America's Great Depression (31 page)

Once the credit system had become infected with cheap money, it was impossible to cut down particular outlets of this credit without cutting down all credit, because it
The Development of the Inflation

167

is impossible to keep different kinds of money separated in water-tight compartments. It was impossible to make money scarce for stock-market purposes, while simultaneously keeping it cheap for commercial use. . . . When Reserve credit was created, there was no possible way that its employment could be directed into specific uses, once it had flowed through the commercial banks into the general credit stream.51

And so ended the great inflationary boom of the 1920s. It should be clear that the responsibility for the inflation rests upon the federal government—upon the Federal Reserve authorities primarily, and upon the Treasury and the Administration—sec-ondarily.52 The United States government had sowed the wind and the American people reaped the whirlwind: the great depression.

51A. Wilfred May, “Inflation in Securities,” in H. Parker Willis and John M.

Chapman, eds.,
The Economics of Inflation
(New York: Columbia University Press, 1935), pp. 292–93. Also see Charles O. Hardy,
Credit Policies of the Federal Reserve
System
(Washington, D.C.: Brookings Institution, 1932) pp. 124–77; and Oskar Morgenstern “Developments in the Federal Reserve System,”
Harvard Business
Review
(October, 1930): 2–3.

52For an excellent contemporary discussion of the Federal Reserve, and of its removal of the natural checks on commercial bank inflation, see Ralph W. Robey,

“The Progress of Inflation and ‘Freezing’ of Assets in the National Banks,”
The
Annalist
(February 27, 1931): 427–29. Also see C.A. Phillips, T.F. McManus, and R.W. Nelson,
Banking and the Business Cycle
(New York: Macmillan, 1937), pp.

140–42; and C. Reinold Noyes, “The Gold Inflation in the United States,”
American Economic Review
(June, 1930): 191–97.

6

Theory and Inflation: Economists

and the Lure of a Stable Price Level

One of the reasons that most economists of the 1920s did not recognize the existence of an inflationary problem was the widespread adoption of a stable price level as the goal and criterion for monetary policy. The extent to which the Federal Reserve authorities were guided by a desire to keep the price level stable has been a matter of considerable controversy. Far less controversial is the fact that more and more economists came to consider a stable price level as the major goal of monetary policy. The fact that general prices were more or less stable during the 1920s told most economists that there was no inflationary threat, and therefore the events of the great depression caught them completely unaware.

Actually, bank credit expansion creates its mischievous effects by distorting price relations and by raising and altering prices compared to what they would have been without the expansion.

Statistically, therefore, we can only identify the increase in money supply, a simple fact. We cannot prove inflation by pointing to price increases. We can only approximate explanations of complex price movements by engaging in a comprehensive economic history of an era—a task which is beyond the scope of this study. Suffice it to say here that the stability of wholesale prices in the 1920s was the result of monetary inflation offset by increased productivity, which lowered costs of production and increased the supply of
169

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America’s Great Depression

goods. But this “offset” was only
statistical
; it did not eliminate the boom–bust cycle, it only
obscured
it. The economists who emphasized the importance of a stable price level were thus especially deceived, for they should have concentrated on what was happen-ing to the supply of money. Consequently, the economists who raised an alarm over inflation in the 1920s were largely the qualitativists. They were written off as hopelessly old-fashioned by the

“newer” economists who realized the overriding importance of the quantitative in monetary affairs. The trouble did not lie with particular credit on particular markets (such as stock or real estate); the boom in the stock and real estate markets reflected Mises’s trade cycle: a disproportionate boom in the prices of titles to capital goods,
caused
by the increase in money supply attendant upon bank credit expansion.1

The stability of the price level in the 1920s is demonstrated by the Bureau of Labor Statistics Index of Wholesale Prices, which fell to 93.4 (100 = 1926) in June 1921, rose slightly to a peak of 104.5 in November 1925, and then fell back to 95.2 by June 1929.

