1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar

The Ludwig von Mises Institute

Advancing Austrian Economics, Liberty, and Peace

Advancing the scholarship of liberty in the tradition of the Austrian School

Search Mises.org

Murphy Sets the Record Straight

Mises Daily: Tuesday, June 16, 2009 by


Will Barack Obama's New Deal finally sink the American economy into the sands? This is the question author Robert P. Murphy poses at the end of his latest myth buster, The Politically Incorrect Guide to the Great Depression and the New Deal. Readers who follow Murphy's narrative from page one will understand that unless the current administration suddenly turns pro free market and gets out of the way, our future looks grim at best.

According to Austrian theory, inflation generates the business cycle, which means it causes periodic depressions. When a collapse came in 1929, government broke with precedent and adopted measures to minimize the pain of readjustment but in so doing retarded recovery. Through a long succession of economic interventions, both the Hoover and Roosevelt administrations turned what likely would have been a typically brief depression into the Great Depression. Historians and economists, though, have developed arguments extolling the fascist policies of the Roosevelt years for saving an inherently flawed capitalist system, while heaping blame on Hoover for his do-nothing approach. Intentionally or not, they created a mythology that has been fed to generations of American school kids.

It is Murphy's purpose to set the record straight.

In dealing with such an emotionally charged topic as the Depression, the author shows remarkable patience and fairness throughout. Yet his logic is unyielding. At the end of his book, there is hardly a Depression myth left standing. But at the end, I suspect it isn't only free marketeers who are still reading.

The Great Myths

The political account of the Great Depression, a tradition taught throughout the land from the Cold War to the present day, tells us that

  • following the crash, Hoover's "do-nothing" policies brought the laissez-faire economy to its knees;
  • the Federal Reserve, our government-created economic stabilizer, failed to provide enough credit to keep prices from falling during the early 1930s;
  • People demanded and Roosevelt provided a radical new approach to government's relationship to the economy, which eventually got us out of the Depression;
  • Roosevelt had to abolish the gold standard to stabilize the banking system;
  • More recent research reveals it wasn't New Deal policies as such that ended the Depression, but those policies writ large in the monumental expenditures and manpower requirements of World War II.

Because these are the politically correct views of the Depression, our leaders are drawing on these myths to "fix" the current crisis.

Hoover the Interventionist

There was nothing "laissez-faire" about Herbert Hoover. He was a staunch interventionist throughout his political career. As secretary of commerce under Warren Harding, he "set out to reconstruct America [his words]" to fix the depression of 1920–1921 (p. 32). "Throughout 1921," Murphy writes,

Hoover did what he could to persuade Congress to enact public works programs to stabilize the economy. Fortunately, the depression ended before Hoover's grandiose plans could be realized. (p. 32)

When the next collapse came in 1929, he called leading financiers and businessmen to the White House and got them to agree to support current wages, positions, and investment spending. One of those in attendance was Henry Ford, who thought wages "must not even stay on their present level; they must go up" (p. 37). Hoover himself thought "high wages and low prices" were the "very essence of great production" (p. 33).

Indeed, during the 1930s, as the prices of most goods and services were plummeting, wages remained high. Workers with jobs frequently had more buying power than they had in the booming '20s. But with falling revenue, businesses couldn't maintain their staff levels. "[U]nemployment went up and up and up, hitting the unimaginable monthly peak of 28.3 percent in March 1933" (p. 42).

By contrast, without wage support in the earlier depression, unemployment peaked at 11.7 percent in 1921, then fell to 2.4 percent by 1923. "That is how a market with flexible wages and prices quickly corrects itself after a Fed-induced inflation," Murphy adds (p. 42).

Hoover's Tax on Imports

Concerned about falling farm prices following the crash, Hoover called on government to make Americans pay more for food. But the Smoot-Hawley Tariff of June 17, 1930, did more than raise prices of farm products. It raised taxes on over 20,000 imported goods to record levels. Among the tariff increases were over 800 items used in making cars. In combination with retaliatory tariffs from European countries, Smoot-Hawley pulled American car sales down from 5.3 million in 1929 to 1.8 million in 1932 (p. 43).

