America's Great Depression (9 page)

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America’s Great Depression

may actually mean profits for the firm, since assets now cost much less to be replaced. This overstatement of losses, however, restricts consumption and encourages saving; a man may merely think he is replacing capital, when he is actually making an added investment in the business.

Credit contraction will have another beneficial effect in promoting recovery. For bank credit expansion, we have seen, distorts the free market by lowering price differentials (the “natural rate of interest” or going rate of profit) on the market. Credit contraction, on the other hand, distorts the free market in the reverse direction.

Deflationary credit contraction’s first effect is to lower the money supply in the hands of business, particularly in the higher stages of production. This reduces the demand for factors in the higher stages, lowers factor prices and incomes, and increases price differentials and the interest rate. It
spurs
the shift of factors, in short, from the higher to the lower stages. But this means that credit contraction, when it follows upon credit expansion, speeds the market’s adjustment process. Credit contraction returns the economy to free-market proportions much sooner than otherwise.

But, it may be objected, may not credit contraction overcom-pensate the errors of the boom and itself cause distortions that need correction? It is true that credit contraction may overcom-pensate, and, while contraction proceeds, it may cause interest rates to be higher than free-market levels, and investment lower than in the free market. But since contraction causes no positive
mal
-

investments, it will not lead to any painful period of depression and adjustment. If businessmen are misled into thinking that less capital is available for investment than is really the case, no lasting dam-age in the form of wasted investments will ensue.13 Furthermore, in 13Some readers may ask: why doesn’t credit contraction lead to malinvestment, by causing overinvestment in lower-order goods and underinvestment in higher-order goods, thus reversing the consequences of credit expansion? The answer stems from the Austrian analysis of the structure of production. There is no arbitrary choice of investing in lower or higher-order goods. Any increased investment
must
be made in the higher-order goods, must lengthen the structure of production. A decreased amount of investment in the economy simply reduces higher-order capital. Thus, credit contraction will cause
not
excess of investment
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19

the nature of things, credit contraction is severely limited—it cannot progress beyond the extent of the preceding inflation.14 Credit
expansion
faces no such limit.

GOVERNMENT DEPRESSION POLICY: LAISSEZ-FAIRE

If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt? The first and clearest injunction is:
don’t interfere with
the market’s adjustment process
. The more the government intervenes to delay the market’s adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery. Government hampering aggravates and perpetuates the depression. Yet, government depression policy has always (and would have even more today) aggravated the very evils it has loudly tried to cure. If, in fact, we list logically the various ways that government could
hamper
market adjustment, we will find that we have precisely listed the favorite “anti-depression” arsenal of government policy. Thus, here are the ways the adjustment process can be hobbled:

(1)
Prevent or delay liquidation.
Lend money to shaky businesses, call on banks to lend further, etc.

(2)
Inflate further.
Further inflation blocks the necessary fall in prices, thus delaying adjustment and prolonging depression. Further credit expansion creates more malinvestments, which, in their turn, will have to be liquidated in some later depression. A government “easy money” policy prevents the market’s return to the necessary higher interest rates.

(3)
Keep wage rates up.
Artificial maintenance of wage rates in a depression insures permanent mass unemployment. Furthermore, in a deflation, when prices are falling, keeping the same rate of in the lower orders, but simply a shorter structure than would otherwise have been established.

14In a gold standard economy, credit contraction is limited by the total size of the gold stock.

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America’s Great Depression

money wages means that real wage rates have been pushed higher.

In the face of falling business demand, this greatly aggravates the unemployment problem.

(4)
Keep prices up.
Keeping prices above their free-market levels will create unsalable surpluses, and prevent a return to prosperity.

(5)
Stimulate consumption and discourage saving.
We have seen that more saving and less consumption would speed recovery; more consumption and less saving aggravate the shortage of saved-capital even further. Government can encourage consumption by

“food stamp plans” and relief payments. It can discourage savings and investment by higher taxes, particularly on the wealthy and on corporations and estates. As a matter of fact, any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is
all consumption. Some
of the private funds would have been saved and invested;
all
of the government funds are consumed.15 Any increase in the relative size of government in the economy, therefore, shifts the societal consumption–investment ratio in favor of consumption, and prolongs the depression.

(6)
Subsidize unemployment
. Any subsidization of unemployment (via unemployment “insurance,” relief, etc.) will prolong unemployment indefinitely, and delay the shift of workers to the fields where jobs are available.

15In recent years, particularly in the literature on the “under-developed countries,” there has been a great deal of discussion of government “investment.” There can be no such investment, however. “Investment” is defined as expenditures made not for the direct satisfaction of those who make it, but for other, ultimate consumers. Machines are produced not to serve the entrepreneur, but to serve the ultimate consumers, who in turn remunerate the entrepreneurs. But government acquires its funds by seizing them from private individuals; the spending of the funds, therefore, gratifies the desires of
government officials.

Government officials have forcibly shifted production from satisfying private consumers to satisfying themselves; their spending is therefore pure consumption and can by no stretch of the term be called “investment.” (Of course, to the extent that government officials do not realize this, their “consumption” is really
waste
-

spending.)

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21

These, then, are the measures which will delay the recovery process and aggravate the depression. Yet, they are the time-honored favorites of government policy, and, as we shall see, they were the policies adopted in the 1929–1933 depression, by a government known to many historians as a “laissez-faire” administration.

