America's Great Depression (5 page)

Along with the renewed emphasis on business cycles, the late 1960s saw the emergence of the “monetarist” Chicago School,
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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), emu-lates 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
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monetary 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

The 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 1819–1821.1 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.

1The 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.

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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 2Even taken by itself, the “contraction” phase of the depression, from 1929–1933, was unusually long and unusually severe, particularly in its degree of unemployment.

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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, on an unproven assumption—the assumption that business cycles in general, and depressions in particular, arise from the depths of the free-market, capitalist economy. If we then assume that the business cycle stems from—is

“endogenous” to—the free market, then the common reaction seems plausible. And yet, the assumption is pure myth, resting not on proof but on simple faith. Karl Marx was one of the first to maintain that business crises stemmed from market processes. In the twentieth century, whatever their great positive differences, almost all economists—Mitchellians, Keynesians, Marxians, or whatnot—are convinced of this view. They may have conflicting causal theories to explain the phenomenon, or, like the Mitchellians, they may have no causal theory at all—but they are all convinced that business cycles spring from deep within the capitalist system.

Yet there is another and conflicting tradition of economic thought—now acknowledged by only a few economists, and by almost none of the public. This view holds that business cycles and depressions stem from disturbances generated in the market by
monetary intervention
. The monetary theory holds that money and credit-expansion, launched by the banking system, causes booms and busts. This doctrine was first advanced, in rudimentary form, by the Currency School of British classical economists in the early nineteenth century, and then fully developed by Ludwig von Mises and his followers in the twentieth. Although widely popular in early-nineteenth-century America and Britain, the Currency School thesis has been read out of business cycle theory and relegated to another compartment: “international trade theory.” Nowadays, the monetary theory, when acknowledged at all, is scoffed at as oversimplified. And yet, neither simplicity nor single-cause explanation is a defect
per se
in science; on the contrary, other things being equal, science will prefer the simpler to the more complex explanation. And science is always searching for a unified

“single cause” explanation of complex phenomena, and rejoices
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when it can be found. If a theory is incorrect, it must be combat-ted on its demerits only; it must not be simply accused of being monocausal or of relying on causes external to the free market.

Perhaps, after all, the causes are external—exogenous—to the market! The only valid test is correctness of theoretical reasoning.

This book rests squarely on the Misesian interpretation of the business cycle.3 The first part sets forth the theory and then refutes some prominent conflicting views. The theory itself is discussed relatively briefly, a full elaboration being available in other works.

The implications of this theory for governmental policy are also elaborated—implications which run flatly counter to prevailing views. The second and third parts apply the theory to furnish an explanation of the causes of the 1929 depression in the United States. Note that I make no pretense of using the historical facts to

“test” the truth of the theory. On the contrary, I contend that economic theories cannot be “tested” by historical or statistical fact.

These historical facts are complex and cannot, like the controlled and isolable physical facts of the scientific laboratory, be used to test theory. There are always many causal factors impinging on each other to form historical facts. Only causal theories
a priori
to these facts can be used to isolate and identify the causal strands.4

For example, suppose that the price of zinc rises over a certain time period. We may ask: why has it risen? We can only answer the question by employing various causal theories arrived at prior to our investigation. Thus, we know that the price might have risen from any one or a combination of these causes: an increase in demand for zinc; a reduction in its supply; a general increase in the supply of money and hence in monetary demand for all goods; a reduction in the general demand for money. How do we know which particular theory applies in these particular cases? Only by 3It must be emphasized that Ludwig von Mises is in no way responsible for any of the contents of this book.

4This is by no means to deny that the ultimate premises of economic theory, e.g., the fundamental axiom of action, or the variety of resources, are derived from experienced reality. Economic theory, however, is
a priori
to all other historical facts.

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looking at the facts and seeing which theories are applicable. But whether or not a theory is
applicable
to a given case has no relevance whatever to its truth or falsity as a theory. It
neither confirms
nor refutes
the thesis that a decrease in the supply of zinc will,
ceteris
paribus,
raise the price, to find that this cut in supply actually occurred (or did not occur) in the period we may be investigating.

The task of the economic historian, then, is to make the relevant applications of theory from the armory provided him by the economic theorist. The only
test
of a theory is the correctness of the premises and of the logical chain of reasoning.5

The currently dominant school of economic methodologists—

the positivists—stand ready, in imitation of the physical scientists, to use false premises provided the conclusions prove sound upon testing. On the other hand, the institutionalists, who eternally search for more and more facts, virtually abjure theory altogether.

Both are in error. Theory cannot emerge, phoenixlike, from a cauldron of statistics; neither can statistics be used to test an economic theory.

The same considerations apply when gauging the results of political policies. Suppose a theory asserts that a certain policy will cure a depression. The government, obedient to the theory, puts the policy into effect. The depression is not cured. The critics and advocates of the theory now leap to the fore with interpretations.

5This “praxeological” methodology runs counter to prevailing views.

Exposition of this approach, along with references to the literature, may be found in Murray N. Rothbard, “In Defense of ‘Extreme
A Priorism
’,”
Southern Economic
Journal
(January, 1957): 214–20; idem, “Praxeology: Reply to Mr. Schuller,”
American Economic Review
(December, 1951): 943–46; and idem, “Toward A Reconstruction of Utility and Welfare Economics,” in Mary Sennholz, ed.,
On
Freedom and Free Enterprise
(Princeton, N.J.: D. Van Nostrand, 1956), pp. 224–62.