Hoover hurt the very group he was trying to protect. Because tariff hikes mean fewer foreign goods are sold in this country, foreigners have fewer dollars with which to buy American goods. Not surprisingly, American exports dropped from $7 billion in 1929 to $2.5 billion by 1932. Since the US agricultural industry was a net exporter, American farmers were hurt more than many other producers.

Hoover as a Tax-and-Spend Democrat

Incredible as it seems today, the federal government ran budget surpluses every year of the Roaring '20s and managed to pay down its debt from $25 billion in FY 1919 to $16.2 billion in FY 1930 (p. 47). With plummeting tax receipts following the crash, Hoover turned to deficit financing to support a budget increase of 42 percent during his first two years, a classic Keynesian response to a collapse in "aggregate demand" (p. 48). In an attempt to reduce the growing budget deficit, Hoover and Secretary of the Treasury Andrew Mellon convinced Congress to pass a huge and encompassing tax increase in 1932. Yet as we would expect from the Laffer curve, the Treasury saw only modest gains in receipts due to the shrunken tax base.

As Murphy points out, government cut its budget during the depression of 1920–1921 — from $5 billion in FY 1921 to $3.3 billion in FY 1922. When the depression was over for Harding, Hoover was trying to rein in his deficits.

Murphy concedes that, in light of the data alone, it's theoretically possible Keynesians are right. They could argue, say, that the budget cuts during the early '20s actually exacerbated the depression, while Hoover's stimulus during the '30s averted even higher unemployment rates. But following the principle of keeping assumptions to a minimum — Occam's razor — we should stick with what has always worked, he concludes. Both government and the people should slash spending during a depression (p. 50).

Hoover's New Deal Lite

Waste and corruption go hand in hand with interventionism. Through his Federal Farm Board, Hoover kept prices for farm products above market levels, thereby causing overproduction, and within weeks of the crash "spearheaded a massive increase in public works spending" (p. 58). In 1932, he founded the Reconstruction Finance Corporation to prop up unhealthy banks and railroads. Banks with the proper political connections found themselves at the head of the line receiving loans.

Later in life, Hoover boasted that he spent more on public works during his administration than had been spent in all of the previous 30 years. By the end of his term, Hoover had made the greatest peacetime expansion of government in US history (p. 59).

So where did his laissez-faire reputation come from? Partly from his 1932 presidential campaign, where he sounded more conservative than FDR, who was an admirer of economic fascism. Partly from his refusal to provide direct federal relief to the unemployed, preferring instead the aid of local governments and charities. Partly from his respect for the Constitution, which, compared to the court-packing FDR, was significant. And partly for his support of the gold standard. He was neither a laissez-faire man nor a full-blown central planner. He was an interventionist — and a mild one only by today's standards.

The Tightwad Fed

During what is now a well-known birthday tribute to Milton Friedman in 2002, then-Fed governor Ben Bernanke issued an apology and a promise:

I would like to say to Milton and Anna [Schwartz]: Regarding the Great Depression, you're right. We did it. We're very sorry. But thanks to you, we won't do it again. (p. 64)

The "it" Bernanke won't do again was the Fed's alleged tight-money policy following the crash. And Bernanke, one could argue, has been striving to keep his word. "During the last three months of 2008," Murphy tells us, "the Fed expanded bank reserves at an annualized rate of more than 400,000 percent." That may be too little, too late for Paul Krugman, but it is far and away the greatest "stimulus" to bank reserves in the history of the Fed (p. 64).

As Friedman wrote in Free to Choose, following the crash,

Instead of actively expanding the money supply by more than the usual amount to offset the contraction, the [Federal Reserve] System allowed the quantity of money to decline slowly throughout 1930. (p. 65)

From late 1930 to early 1933, roughly a third of the money disappeared from the economy. According to Friedman, this was one of the major causes of the depression.

In truth, the Fed was not the engine of deflation depicted above.

