard abandoned, there is no necessity for the Federal Reserve or its controlled banks to redeem dollars in gold, and so the Fed may expand the supply of paper and bank dollars to its heart’s content. The more it does so, the more prices tend to accelerate upward, dislocating the economy and bringing impoverishment to those people whose incomes fall behind in the inflationary race. The Austrian theory further shows that inflation is not the only unfortunate consequence of governmental expansion of the supply of money and credit.
For this expansion distorts the structure of investment and production, causing excessive investment in unsound projects in the capital goods industries. This distortion is reflected in the well-known fact that, in every boom period, capital goods prices rise further than the prices of consumer goods. The recession periods of the business cycle then become inevitable, for the recession is the necessary corrective process by which the market liquidates the unsound investments of the boom and redirects resources from the capital goods to the consumer goods industries.
The longer the inflationary distortions continue, the more severe the recession-adjustment must become. During Introduction xxix the recession, the shift of resources takes place by means of capital goods prices falling relative to consumer goods. During the depression of 1974???75, we have seen this occur, with industrial raw material prices falling rapidly and substantially, with wholesale prices remaining level or declining slightly, but with consumer goods prices still rising rapidly???in short, the inflationary depression. What, then, should the government do if the Austrian theory is the correct one?
In the first place, it can only cure the chronic and potentially runaway inflation in one way: by ceasing to inflate: by stopping its own expansion of the money supply by Federal Reserve manipulation, either by lowering reserve requirements or by purchasing assets in the open market. The fault of inflation is not in business “monopoly,” or in union agitation, or in the hunches of speculators, or in the “greediness” of consumers; the fault is in the legalized counterfeiting operations of the government itself. For the government is the only institution in society with the power to counterfeit???to create new money.
So long as it continues to use that power, we will continue to suffer from inflation, even unto a runaway inflation that will utterly destroy the currency. At the very least, we must call upon the government to stop using that power to inflate. But since all power possessed will be used and abused, a far sounder method of ending inflation would be to deprive the government completely of the power to counterfeit: either by passing a law forbidding the Fed to purchase any further assets or to lower reserve requirements, or more fundamentally, to abolish the Federal Reserve System altogether.
We existed without such a central banking system before 1913, and we did so with far less rampant inflations or depressions. Another vital reform would be to return to a gold standard???to a money based on a commodity produced, not by government printing presses, but by the market itself. In 1933, the federal government seized and confiscated the public’s gold under the guise of a temporary emergency measure; that emergency has been over for forty years, but the public’s gold still remains beyond our reach at Fort
Knox. As for avoiding depressions, the remedy is simple: again, to avoid inflations by stopping the Fed’s power to inflate. If we are in a depression, as we are now, the only proper course of action is to Introduction to the Third Edition xxx avoid governmental interference with the depression, and thereby to allow the depression???adjustment process to complete itself as rapidly as possible, and thus to restore a healthy and prosperous economic system.
Before the massive government interventions of the 1930s, all recessions were short-lived. The severe depression of 1921 was over so rapidly, for example, that Secretary of Commerce Hoover, despite his interventionist inclinations, was not able to convince President Harding to intervene rapidly enough; by the time Harding was persuaded to intervene, the depression was already over, and prosperity had arrived.
When the stock market crash arrived in October, 1929, Herbert Hoover, now the president, intervened so rapidly and so massively that the market??? adjustment process was paralyzed, and the Hoover???Roosevelt New Deal policies managed to bring about a permanent and massive depression, from which we were only rescued by the advent of World War II. Laissez-faire???a strict policy of non-intervention by the government ???is the only course that can assure a rapid recovery in any depression crisis. In this time of confusion and despair, then, the Austrian School offers us both an explanation and a prescription for our current ills.
It is a prescription that is just as radical as, and perhaps even more politically unpalatable than, the idea of scrapping the free economy altogether and moving toward a totalitarian and unworkable system of collectivist economic planning. The Austrian prescription is precisely the opposite: we can only surmount the present and future crisis by ending government intervention in the economy, and specifically by ending governmental inflation and control of the money supply, as well as interference in any recession??? adjustment process.
In times of breakdown, mere tinkering reforms are not enough; we must take the radical step of getting the government out of the economic picture, of separating government completely from the money supply and the economy, and advancing toward a truly free and unhampered market and enterprise economy. MURRAY N. ROTHBARD Palo Alto, California May 1975 Introduction to the Second Edition I n the years that have elapsed since the publication of the first edition, the business cycle has re-emerged in the consciousness of economists.