Since deflation also speeds recovery, the government should encourage, rather than interfere with, a credit contraction. In a gold-standard economy, such as we had in 1929, blocking deflation has further unfortunate consequences. For a deflation increases the reserve ratios of the banking system, and generates more confidence in citizen and foreigner alike that the gold standard will be retained. Fear for the gold standard will precipitate the very bank runs that the government is anxious to avoid. There are other values in deflation, even in bank runs, which should not be overlooked. Banks should no more be exempt from paying their obligations than is any other business. Any interference with their comeuppance via bank runs will establish banks as a specially privileged group, not obligated to pay their debts, and will lead to later inflations, credit expansions, and depressions. And if, as we contend, banks are inherently bankrupt and “runs” simply reveal that bankruptcy, it is beneficial for the economy for the banking system to be reformed, once and for all, by a thorough purge of the fractional-reserve banking system. Such a purge would bring home forcefully to the public the dangers of fractional-reserve banking, and, more than any academic theorizing, insure against such banking evils in the future.16

The most important canon of sound government policy in a depression, then, is to keep itself from interfering in the adjustment process. Can it do anything more positive to aid the adjustment? Some economists have advocated a government-decreed wage cut to spur employment, e.g., a 10 percent across-the-board reduction. But free-market adjustment is the reverse of any

“across-the-board” policy. Not all wages need to be cut; the degree of required adjustments of prices and wages differs from case to 16For more on the problems of fractional-reserve banking, see below.

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America’s Great Depression

case, and can only be determined on the processes of the free and unhampered market.17 Government intervention can only distort the market further.

There is one thing the government can do positively, however: it can drastically
lower
its relative role in the economy, slashing its own expenditures and taxes, particularly taxes that interfere with saving and investment. Reducing its tax-spending level will automatically shift the societal saving-investment–consumption ratio in favor of saving and investment, thus greatly lowering the time required for returning to a prosperous economy.18 Reducing taxes that bear most heavily on savings and investment will further lower social time preferences.19 Furthermore, depression is a time of economic strain.

Any reduction of taxes, or of any regulations interfering with the free market, will stimulate healthy economic activity; any increase in taxes or other intervention will depress the economy further.

In sum, the proper governmental policy in a depression is strict laissez-faire, including stringent budget slashing, and coupled perhaps with positive encouragement for credit contraction. For 17See W.H. Hutt, “The Significance of Price Flexibility,” in Henry Hazlitt, ed.,
The Critics of Keynesian Economics
(Princeton, N.J.: D. Van Nostrand, 1960), pp. 390–92.

18I am indebted to Mr. Rae C. Heiple, II, for pointing this out to me.

19Could government increase the investment–consumption ratio by
raising
taxes in any way? It could not tax
only
consumption even if it tried; it can be shown (and Prof. Harry Gunnison Brown has gone a long way to show) that any ostensible tax on “consumption” becomes, on the market, a tax on incomes, hurting saving as well as consumption. If we assume that the poor consume a greater proportion of their income than the rich, we might say that a tax on the poor used to subsidize the rich will raise the saving–consumption ratio and thereby help cure a depression. On the other hand, the poor do not necessarily have higher time preferences than the rich, and the rich might well treat government subsidies as special windfalls to be consumed. Furthermore, Harold Lubell has maintained that the effects of a
change
in income distribution on social consumption would be negligible, even though the absolute proportion of consumption is greater among the poor. See Harry Gunnison Brown, “The Incidence of a General Output or a General Sales Tax,”
Journal of Political Economy
(April, 1939): 254–62; Harold Lubell, “Effects of Redistribution of Income on Consumers’ Expenditures,”
American Economic Review
(March, 1947): 157–70.

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23

decades such a program has been labelled “ignorant,” “reactionary,” or “Neanderthal” by conventional economists. On the contrary, it is the policy clearly dictated by economic science to those who wish to end the depression as quickly and as cleanly as possible.20

It might be objected that depression only began when credit expansion ceased. Why shouldn’t the government continue credit expansion indefinitely? In the first place, the longer the inflationary boom continues, the more painful and severe will be the necessary adjustment process, Second, the boom cannot continue indefinitely, because eventually the public awakens to the governmental policy of permanent inflation, and flees from money into goods, making its purchases while the dollar is worth more than it will be in future. The result will be a “runaway” or
hyperinflation
, so familiar to history, and particularly to the modern world.21 Hyperinflation, on any count, is far worse than any depression: it destroys the currency—the lifeblood of the economy; it ruins and shatters the middle class and all “fixed income groups”; it wreaks havoc unbounded. And furthermore, it leads finally to unemployment and lower living standards, since there is little point in working when earned income depreciates by the hour. More time is spent hunting goods to buy. To avoid such a calamity, then, credit expansion must stop sometime, and this will bring a depression into being.

PREVENTING DEPRESSIONS

Preventing a depression is clearly better than having to suffer it.

If the government’s proper policy during a depression is laissez-faire, what should it do to prevent a depression from beginning?

20Advocacy of any governmental policy must rest, in the final analysis, on a system of ethical principles. We do not attempt to discuss ethics in this book.

Those who
wish
to prolong a depression, for whatever reason, will, of course, enthusiastically support these government interventions, as will those whose prime aim is the accretion of power in the hands of the state.

21For the classic treatment of hyperinflation, see Costantino Bresciani–

Turroni,
The Economics of Inflation
(London: George Allen and Unwin, 1937).