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How the Fed Caused America’s Great Depression

[This review of Rothbard America's Great Depression was originally published by the Foundation for Economic Education.]

It may not be conventional to review the fifth edition of a book that appears several years after its author’s passing. But America’s Great Depression is not a conventional book. It is written with verve and aplomb. And its rendition of the Austrian theory of the business cycle, critique of alternative theories, and detailed history of the early events and causes of the Great Depression (1929–1933) have captured the attention of a small but growing group of students and researchers for nearly four decades.

Each of the five editions has had a different publisher, the first four with an introduction by the author. With the fifth edition, we get a quality hardback, new typesetting with footnotes instead of endnotes, and a spirited introduction by historian Paul Johnson. A new dust jacket is fashioned from a photograph showing throngs of men in winter coats and fedoras standing despondently in line and casting long shadows. The image cries out for an explanation: How could things have gone so wrong?

The Great Depression has cast a long shadow of its own over twentieth-century economic history and policy issues. In many circles—even academic circles—it is still acceptable simply to point to the experience of the 1930s as clear evidence that market economies are prone to collapse. Rothbard provides an alternative understanding. Unsound policies of the central bank set the economy off on an unsustainable growth path in the 1920s, creating the conditions for the crash at the end of that decade. Attempts by the government to undo or mitigate the damage only made matters worse.

The excesses of the twenties, the downturn, and the dramatic slide into deep depression are all traced to governmental disruptions of the market process.

Reasserting the Austrian view of boom and bust, the initial publication of America’s Great Depression had a certain strategic significance. Through the 1930s and into the early 1940s, F. A. Hayek had contributed importantly to our understanding of business cycles but then abandoned the topic in favor of the broader issues of political economy. Rothbard offered the Austrian view anew in 1963. America’s Great Depression stood as a complement to the relevant chapters of Ludwig von Mises’s Human Action, issued in a revised edition that same year, and as a supplement to Rothbard’s own Man, Economy, and State, which had been published the year before.

Equally significant in 1963 was the book’s contrast with competing views of the events of the interwar period and its relationship to the general development of macroeconomic thought. In that same year, Milton Friedman and Anna Schwartz published their Monetary History of the United States: 1867–1960. They too blamed the Federal Reserve for the Great Depression. However, the central focus in their treatment of the episode was the collapse of the money supply (1929–1933) that took the economy into deep depression. There was no suggestion that during the previous boom, credit expansion had caused interest rates to be artificially low and hence had caused resources to be systematically misallocated in a way that would eventually require liquidation and reallocation. To the contrary, the nearly constant level of prices throughout the twenties was taken as a sign of macro-economic health.

Rothbard showed that policy-distorted interest rates give rise to a mismatch between the intertemporal production plans of entrepreneurs and the preferences of consumers, the latter being expressed by people’s willingness to save. With the central bank’s policy of cheap credit, more investment projects are initiated than can actually be completed. Too many resources are committed to the early stages of production, leaving insufficient resources for the late stages. The artificial boom is destined to end in a bust.

But wasn’t it the subsequent collapse of the money supply that converted the bust into deep depression? Rothbard says no, pointing out that the Federal Reserve, instead of trying to reflate in the early 1930s, should have deliberately deflated—“to bolster confidence in gold” and to “speed up the adjustments needed to end the depression.” With this argument, he dismisses the monetarists’ concern about monetary deflation and about the resulting economywide discoordination that accompanies the piecemeal downward adjustment of prices. (Then and now, some of Rothbard’s readers would acknowledge the harmful effects of monetary collapse—though without this acknowledgment detracting from the key Austrian insights about the nature of the initial downturn.)

Blaming business cycles on government was a hard sell in the 1960s—the decade in which Keynesianism ruled supreme—both in the seats of power and in the halls of academe. Rothbard is to be credited for keeping alive (during a period when the Austrian school was almost completely in eclipse) the key ideas about how the market process goes right if left on its own and how it goes so wrong when the central bank induces more growth than savers are willing to finance.

In the introduction to the fourth edition, Rothbard remarked that interest in his book on business cycles itself exhibited a cyclical pattern. Each subsequent edition was published during a period of macroeconomic disorder—high unemployment, high inflation, or both. His final introduction was written during the inflationary recession of the early 1980s. Since that time, the economy has experienced almost uninterrupted economic expansion. It seems fitting that the fifth edition appears at the end of a record-breaking expansion that is widely attributed to the pro-growth policies of the central bank.

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