Book Review: America’s Great Depression, by Murray Rothbard
Understanding the dynamics of economic calamities is extremely important; unless we heed the lessons learned when they happen, we are going to repeat the cycle.
If Murray Rothbard’s account of the events leading up to–and following–the onset of the Great Depression are accurate, then we have not learned that lesson. Rothbard lays that out in unadulterated detail in America’s Great Depression.
In fact, as one reads the book, all one needs to do is change the names and the dollar amounts, and we get a near-identical picture of our current financial crisis.
Rothbard starts by making the case for the Austrian (Von Mises) theory of the business cycle: that boom-bust cycles are caused by infation of the money supply which leads to an eventual correction (recession/depression) that causes the money supply to deflate, leading to drops in wages and prices. (Prior to 1929, depressions usually lasted little more than a year before full employment eventually returned.)
After he lays out the dynamic, he then confronts–very effectively–the various criticisms of the Austrian model.
Once Rothbard has made the case for the Austrian model, he lays out a stunning assessment of the events of the 1920s and early 1930s.
Here are some observations:
*Just like the 1020s, the Federal Reserve inflated the money supply in the late 1990s. The stock market bubble burst in 1929; the tech bubble burst in March 2000.
*When the stock market crashed in 1929, the Fed responded by inflating the money supply even further. In 2001, the Fed cut the Fed Funds Rate and the Discount Rate by a combined 1,000 basis points.
*The Hoover Administration, contrary to modern dogma, responded with a very interventionist policy:
- They worked with industry leaders in an attempt to keep prices and wages stable.
- They implemented public works programs in an effort to help the unemployed.
- They formed government enterprises to help stem the tide of foreclosures.
- They implemented bankruptcy reforms that favored the debtors.
- They implemented bank holidays in an attempt to stem the tide of bank failures.
- They worked with the Federal Reserve to keep pumping the money into the financial system.
- They fought to stop short-selling
Contrast that with today’s actions by President Bush, Treasury Secretary Paulson, and Fed Chairman Bernanke:
- They have dumped trillions of dollars into the financial system, in order to provide liquidity to the credit market.
- They have increased the FDIC guarantee of depositor accounts to $250,000.
- They passed an $800 billion “bailout” package to prop up financial institutions.
- They seized control of Fannie Mae, Freddie Mac, and AIG.
- They passed an economic stimulus package earlier this year.
- They are taking ownership interest in large national and regional banks.
- They are even looking at directly aiding distressed homeowners.
- They blocked the short-selling of financial stocks.
Sadly, Rothbard makes the damning case that none of the government efforts to “help” the economy worked; in fact, their interference in the market only made the Great Depression worse. A 1 or 2 year correction turned into a 10-year disaster during which the GDP fell over 50%.
If Rothbard’s case is accurate–and it appears to be so–then the world in general, the United States in particular, is in for a nasty ride.
Why does Rothbard’s case seem strong? It is monetarily sound.
If you are working and earning $30,000 per year, then start taking out loans and opening up credit card accounts–credit expansion–then you will be able to spend a lot more and acquire a lot of assets faster than you would by living on your salary.
The trouble is, you cannot run up an infinite amount of debt. At some point, the deflation must happen. Either (a) you cut your spending and pay down your debts, (b) the creditors move in and seize your assets, or (c) you go bankrupt, or (d) first (b) then (c). After the correction, assuming you have learned your lessons, you can then recover.
It’s the same way with economies, only nations–unfortunately–can always print more money and create new credit out of thin air whereas we cannot. When nations create large amounts of fiat money, it comes back and bites us one of two ways:
(1) It results in high inflation, possibly hyperinflation (like Zimbabwe)
(2) It results in larger government debt (like the United States)
Either way, it adversely impacts the economy by impeding the natural correction process. At best, it defers the crash for a later date (and at compound interest). At worst, it prolongs a crash that is in progress.
Rothbard has provided a necessary indictment of three sacred mantras in serious need of public debate today:
(1) Government intervention to ease the effect of recessions
(2) The Federal Reserve and their role in business cycles
(3) Fractional reserve banking.
Rothbard makes a devastating case against government intervention–in the form of increased spending–to prevent and mitigate recessions. He shows that, as the depression kicked in, the government’s burden on the taxpayer–and the GDP–actually increased. This resulted in money going to government–which produces little or no economic value–where it could have gone to industry, which does produce economic value. He also takes Hoover’s attack on short-sellers to task, as it prevented the necessary corrections that would have made market liquidation more orderly.
In fact, he makes a strong case that, during recessions, government sould cut spending and reduce their proportionate load on the taxpayers.
Arguably, his most damaging indictment was on the Federal Reserve. Their monetary policies of the 1920s–in collusion with the Harding, Coolidge, and Hoover administrations–ramped up a level of global economic activity that was not sustainable. We created money faster than the economy created value. This made for a crash that should not have been surprising.
In addition to the Federal Reserve, Rothbard aimed both barrels at the paradigm of fractional-reserve banking. He quite aptly referred to it as a counterfeiting system. Most people don’t realize this, but when a bank gives you a loan, they are not giving you money; they are creating money on your behalf. When debts go unpaid and banks must write that off, that results in the destruction of money and a deflation of the money supply.
In lieu of fractional reserve banking, Rothbard makes a strong case for the gold standard, which mitigates the capacity of our Treasury to play with the money supply.
This does leave us a warning, however: even within a gold standard, government will work to inflate the money supply. This is because, as Rothbard eloquently puts it: politically, inflation is always preferable to recession.
Unfortunately, Rothbard’s critique of Hoover-Roosevelt does not shine a positive light on Bush-Paulson-Bernanke. Even worse, both major Presidential candidates–McCain and Obama–support the very same policies that Bush has implemented; they differ only on details. Neither has said a word about monetary policy or the role of the Fed.
In fact, while Bernanke likes to say that he learned the lesson of the Great Depression–he credits Friedman’s monetarism and promises that he will never let it happen again–even Anna Schwartz, Friedman’s partner in A Monetary History of the United States–chides Bernanke for “fighting the last war”.
Bush, in turn, has abandoned the supply-side heritage of Reagan in favor of Hoover-FDR Keynesianism on steroids.
What can we expect in the next 6 to 12 months? If I had the perfect answer, I’d be on television.
While the bailout money could provide some semblance of a recovery as lenders start lending again, the resultant debt is going to bode catastrophically for the American people. Economic activity is not going to reach its prior level for many years. Irrespective of who wins on Tuesday, neither will be able to snap a finger and make all things well.
For now, Americans need to cut spending, stock up on necessities (food), and work to pay down debts. I’d venture to say that, regardless of the short-term effect of the bailout, things are going to be trending badly for a while.
As Rothbard points out, government is not helping this one bit.