The price level, in short, rose slightly until 1925 and fell slightly thereafter. Consumer price indices also behaved in a similar manner.2 On the other hand, the Snyder Index of the General Price Level, which includes all types of prices (real estate, stocks, rents, and wage rates, as well as wholesale prices) rose considerably during the period, from 158 in 1922 (1913 = 100) to 179 in 1929, a rise of 13 percent. Stability was therefore achieved only in consumer and wholesale prices, but these were and still are the fields considered especially important by most economic writers.

1The qualitative aspect of credit is important to the extent that bank loans must be to
business,
and not to government or to consumers, to put the trade cycle mechanism into motion.

2The National Industrial Conference Board (NICB) consumer price index rose from 102.3 (1923 = 100) in 1921 to 104.3 in 1926, then fell to 100.1 in 1929; the Bureau of Labor Statistics (BLS) consumer good index fell from 127.7 (1935–1939 =

100) in 1921 to 122.5 in 1929.
Historical Statistics of the U.S., 1789–1945
(Washington, D.C.: U.S. Department of Commerce, 1949), pp. 226–36, 344.

Theory and Inflation: Economists and the Lure of a Stable Price Level
171

Within the overall aggregate of wholesale prices, foods and farm products rose over the period while metals, fuel, chemicals, and home furnishings fell considerably. That the boom was largely felt in the
capital goods industries
can be seen by (a) the quadrupling of stock prices over the period, and by (b) the fact that durable goods and iron and steel production each increased by about 160 percent, while the production of non-durable goods (largely consumer goods) increased by only 60 percent. In fact, production of such consumer items as manufactured foods and textile products increased by only 48 percent and 36 percent respectively, from 1921 to 1929. Another illustration of Mises’s theory was that wages were bid up far more in the capital goods industries. Overbidding of wage rates and other costs is a distinctive feature of Mises’s analysis of capital goods industries in the boom. Average hourly earnings, according to the Conference Board Index, rose in selected manufacturing industries from $.52 in July 1921 to $.59 in 1929, a 12 percent increase. Among this group, wage rates in consumer goods’ industries such as boots and shoes remained constant; they rose 6 percent in furniture, less than 3 percent in meat packing, and 8 percent in hardware manufacturing. On the other hand, in such capital goods’ industries as machines and machine tools, wage rates rose by 12 percent, and by 19 percent in lumber, 22 percent in chemicals, and 25 percent in iron and steel.

Federal Reserve credit expansion, then, whether so intended or not, managed to keep the price level stable in the face of an increased productivity that would, in a free and unhampered market, have led to falling prices and a spread of increased living standards to everyone in the population. The inflation distorted the production structure and led to the ensuing depression–adjustment period. It also prevented the whole populace from enjoying the fruits of progress in lower prices and insured that only those enjoying higher monetary wages and incomes could benefit from the increased productivity.

There is much evidence for the charge of Phillips, McManus, and Nelson that “the end-result of what was probably the greatest price-level stabilization experiment in history proved to be, simply,
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America’s Great Depression

the greatest depression.”3 Benjamin Strong was apparently converted to a stable-price-level philosophy during 1922. On January 11, 1925, Strong privately wrote:

that it was my belief, and I thought it was shared by all others in the Federal Reserve System, that our whole policy in the future, as in the past, would be directed toward the stability of prices so far as it was possible for us to influence prices.4

When asked, in the Stabilization Hearings of 1927, whether the Federal Reserve Board could “stabilize the price level to a greater extent” than in the past, by open-market operations and other control devices, Governor Strong answered,

I personally think that the administration of the Federal Reserve System since the reaction of 1921 has been just as nearly directed as reasonable human wisdom could direct it toward that very object.5

It appears that Governor Strong had a major hand, in early 1928, in drafting the bill by Representative James G. Strong of Kansas (no relation) to compel the Federal Reserve System to promote a stable price level.6 Governor Strong was ill by this time and out of control of the System, but he wrote the final draft of the bill along with Representative Strong. In the company of the Congressman and Professor John R. Commons, one of the leading the-oreticians of a stable price level, Strong discussed the bill with 3C.A. Phillips, T.F. McManus, and R.W. Nelson,
Banking and the Business
Cycle
(New York: Macmillan, 1937), pp. 176ff.

