America's Great Depression (6 page)

The major methodological works of this school are: Ludwig von Mises,
Human
Action
(New Haven, Conn.: Yale University Press, 1949); Mises,
Theory and
History
(New Haven, Conn.: Yale University Press, 1957); F.A. Hayek,
The
Counterrevolution of Science
(Glencoe, Ill.: The Free Press, 1952); Lionel Robbins,
The Nature and Significance of Economic Science
(London: Macmillan, 1935), Mises,
Epistemological Problems of Economics
(Princeton, N.J.: D. Van Nostrand, 1960); and Mises,
The Ultimate Foundation of Economic Science
(Princeton, N.J.: D. Van Nostrand, 1962).

Introduction

xli

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 construct-ing 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.

6Similarly, if the economy had recovered, the advocates would claim success for the theory, while critics would assert that recovery came
despite
the baleful influence of governmental policy, and more painfully and slowly than would otherwise have been the case. How should we decide between them?

Introduction to the First Edition

xlii

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 confin-ing 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
Introduction

xliii

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

7The only really valuable studies of the 1929 depression are: Lionel Robbins,
The Great Depression
(New York: Macmillan, 1934), which deals with the United States only briefly; C.A. Phillips, T.F. McManus, and R.W. Nelson,
Banking and
the Business Cycle
(New York: Macmillan, 1937); and Benjamin M. Anderson,
Economics and the Public Welfare
(New York: D. Van Nostrand, 1949), which does not deal solely with the depression, but covers twentieth-century economic history. Otherwise, Thomas Wilson’s drastically overrated
Fluctuations in Income and
Employment
(3rd ed., New York: Pitman, 1948) provides almost the “official” interpretation of the depression, and recently we have been confronted with John K. Galbraith’s slick, superficial narrative of the pre-crash stock market,
The Great
Crash, 1929
(Boston: Houghton Mifflin, 1955). This, aside from very brief and unilluminating treatments by Slichter, Schumpeter, and Gordon is just about all.

There are many tangential discussions, especially of the alleged “mature economy” of the later 1930s. Also see, on the depression and the Federal Reserve System, the recent brief article of O.K. Burrell, “The Coming Crisis in External Convertibility in U.S. Gold,”
Commercial and Financial Chronicle
(April 23, 1959): 5, 52–53.

Part I

Business Cycle Theory

1

The Positive

Theory of the Cycle

Study of business cycles must be based upon a satisfactory cycle theory. Gazing at sheaves of statistics without “pre-judgment” is futile. A cycle takes place in the economic world, and therefore a usable cycle theory must be integrated with general economic theory. And yet, remarkably, such integration, even attempted integration, is the exception, not the rule. Economics, in the last two decades, has fissured badly into a host of airtight compartments—each sphere hardly related to the others.

Only in the theories of Schumpeter and Mises has cycle theory been integrated into general economics.1

The bulk of cycle specialists, who spurn any systematic integration as impossibly deductive and overly simplified, are thereby (wittingly or unwittingly) rejecting economics itself. For if one may forge a theory of the cycle with little or no relation to general economics, then general economics must be incorrect, failing as it does to account for such a vital economic phenomenon. For institutionalists—the pure data collectors—if not for others, this is a welcome conclusion. Even institutionalists, however, must use theory sometimes, in analysis and recommendation; in fact, they end by using a concoction of
ad hoc
hunches, insights, etc., 1Various neo-Keynesians have advanced cycle theories. They are integrated, however, not with
general
economic theory, but with holistic Keynesian systems—

systems which are very
partial
indeed.

3

4

America’s Great Depression

plucked unsystematically from various theoretical gardens. Few, if any, economists have realized that the Mises theory of the trade cycle is not just another theory: that, in fact, it meshes closely with a general theory of the economic system.2 The Mises theory
is,
in fact, the economic analysis of the necessary consequences of
intervention
in the free market by bank credit expansion. Followers of the Misesian theory have often displayed excessive modesty in pressing its claims; they have widely protested that the theory is

“only one of many possible explanations of business cycles,” and that each cycle may fit a different causal theory. In this, as in so many other realms, eclecticism is misplaced. Since the Mises theory is the only one that stems from a general economic theory, it is the only one that can provide a correct explanation. Unless we are prepared to abandon general theory, we must reject all proposed explanations that do not mesh with general economics.

BUSINESS CYCLES AND BUSINESS FLUCTUATIONS

It is important, first, to distinguish between
business cycles
and ordinary
business fluctuations
. We live necessarily in a society of continual and unending change, change that can never be precisely charted in advance. People try to forecast and anticipate changes as best they can, but such forecasting can never be reduced to an exact science. Entrepreneurs are in the business of forecasting changes on the market, both for conditions of demand and of supply. The more successful ones make profits
pari passus
with their accuracy of judgment, while the unsuccessful forecasters fall by the wayside. As a result, the successful entrepreneurs on the free market will be the ones most adept at anticipating future business conditions. Yet, the forecasting can never be perfect, and entrepreneurs will continue to differ in the success of their judgments. If this were not so, no profits or losses would ever be made in business.

2There is, for example, not a hint of such knowledge in Haberler’s well-known discussion. See Gottfried Haberler,
Prosperity and Depression
(2nd ed., Geneva, Switzerland: League of Nations, 1939).

The Positive Theory of the Cycle

5

Changes, then, take place continually in all spheres of the economy. Consumer tastes shift; time preferences and consequent proportions of investment and consumption change; the labor force changes in quantity, quality, and location; natural resources are discovered and others are used up; technological changes alter production possibilities; vagaries of climate alter crops, etc. All these changes are typical features of any economic system. In fact, we could not truly conceive of a changeless society, in which everyone did exactly the same things day after day, and no economic data ever changed. And even if we could conceive of such a society, it is doubtful whether many people would wish to bring it about.

It is, therefore, absurd to expect every business activity to be

“stabilized” as if these changes were not taking place. To stabilize and “iron out” these fluctuations would, in effect, eradicate any rational productive activity. To take a simple, hypothetical case, suppose that a community is visited every seven years by the seven-year locust. Every seven years, therefore, many people launch preparations to deal with the locusts: produce anti-locust equipment, hire trained locust specialists, etc. Obviously, every seven years there is a “boom” in the locust-fighting industry, which, hap-pily, is “depressed” the other six years. Would it help or harm matters if everyone decided to “stabilize” the locust-fighting industry by insisting on producing the machinery evenly every year, only to have it rust and become obsolete? Must people be forced to build machines before they want them; or to hire people before they are needed; or, conversely, to delay building machines they want—all in the name of “stabilization”? If people desire more autos and fewer houses than formerly, should they be forced to keep buying houses and be prevented from buying the autos, all for the sake of stabilization? As Dr. F.A. Harper has stated: This sort of business fluctuation runs all through our daily lives. There is a violent fluctuation, for instance, in the harvest of strawberries at different times during the year. Should we grow enough strawberries in green-houses so as to stabilize that part of our economy throughout the year.3

3F.A. Harper,
Why Wages Rise
(Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1957), pp. 118–19.