[The] Fed tried unprecedented measures to bolster the financial sector, but its efforts were overwhelmed by the public's behavior, which, naturally, was to hoard money. The resulting decline in the money stock was therefore a tidal wave that the Fed could not contain… (pp. 72–73)

When people withdraw money from banks, the fractional-reserve multiplier is reversed — a $1,000 withdrawal means the money supply declines by another $9,000, roughly. But monetarists insist the Fed should have inflated harder to offset the effects of scared depositors.

How hard did the Fed try? It cut its discount rate three days after Black Tuesday. It cut it again in 1929 and five more times in 1930. Although the rate was already at a record low, the Fed cut it yet again to 1.5 percent in May 1931. It reversed course later that year only to stem the outflow of gold following Britain's abandonment of the gold standard (p. 76).

The cry of "too little, too late" fades as a plausible explanation when we consider the fact that the Fed bumped its discount rate during the earlier depression to a record-high 7 percent in June 1920 and didn't begin cutting its rate until May 1921, when recovery was well underway.

It merits repeating: the Fed's record-high discount rate occurred only during the brief 1920–1921 depression, while its record-low discount rate occurred only during the 1929–1931 decline. If the monetarist position were correct, Murphy concludes, "then the Fed's merciless behavior in 1920–1921 should have spawned a much greater depression… But as we know, the 1920s were arguably the most prosperous decade in US history."

Where Friedman Went Wrong

Depressions in earlier periods of US history usually ended within two years and were accompanied by falls in the money supply. How, then, could the coauthor of A Monetary History of the United States come to believe that injections of artificial money would revive a collapsing economy, especially in light of the short duration of the 1920–1921 depression?

As Murphy explains, Friedman and Schwartz built their case on different considerations:

Friedman could correctly point to incipient recessions during the 1920s that were nipped in the bud with Fed rate cuts. The stock market crashed after the Fed repeatedly hiked rates in 1928 and 1929, and so Friedman naturally concluded that low rates successfully kept depression at bay… (p. 78)

Also, the United States was one of the last countries to abandon the gold standard. Countries that did so earlier recovered sooner. Gold, of course, acts as a restraint on inflation, and inflation is the Friedman prescription. When Roosevelt severed the dollar's tie to gold in 1933, "the major economic indicators all turned around — at least temporarily…"

While these arguments may have superficial appeal, they overlook some important points. First, the Fed's rate cuts in the mid-1920s priced capital too low and fueled a boom that was destined to go bust. Also, "the Fed's rate hikes late in the decade didn't push down the stock market, but instead stopped inflating it." With the Fed's spigots running slower, stock prices began retreating to market levels. The depression following the crash was needed so the market could move capital and labor into more sustainable investment projects. Flooding the market with cheap credit was an attempt to make all projects sustainable, but massive money pumping could only be done if central bankers weren't handcuffed by the supply of gold. Money inflation only masked the underlying economic problems, Murphy concludes, as "the world still suffered through many years of economic stagnation" (p. 79).

Failure of the Fascist New Deal

Is there any truth to the claim the New Deal got us out of the Depression? Murphy cites historian Eric Rauchway: "Excepting 1937–1938, unemployment fell each year of Roosevelt's first two terms [while] the US economy grew at average annual growth rates of 9 percent to 10 percent" (p. 100). Is it proper to conclude from this data that the New Deal was working?

As Murphy reminds us, every economic slump eventually ends. Given that most depressions in US history were over within two years, and all of them within five, it is necessary to ask why the Roosevelt economy was still mired in depression after a full seven years. Declining unemployment figures lose their appeal when one recalls that unemployment was at a record high when Roosevelt took office in 1933 and remained in the double-digits throughout the '30s.

Further, the annual growth rates Rauchway cites are misleading. Murphy draws on the work of UCLA economists Ohanian and Cole, who show that by 1939, "total output was still 27 percent below its 'trend' value established before the onset of the Depression. They find that investment was even worse, coming in just under 50 percent of where it should have been" if Roosevelt's policies had really worked (p. 102).