4Lester V. Chandler,
Benjamin Strong, Central Banker
(Washington, D.C.: Brookings Institution, 1958), p. 312. In this view, Strong was, of course, warmly supported by Montagu Norman. Ibid., p. 315.

5Also see ibid., pp. 199ff. And Charles Rist recalls that, in his private conversations, “Strong was convinced that he was able to fix the price level, by his interest and credit policy.” Charles Rist, “Notice Biographique,”
Revue d’Èconomie
Politique
(November–December, 1955): 1029.

6Strong thus overcame his previous marked skepticism toward any legislative mandate for price stabilization. Before this, he had preferred to leave the matter strictly to Fed discretion. See Chandler,
Benjamin Strong, Central Banker,
pp. 202ff.

Theory and Inflation: Economists and the Lure of a Stable Price Level
173

members of the Federal Reserve Board. When the Board disapproved, Strong felt bound, in his public statements, to go along with them.7 We must further note that Carl Snyder, a loyal and almost worshipful follower of Governor Strong, and head of the Statistical Department of the Federal Reserve Bank of New York, was a leading advocate of monetary and credit control by the Federal Reserve to stabilize the price level.8

Certainly, the leading British economists of the day firmly believed that the Federal Reserve was deliberately and successfully stabilizing the price level. John Maynard Keynes hailed “the successful management of the dollar by the Federal Reserve Board from 1923 to 1928” as a “triumph” for currency management.

D.H. Robertson concluded in 1929 that “a monetary policy consciously aimed at keeping the general price level approximately stable . . . has apparently been followed with some success by the Federal Reserve Board in the United States since 1922.”9 Whereas Keynes continued to hail the Reserve’s policy a few years after the depression began, Robertson became critical,

Looking back . . . the great American “stabilization” of 1922–1929 was really a vast attempt to destabilize the value of money in terms of human effort by means of a colossal program of investment . . . which succeeded for a surprisingly long period, but which no human ingenu-ity could have managed to direct indefinitely on sound and balanced lines.10

7See the account in Irving Fisher, ibid., pp. 170–71. Commons wrote of Governor Strong: “I admired him both for his open-minded help to us on the bill and his reservation that he must go along with his associates.” 8See Fisher’s eulogy of Snyder,
Stabilised Money
, pp. 64–67; and Carl Snyder,

“The Stabilization of Gold: A Plan,”
American Economic Review
(June, 1923): 276–85; idem,
Capitalism the Creator (
New York: Macmillan, 1940)
,
pp. 226–28.

9D.H. Robertson, “The Trade Cycle,”
Encyclopaedia Britannica,
14th ed.

(1929), vol. 22, p. 354.

10D.H. Robertson, “How Do We Want Gold to Behave?” in
The International
Gold Problem
(London: Humphrey Milford, 1932), p. 45; quoted in Phillips, et al.,
Banking and the Business Cycle,
pp. 186–87.

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America’s Great Depression

The siren song of a stable price level had lured leading politicians, to say nothing of economists, as early as 1911. It was then that Professor Irving Fisher launched his career as head of the “stable money” movement in the United States. He quickly gained the adherence of leading statesmen and economists to a plan for an international commission to study the money and price problem.

Supporters included President William Howard Taft, Secretary of War Henry Stimson, Secretary of Treasury Franklin MacVeagh, Governor Woodrow Wilson, Gifford Pinchot, seven Senators, and economists Alfred Marshall, Francis Edgeworth, and John Maynard Keynes in England. President Taft sent a special message to Congress in February, 1912, urging an appropriation for such an international conference. The message was written by Fisher, in collaboration with Assistant Secretary of State Huntington Wilson, a convert to stable money. The Senate passed the bill, but it died in the House. Woodrow Wilson expressed interest in the plan but dropped the idea in the press of other matters.

In the spring of 1918, a Committee on the Purchasing Power of Money of the American Economic Association endorsed the principle of stabilization. Though encountering banker opposition to his stable-money doctrine, led notably by A. Barton Hepburn of the Chase National Bank, Fisher began organizing the Stable Money League at the end of 1920, and established the League at the end of May, 1921—at the beginning of our inflationary era.