During the 1960s, we were again promised, as in the New Era of the 1920s, the abolition of the business cycle by Keynesian and other sophisticated policies of government. The substantial and marked recession which began around November, 1969, and from which at this writing we have not yet recovered, has been a salutary if harsh reminder that the cycle is still very much alive. One feature of this current recession that has been particularly unpleasant and surprising is the fact that prices of consumer goods have continued to rise sharply throughout the recession.
In the classic cycle, prices fall during recessions or depressions, and this decline in prices is the one welcome advantage that the consumer can reap from such periods of general gloom. In the present recession, however, even this advantage has been removed, and the consumer thus suffers a combination of the worst features of recession and inflation. Neither the established Keynesian nor the contemporary “monetarist” schools anticipated or can provide a satisfactory explanation of this phenomenon of “inflationary recession. Yet the “Austrian” theory contained in this book not only explains this occurrence, but demonstrates that it is a general and universal tendency in recessions. For the essence of recession, as the Austrian theory shows, is a readjustment of the economy to liquidate the distortions imposed by the boom???in particular, the overexpansion xxxii Introduction xxxiii of the “higher” orders of capital goods and the underinvestment in consumer goods industries.
One of the ways by which the market redirects resources from the capital goods to the consumer goods sphere is by prices declining relatively in the former category and rising relatively in the latter category. Bankruptcies and relative price and wage contractions in the overblown and malinvested higher orders of capital goods will redirect land, labor, and capital resources into consumer goods and thereby reestablish the efficient responsiveness to consumer demands that is the normal condition of an unhampered market economy.
In short, the prices of consumer goods always tend to rise, relative to the prices of producer goods, during recessions. The reason that this phenomenon has not been noted before is that, in past recessions, prices have generally fallen. If, for example, consumer goods prices fall by 10 percent and, say, cement prices fall by 20 percent, no one worries about an “inflation” during the recession; but, actually, consumer goods prices in this case, too, have risen relative to the prices of producer goods.
Prices in general fell during recessions because monetary and banking deflation used to be an invariable feature of economic contractions. But, in the last few decades, monetary deflation has been strictly prevented by governmental expansion of credit and bank reserves, and the phenomenon of an actual decline in the money supply has become at best a dim memory. The result of the government’s abolition of deflation, however, is that general prices no longer fall, even in recessions.
Consequently, the adjustment between consumer goods and capital goods that must take place during recessions, must now proceed without the merciful veil of deflation. Hence, the prices of consumer goods still rise relatively, but now, shorn of general deflation, they must rise absolutely and visibly as well. The government policy of stepping in to prevent monetary deflation, therefore, has deprived the public of the one great advantage of recessions: a falling cost of living. Government intervention against deflation has brought us the unwelcome phenomenon of inflationary recession.
Along with the renewed emphasis on business cycles, the late 1960s saw the emergence of the “monetarist” Chicago School, Introduction to the Second Edition xxxiv headed by Milton Friedman, as a significant competitor to the Keynesian emphasis on compensatory fiscal policy. While the Chicago approach provides a welcome return to the pre-Keynesian emphasis on the crucial role of money in business cycles, it is essentially no more than a recrudescence of the “purely monetary” theory of Irving Fisher and Sir Ralph Hawtrey during the 1910s and 1920s.
Following the manner of the English classical economists of the nineteenth century, the monetarists rigidly separate the “price level” from the movement of individual prices; monetary forces supposedly determine the former while supply and demand for particular goods determine the latter. Hence, for the monetarists, monetary forces have no significant or systematic effect on the behavior of relative prices or in distorting the structure of production.
Thus, while the monetarists see that a rise in the supply of money and credit will tend to raise the level of general prices, they ignore the fact that a recession is then required to eliminate the distortions and unsound investments of the preceding boom. Consequently, the monetarists have no causal theory of the business cycle; each stage of the cycle becomes an event unrelated to the following stage. Furthermore, as in the case of Fisher and Hawtrey, the current monetarists uphold as an ethical and economic ideal the maintenance of a stable, constant price level.
The essence of the cycle is supposed to be the rise and fall???the movements???of the price level. Since this level is determined by monetary forces, the monetarists hold that if the price level is kept constant by government policy, the business cycle will disappear. Friedman, for example, in his A Monetary History of the United States, 1867???1960 (1963), emulates his mentors in lauding Benjamin Strong for keeping the wholesale price level stable during the 1920s.
