America's Great Depression [Hardcover]

 

 

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Rothbard has been called many things, but a poor writer is one accusation with little validity. Rothbard has consistently presented some of the clearest and most precise writing in any area of economics. What is a clear sign of a weak writing style? WRITING IN ALL UPPER CASE. Read this book, not angry reviews.

Anyone who wishes to understand why Hoover and FDR turned what should have been a deep but short economic contraction needs to read Murray Rothbard's great book, America's Great Depression.

Rothbard begins the book with the Austrian business cycle theory. He notes that because cycles take place in the real economic world there has to be a usable cycle theory that is integrated with general economic theory. Yet, observes Rothbard, most modern economists do not even attempt such an integration and choose to concentrate on various areas of economics that do not seem to relate to others. "Only in the theories of Schumpeter and Ludwig von Mises," writes Rothbard, "has cycle theory been integrated into general economics."

For those that are not well versed in economics, Ludwig von Mises is the great figure in the Austrian School of Economics, a great and uncompromising thinker, and one of the great champions of freedom in the twentieth century. Those interested in the great man might want to look at Ludwig Von Mises: The Man and His Economics or to pick up a copy of Jörg Guido Hülsmann's wonderful book, Mises: The Last Knight of Liberalism when Amazon.ca starts to carry it. (You can find that title on the US site.)

Rothbard goes on to note that, Mises was the one economist to get it right. His theory of the business cycle meshed with the general theory of economics; it explained what must happen when governments and central banks intervene in the markets when they expand bank credit. Rothbard goes observes that, all proposed explanations that do not fit with general economics have to be rejected. That leaves Mises' theory as the only workable alternative because it is, "the only one that stems from a general economic theory, it is the only one that can provide a correct explanation."

Rothbard points out that fluctuations are common and are not a major concern because it is easy for individual businesses to miscalculate and make errors. What is of concern are error clusters that effect entire sectors and the general economy. Given the fact that entrepreneurs are in the business of forecasting and only stay in business by being prudent and generally correct, how can it be that so many entrepreneurs can be wrong at the same time? And why is it, asks Rothbard, that the capital-goods industries experience greater volatility than the consumer-goods industries?

The answer comes from Mises, who argues that the error clusters and capital-goods volatility are the result of monetary intervention in the markets, specifically bank credit expansion to businesses. In a free market economy with a given money supply, some of the money would be used for consumption and the rest would be saved and invested various orders of production. The proportion of consumption to investment would be determined by the time preferences of individuals. (This is the degree to which an individual prefers present to future satisfactions; it is the judgement made by the individual who decides if he wants to spend $1,000 on a flat screen television today or would rather wait a year because the $1,000 in savings will earn an extra $30 over the next year.) In an unhampered market, time preference shows up in the interest rate and provides much needed signals to entrepreneurs that tell them what they should do. The problem comes when central banks intervene and increase the money supply. The cheap money causes consumption to increase but lowers rate and makes long term investments in capital goods industries look profitable. But reality has to intervene and eventually the monetary expansion has to come to an end. When it does, all those investments made in 'higher order' industries far from the consumer are exposed and a crash follows.

This is why consumer goods industries suffer far less than capital goods industries during recessions; people still have to eat, shave, wash their hair, buy toothpaste, etc. But they certainly do not need to make immediate investments in expanding manufacturing capacity or demand a greater supply of steel, copper, etc.

I do not mean to linger and draw out this part but it is very important to go over it because it is critical for understanding the business cycle and why depressions happen. So I will provide Mises' explanation of the general contractor.

Mises asked us to imagine a general contractor who has at his disposal a fixed amount of bricks, the labour of a number of workers, lumber, shingles and all of the things that are needed to build a large house. Suppose, says Mises, that some assistant who was placed in charge of keeping inventory of the bricks gets the count wrong and inflates it by 20%. When the general contractor works with the architect to draw up the blueprint for the house, he overestimates the number of bricks. Because of the error,the project plan becomes unworkable; there are not enough bricks to finish the house as designed. How much is lost depends on when the error is found. If the contractor figures it out when the foundation excavation is done there isn't much waste because putting in some of the dirt back is not very difficult or labour intensive. But if the error is found later in the construction process, the loss is much larger and the house would have to be redesigned and of much poorer quality. The worst case scenario has the error discovered by the subordinates but they cover it up in the hope that the work can continue and that everyone will get paid for as long as possible. In such a case the loss would likely be total with only a small percentage of the investment being recovered through salvage operations.