Since the collapse was worldwide, it's instructive to ask how other countries fared during the Depression. There was no "Canadian New Deal," for example, yet unemployment rates in Canada were not nearly as severe. During Hoover's years, US unemployment was, on average, 3.9 percent higher than Canada's, and during Roosevelt's tenure it got worse, with the gap increasing to 5.9 percent (p. 104).

Roosevelt did succeed in ending the decline in consumer prices that had prevailed during Hoover's term. While this was something inflationists celebrate, it was hardly a welcome trend for out-of-work breadwinners trying to feed their families. After Roosevelt confiscated Americans' gold, repudiated gold clauses in contracts, and put the domestic economy on a fiat-dollar standard, the Fed's printing press went to work and bumped prices during his first term by a cumulative 13 percent (p. 105). With their nominal revenue increased, businesses could hire more workers. "One of the perverse incentives of inflation," Murphy observes,

is that it can balance off government high-wage policies (as long as these policies aren't indexed to inflation). To that degree, inflation can help cure unemployment. (pp. 105–106)

(Murphy notes that "The famous bullion depository at Fort Knox was built precisely to house all the gold that FDR seized from the American people" (p. 128). If gold money is truly a relic from some barbarous past, why would the government bother securing it in an underground vault lined with granite walls and protected by a 22-ton, blast-proof door, then further safeguarded with — among other things — video cameras, armed guards, and Army units "totaling over 30,000 soldiers, with associated tanks, armored personnel carriers, attack helicopters, and artillery," as Wikipedia reports?)

Another measure of New Deal failure is the paucity of private investment, which didn't regain its 1929 level until 1941. As Murphy notes, "those who controlled private capital largely walked away from the US economy for the entire 1930s …" They even refused to replace existing machinery as it wore out. For much of the Depression, net investment fell to less than zero. Thus, capital consumption made growth rate figures highly misleading. This "strike" by the capitalists was a critical factor in the lackluster recovery (p. 111).

To Keynesians, though, their refusal to invest made good business sense. Why invest if no one is buying your final products? As Krugman has noted, all you would do is build up inventory. But if a fall in demand were driving the Depression, Murphy asks, how did we ever emerge from all our earlier depressions, where Keynesian deficits were conspicuously missing?

Murphy cites the analysis of Robert Higgs, who in 1997 advanced the idea that investment inactivity could be attributed to regime uncertainty. Investors had good reasons to be on strike. The inconsistency of administration policies, and especially its wanton disregard of property rights, coupled with Roosevelt's invective against the capitalist class and his threats against the Court, severely undercut investors' confidence "in their capital and its prospective returns" (p. 113). The New Dealers themselves admitted their approach was experimental — if one thing fails, try something else. "But above all, try something," Roosevelt insisted (p. 115).

World War II

Roosevelt eventually tried something that "worked" — baiting Japan into attacking Pearl Harbor (my view). It worked in the sense of getting the United States into the war and mopping up many of the unemployed. According to some historians, World War II was the event that brought about full recovery, while simultaneously confirming Roosevelt's tried-and-failed attempts. According to Pulitzer Prize–winning historian David M. Kennedy in his book Freedom From Fear, the Keynesian approach Roosevelt followed was sound in principle but just didn't go far enough. Kennedy claims Roosevelt's "scale of compensatory spending" was inadequate "to restore the economy to pre-Depression levels, let alone expand it." The Second World War provided the level of expenditures needed to end the Depression and "clinched the Keynesian doctrine that government spending could underwrite prosperity."[1]

Whatever virtues one may find in World War II, Murphy says, getting us out of the Depression was not one of them. The error in thinking it did is based on the broken-window fallacy, which in its simplest form says that acts of destruction can increase the total wealth of society. If a hoodlum breaks a grocer's window, it should be obvious that the local glazier will benefit but not the grocer. The destructionists disagree; not only the glazier, but those he does business with will benefit, they claim.