To the monetarists, the inflation of money and bank credit engineered by Strong led to no ill effects, no cycle of boom and bust; on the contrary, the Great Depression was caused by the tight money policy that ensued after Strong’s death. Thus, while the Fisher???Chicago monetarists and the Austrians both focus on the vital role of money in the Great Depression as in other business cycles, the causal emphases and policy conclusions are diametrically opposed. To the Austrians, the Introduction xxxv onetary inflation of the 1920s set the stage inevitably for the depression, a depression which was further aggravated (and unsound investments maintained) by the Federal Reserve efforts to inflate further during the 1930s. The Chicagoans, on the other hand, seeing no causal factors at work generating recession out of preceding boom, hail the policy of the 1920s in keeping the price level stable and believe that the depression could have been quickly cured if only the Federal Reserve had inflated far more intensively during the depression.
The long-run tendency of the free market economy, unhampered by monetary expansion, is a gently falling price level, falling as the productivity and output of goods and services continually increase. The Austrian policy of refraining at all times from monetary inflation would allow this tendency of the free market its head and thereby remove the disruptions of the business cycle. The Chicago goal of a constant price level, which can be achieved only by a continual expansion of money and credit, would, as in the 1920s, unwittingly generate the cycle of boom and bust that has proved so destructive for the past two centuries.
MURRAY N. ROTHBARD New York, New York July 1971 Introduction to the First Edition T he year 1929 stands as the great American trauma. Its shock impact on American thought has been enormous. The reasons for shock seem clear. Generally, depressions last a year or two; prices and credit contract sharply, unsound positions are liquidated, unemployment swells temporarily, and then rapid recovery ensues. The 1920???1921 experience repeated a familiar pattern, not only of such hardly noticeable recessions as 1899???1900 and 1910???1912, but also of such severe but brief crises as 1907???1908 and 1819???1821. Yet the Great Depression that ignited in 1929 lasted, in effect, for eleven years. In addition to its great duration, the 1929 depression stamped itself on the American mind by its heavy and continuing unemployment. While the intensity of falling prices and monetary contraction was not at all unprecedented, the intensity and duration of unemployment was new and shocking. The proportion of the American labor force that was unemployed had rarely reached 10 percent at the deepest trough of previous depressions; yet it surpassed 20 percent in 1931, and remained above 15 percent until the advent of World War II.
The depression of 1873???1879 was a special case. It was, in the first place, a mild recession, and second, it was largely a price decline generated by the monetary contraction attending return to the pre-Civil War gold standard. On the mildness of this depression, particularly in manufacturing, see O. V. Wells, “The Depression of 1873???79,” Agricultural History 11 (1937): 240. 1 xxxvi Introduction xxxvii If we use the commonly accepted dating methods and business cycle methodology of the National Bureau of Economic Research, we shall be led astray in studying and interpreting the depression.
Unfortunately, the Bureau early shifted its emphasis from the study of the qualitatively important periods of “prosperity” and “depression,” to those of mere “expansion” and “contraction. ” In its dating methods, it picks out one month as the peak or trough, and thus breaks up all historical periods into expansions and contractions, lumping them all together as units in its averages, regardless of importance or severity. Thus, the long boom of the 1920s is hardly recognized by the Bureau???which highlights instead the barely noticeable recessions of 1923 and 1926.
Furthermore, we may agree with the Bureau???and all other observers???that the Great Depression hit its trough in 1932???1933, but we should not allow an artificial methodology to prevent our realizing that the “boom” of 1933???1937 took place within a continuing depression. When unemployment remains over 15 percent, it is folly to refer to the 1933???1937 period as “prosperity. ” It is still depression, even if slightly less intense than in 1933. 2 The chief impact of the Great Depression on American thought was universal acceptance of the view that “laissez-faire capitalism” was to blame.
The common opinion???among economists and the lay public alike???holds that “Unreconstructed Capitalism” prevailed during the 1920s, and that the tragic depression shows that old-fashioned laissez-faire can work no longer. It had always brought instability and depression during the nineteenth century; but now it was getting worse and becoming absolutely intolerable. The government must step in to stabilize the economy and iron out the business cycle. A vast army of people to this day consider capitalism almost permanently on trial.
If the modern array of monetary???fiscal management and stabilizers cannot save capitalism from another severe depression, this large group will turn to socialism as the final answer. To them, another 2 Even taken by itself, the “contraction” phase of the depression, from 1929???1933, was unusually long and unusually severe, particularly in its degree of unemployment. Introduction to the First Edition xxxviii depression would be final proof that even a reformed and enlightened capitalism cannot prosper.
Yet, on closer analysis, the common reaction is by no means self-evident. It rests, in fact,