Introduction to the Fifth Edition
Introduction to the Fifth Edition
The 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
hiccups in a steady downward trend. On Monday October 9, 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 12, 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 19, 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 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.
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 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. federal 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, 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
There 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 the 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 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 them 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
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
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, 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; better 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,
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 past 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 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
America 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 juggling fiscal and monetary policy, the government can
"fine-tune" 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.g., 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 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 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 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
In 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 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, 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 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.
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 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 when
it can be found. If a theory is incorrect, it must be combatted 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 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. The critics say that failure proves the theory
incorrect. The advocates say that the government erred in not
pursuing the theory boldly enough, and that what is needed is
stronger measures in the same direction. Now the point is that
empirically there is no possible way of deciding between them.[6] Where is the empirical "test" to resolve the
debate? How can the government rationally decide upon its next
step? Clearly, the only possible way of resolving the issue is in
the realm of pure theory-by examining the conflicting premises and
chains of reasoning.
These methodological considerations chart the course of this
book. The aim is to describe and highlight the causes of the 1929
depression in America. I do not intend to write a complete economic
history of the period, and therefore there is no need to gather and
collate all conceivable economic statistics. I shall only
concentrate on the causal forces that first brought about, and then
aggravated, the depression. I hope that this analysis will be
useful to future economic historians of the 1920s and 1930s in
constructing their syntheses.
It is generally overlooked that study of a business cycle should
not simply be an investigation of the entire economic record of an
era. The National Bureau of Economic Research, for example, treats
the business cycle as an array of all economic activities during a
certain period. Basing itself upon this assumption (and despite the
Bureau's scorn of a priori theorizing, this is very much an
unproven, a priori assumption), it studies the
expansion-contraction statistics of all the time-series it can
possibly accumulate. A National Bureau inquiry into a business
cycle is, then, essentially a statistical history of the period. By
adopting a Misesian, or Austrian approach, rather than the
typically institutionalist methodology of the Bureau, however, the
proper procedure becomes very different. The problem now becomes
one of pinpointing the causal factors, tracing the chains of cause
and effect, and isolating the cyclical strand from the complex
economic world.
As an illustration, let us take the American economy during the
1920s. This economy was, in fact, a mixture of two very different,
and basically conflicting, forces. On the one hand, America
experienced a genuine prosperity, based on heavy savings and
investment in highly productive capital. This great advance raised
American living standards. On the other hand, we also suffered a
credit-expansion, with resulting accumulation of malinvested
capital, leading finally and inevitably to economic crisis. Here
are two great economic forces-one that most people would agree to
call "good," and the other "bad"-each separate, but interacting to
form the final historical result. Price, production, and trade
indices are the composite effects. We may well remember the errors
of smugness and complacency that our economists, as well as
financial and political leaders, committed during the great boom.
Study of these errors might even chasten our current crop of
economic soothsayers, who presume to foretell the future within a
small, precise margin of error. And yet, we should not scoff unduly
at the eulogists who composed paeans to our economic system as late
as 1929. For, insofar as they had in mind the first strand-the
genuine prosperity brought about by high saving and investment-they
were correct. Where they erred gravely was in overlooking the
second, sinister strand of credit expansion. This book concentrates
on the cyclical aspects of the economy of the period-if you will,
on the defective strand.
As in most historical studies, space limitations require
confining oneself to a definite time period. This book deals with
the period 1921-1933. The years 1921-1929 were the boom period
preceding the Great Depression. Here we look for causal influences
predating 1929, the ones responsible for the onset of the
depression. The years 1929-1933 composed the historic contraction
phase of the Great Depression, even by itself of unusual length and
intensity. In this period, we shall unravel the aggravating causes
that worsened and prolonged the crisis.
In any comprehensive study, of course, the 1933-1940 period
would have to be included. It is, however, a period more familiar
to us and one which has been more extensively studied.
The pre-1921 period also has some claim to our attention. Many
writers have seen the roots of the Great Depression in the
inflation of World War I and of the post-war years, and in the
allegedly inadequate liquidation of the 1920-1921 recession.
However, sufficient liquidation does not require a monetary or
price contraction back to pre-boom levels. We will therefore begin
our treatment with the trough of the 1920-1921 cycle, in the fall
of 1921, and see briefly how credit expansion began to distort
production (and perhaps leave unsound positions unliquidated from
the preceding boom) even at that early date. Comparisons will also
be made between public policy and the relative durations of the
1920-1921 and the 1929-1933 depressions. We cannot go beyond that
in studying the earlier period, and going further is not strictly
necessary for our discussion.
One great spur to writing this book has been the truly
remarkable dearth of study of the 1929 depression by economists.
Very few books of substance have been specifically devoted to 1929,
from any point of view. This book attempts to fill a gap by
inquiring in detail into the causes of the 1929 depression from the
standpoint of correct, praxeological economic theory.[7]
MURRAY N. ROTHBARD