The fallacy might be better exposed if we assume the glacier hired the hoodlum to break not only the grocer's window, but the shoemaker's, the baker's, the cobbler's, and that of every other tradesman in the neighborhood. The damage seen remains unchanged as do the subsequent monetary exchanges, and yet if people learned of the deal between the glazier and the hoodlum, they would likely regard it as theft.

If the windows weren't broken, the owners would have that much more money to spend on things they don't have. Unlike the glazier's, their wealth would increase without someone else sustaining a corresponding loss.

As Lew Rockwell tells us,

If the broken window really produces wealth, why not break all windows up and down the whole city block? Indeed, why not break doors and walls? Why not tear down all houses so that they can be rebuilt? Why not bomb whole cities so construction firms can get busy rebuilding?

And by this reasoning, why not go to war?

Higgs and the Myth of Wartime Prosperity

Statistical evidence might suggest war was a godsend to the economy. According to official measures, unemployment fell and GDP increased while the United States geared up for war (p. 151). As Higgs notes, however, the fall in civilian unemployment was more than matched by increases in the armed forces.[2] And one can hardly overlook the striking differences between civilian jobs and military jobs in World War II, as economists do when computing the tradeoffs between them. The war killed over 400,000 military personnel and wounded another 670,000 — and the constant exposure to combat drove many men insane.

The GDP figures are suspect for several reasons. For one, government expenditures are included in GDP, and the massive government outlays from 1940–1945 would naturally boost that total. Nor is government spending as productive as the investments private individuals make with their own money. To a government with a seemingly inexhaustible pool of funds, money is no object, especially in wartime when the sense of urgency is high. But in peacetime, too, government agencies have a disincentive to come in under budget, as they lose what they don't use.

"Higgs pushes the critique even further," Murphy notes (p. 154). Much of the increase in GDP can be attributed to the government's printing press. Though government statisticians look at "real GDP," adjusted for inflation, the numbers are seriously flawed because government price controls during the war prevented the consumer price index (CPI) from rising as it should have. For comparison with earlier periods, prices during the war were meaningless.

We need to remember that, under cover of war, government imposed great hardships on civilians. Many of them had to relocate to find jobs; rent controls made their housing shabby; many everyday goods were rationed, such as gasoline and coffee; and some items weren't made at all, including cars. Saying it was their patriotic duty to suffer doesn't change the fact that civilians during the war most certainly did not enjoy "prosperity," and neither did the formerly unemployed soldiers overseas.

Striving for balance, Murphy does acknowledge ways in which the war did "legitimately stimulate the US economy" (p. 161). At home, the perceived threat of tyranny from abroad motivated people to work harder and consume less. As with World War I, there was a huge increase in demand for US exports, even before Pearl Harbor, and exporters benefited further because many of their overseas competitors "were either killed or had their factories blown apart" (p. 163). And lastly, with the outbreak of war in Europe in 1939 and the sudden interest in American rearmament, Roosevelt decided his antibusiness New Dealers had to go. "By the middle of 1942, more than 10,000 business executives had taken positions in federal war agencies," Murphy writes (quoting Higgs).[3] The armed services quickly became the greatest buyers in industrial history.

Whatever the benefits war might have brought, Murphy contends, "these were swamped by the ways in which World War II was a huge burden" (p. 164, his emphasis). True prosperity did not return until "the federal government relinquished its stranglehold on the American economy." Since President Roosevelt was dead at that point, the notion that he got us out of the Depression is a myth.

There are several excellent books on the Great Depression, but Robert P. Murphy's guide is the most accessible and rebuts all the politically correct falsehoods about that era — the Fed, Hoover, Roosevelt, and World War II. With Obama on track to repeat FDR on a grand scale, Murphy's book becomes a must-read intellectual survival manual.


[1] Quoted in Burt Folsom, New Deal or Raw Deal? How FDR's Economic Legacy Has Damaged America, Threshold Editions (2008), p. 245–246.

[2] See Robert Higgs, Depression, War, and Cold War: Studies in Political Economy, chapter 3: "Wartime Prosperity? A Reassessment of the US Economy in the 1940s,".

[3] Ibid., p. 19