Mises makes it clear that the error is one of malinvestment of resources. It isn't that the builder tried to build a big house but that he miscalculated how big of a house he could build with the resources given. This is exactly what happens when central banks print money and expand credit through the banking system. They make entrepreneurs believe that there are more resources than there actually are and projects that are begun will have to be abandoned at some point as the resources needed to build them at some planned cost do not materialize. This was what happened in the 1920s and what happened in the 1990s and 2000s when easy credit created investment bubbles that had to collapse. But for some reason the central bankers seem to have missed this lesson. They never admitted that their easy credit policies were creating malinvestments in the general economy that would have to be dealt with at some point. All they did was argue that bubbles were impossible to identify and deal with until after they popped. And the way to deal with the bubbles was to do what created them in the first place; print money and expand credit.

In the second part of the book Rothbard explains how the central bank created an inflationary boom in the 1920s by expanding the supply of money and credit and stimulating both consumption and investment all along the production chain. He explains how the increase of the money supply and a number of other factors created inflation that did not show up in the price level. Inflation, argues Rothbard, is by definition the change in the supply of money and credit and does not always show up in the price level. Think of the collapse in television set or computer prices due to the use of new and better technology even in the face of the increase in the supply of money and credit that showed up in the various general price indices. According to Rothbard, the 1920s should have had a significant price level drop much as was seen during the 19th century when productivity gains caused an increase in the purchasing power of the gold-backed dollar. The reason that such a price decline did not occur had to do with the Fed's expansion of the supply of money and credit and by changes in reserve requirements.

The third part of the book covers 1929 to 1933, when FDR and Hoover managed to turn a correction into an eleven-year long 'Great Depression.' Rothbard makes clear that the myth of Hoover as a laissez faire president who fought for free markets was false. Hoover was actually a meddler, who loved government planning and intervention. Instead of letting the economy adjust and liquidate the malinvestments, Hoover created programs to keep prices and employment high and weak industries afloat. Rothbard explains the damage done by the Smoot-Hawley Tariff, discusses the attack on property rights, and the failure of the currency as people dumped Federal Reserve Notes and redeemed them for gold. He also notes that while wages fell nominally, the Hoover policies caused them to increase by 10% in real terms. As such, no adjustments were made and the liquidation that was necessary to start the system on the road to recovery never took place. (Japan made the same error when the BoJ refused to let weak banks go under and industrial malinvestments to be liquidated. This is the reason why Japan has yet to recover.)

If there is a problem with the book it is that Rothbard ends it in 1933, when FDR took over and outdid Hoover by implementing programs that did further harm to the economy and ensured that a correction would not happen. This is why I would recommend to readers that they take a look at the books, Depression, War, and Cold War: Studies in Political Economy or Depression, War, and Cold War: Challenging the Myths of Conflict and Prosperity, in which he focuses on the issue of 'regime uncertainty,' and shows how FDRs, anti-business actions ensured that the capital formation that was necessary for a recovery did not take place... Read more ›

this is one of the most enraging books I have ever read about anything related to economics. The author seems to forget that underneath ALL of the formulas and "trends" in any field of economics lies WEALTH. REAL, SUBSTANTIAL, PRODUCTIVE, LABOR-RELATED WEALTH. This is something even Keynesian economists fail in recognizing...any book which does not recognize the intervention of FDR's fiscal policy as a return to the philosophy of our founding fathers (IE. Henry Clay, Alexander Hamilton)and the only way we could have possibly survived the depression and the mobilization to fight fascism is a POORLY written book from an author who is obviously misinformed by the popular trash of classroom and related ivory tower academia.

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