The analysis also suggests something else, however: as the inflation rate goes toward zero, it seems to become “sticky”: in the modern world, rapid deflation doesn’t happen, and in fact slight positive inflation often persists in the face of an obviously depressed economy…

I don’t agree with his conclusions, however.  The evidence can be interpreted in many different ways, especially depending on what other evidence you decide to bring in.  I could, just as easily, claim that present disinflation owes itself to the Federal Reserve’s expansive monetary policy (a policy which is neither super-inflationary, given the liquidity trap, but neither does it allow for the deflation which would have taken place otherwise).  Krugman concludes that this suggests that the Fed’s objective of price stability is misguided, knowing that the main objective should be full employment.  I argue that the evidence suggests that the Fed should have allowed the structure of production to adjust.
But, now we’re back within the domain of positivism versus praxeology; the evidence doesn’t matter, just the theory.

Steven Horwitz writes,

Yes, during 1920-21 we had deflation and yes we didn’t have a Great Depression.  But we did have a significant drop in GDP and unemployment of around 12%, and a recession that lasted about two years.  It’s possible that better monetary policy could have prevented such a steep recession.  I know free banking could have.

While Horwitz makes clear that giving the Federal Reserve the reins of monetary policy is a “second best” solution, he suggests that by increasing the money supply the Depression of 1920-21 would not have been as bad as it was.  I think Horwitz is right to one degree or another (e.g. from the “Rothbardian perspective” one could say that easy money would have just put off a much larger crash, much like many modern Austrians believe current Fed policy will), but it seems that the business cycle argument really comes down to banking theory.

Horwitz writes that a fall in prices, including wages, is bound to make monetary deflation much more painless than it would otherwise be (see wage rigidity during the Great Depression).  I completely agree, but isn’t that the point?  Artificially high prices due to monetary inflation fall with a decrease in the money supply, as investments are liquidated because they are found to be unprofitable.

In any case, I think that 1920-21 shows that money/liquidity is not the overarching necessity for entrepreneurship/investment/production, capital is.  Prices adjust to deflation (decrease in the money supply) without malinvestment, because the capital is idle until prices readjust.  As Murphy writes,

In particular, I think part of why there was a depression in 1920-1921 was that the huge WW1 bubble was popped, since the Fed had become alarmed by the 20% price inflation. So if that’s right, I don’t see how you could have had the corrective readjustment of resources, without most of the pain that they did in fact experience. Ditto for the fiscal policies: I think there had to be a period of “idle resources” as the US economy reconfigured itself from the arsenal of democracy back into the engine of consumerism.

A lot of readers simply decide to shrug off the “specifics” and agree with the more ambiguous idea of “free banking” (i.e. a banking system without a central bank).  Unfortunately, while I’ve decided to do that in the meantime (instead focusing my studies on economic history) it seems like I just can’t get away from banking theory.  Counterfactual historicism regarding ending depressions requires sound knowledge on monetary theory.

So, I guess it’s back to reading Selgin’s The Theory of Free Banking (maybe this time I will actually read it).

Dear Mr. Weisbrot,

While true that Venezuela is not in the same exact situation as Greece regarding their level of national debt, it remains untrue that Venezuela is in a position to pursue “robust economic expansion”. Instead of borrowing credit, the Hugo Chavez junta instead finances its increasing public expenditure through an inflationary fiscal policy. Yes, this is one “advantage” to having your own central bank.

Venezuela suffered a 22% increase in the price level in 2007, 30.9% in 2008 and 25.1% in 2009, while the bolivar’s money base continues to rise at an exponential rate. So, while Venezuela’s export industry “gains” in the sense of increasing volume of trade (but with decreasing profits), the Venezuelan people as a whole become poorer thanks to a loss in purchasing power. Rising GDP figures due to an increase in the amount of money in circulation is not prosperity.

What will occur to Venezuela is exactly what would occur to Greece had Greece maintained the drachma as the national currency – hyperinflation.

Sincerely,

Jonathan

Monetary data is provided by the Banco Central de Venezuela.  I’d also like to point the read towards my piece on government debt and inflation, “Garet Garrett’s Invaluable Lesson“.  One of the most important quotes,

Government cannot print its way out of a debt that adjusts itself to the rise in the supply of money.

2.  “The Limits of Monetary Policy“, Aaron Lieberman:  The important part is the link to the Cato Handbook, but the blog post makes an interesting suggestion, “Milton Friedman always talked about a set increase in the amount of money each year. In this way, the economy would be allowed to expand and at the same time inflation was anticipated.”  I’m not sure that Friedman makes any sense, in this case.  For those who believe you need growth in the money supply to accommodate economic growth having a set rate of inflation seems to be worthless, as the economy would use more or less money.  For Austrians this still ignores the effects of inflation on the relative prices between consumer-goods and capital-goods.

3.  “The Two Faces of Jean-Baptiste Say“, Brad DeLong:  I’m not a fan of DeLong, but nonetheless he presents us with an interesting blog post (for once).  I, unfortunately, don’t own a copy of either book so it’s difficult for me to comment.  Nevertheless, I don’t quite understand what contradiction he’s trying to find, but maybe it’s because I’m looking at the two quotes from a different angle than DeLong (from the angle of an Austrian, with a different understanding of why the business cycle occurs).

4.  Is Greg Mankiw converting to the “dark side”?  He is consistently taking less Keynesian positions, especially in relation to international trade.  Although it’s hard to tell, his quoting of David Brooks yesterday seems to be as sarcastic as mine.  He also announces Jeff Miron’s new book on libertarianism.

The New York Times published a very good article on the suggestions Ben Bernanke made to the Joint Economic Committee today.  Here are the key quotes,

The Federal Reserve chairman said Wednesday that the government must begin to make “difficult choices” to address its gaping deficits and warned that “postponing them will only make them more difficult.”

The chairman, Ben S. Bernanke, said that a “credible plan” for reining in federal deficits could help long-term interest rates and raise consumer and business confidence. “Although sizable deficits are unavoidable in the near term, maintaining the confidence of the public and financial markets requires that policy makers move decisively to set the federal budget on a trajectory toward sustainable fiscal balance,” he said.

In testimony to the Joint Economic Committee of Congress, Mr. Bernanke did not address monetary policy or say how long the Fed would keep short-term interest rates near zero. When the committee’s chairwoman, Representative Carolyn B. Maloney, Democrat of New York, asked him to elaborate on what it meant for the Fed to keep its benchmark rate there “an extended period,” Mr. Bernanke said the time frame was based on “low resource utilization,” subdued inflation and stable inflation expectations.

Basically, Bernanke is banking on easy credit as a means of stimulating investment and consumption.  I’m not going to lie, Bernanke’s position on stimulus and public expenditure confuses me.  He notably opposed a second stimulus bill, which got him heated criticism from Paul Krugman.  But, any Keynesian economists would tell you that we are currently in a liquidity trap.

I sense a flurry of blog posts from both the Keynesian and the Austrian sides.  I’m already typing my article up.

Although I have researched wide and low, including a number of articles available on JSTOR and written by Keynes himself, I have yet to come across a clear explanation of how Keynes’ system would work.  There are vague explanations, but these hardly do Keynes’ idea justice.  Joseph Stiglitz, however, fills in the gap with an upcoming book called The Stiglitz Report: Reforming the International Monetary and Financial Systems in the Wake of the Global Crisis.  It is released on 27 April, and I have already pre-ordered at Amazon.com.

Don’t get me wrong.  I am no fan of Stiglitz’ economics.  Above, I link to my critique of Making Globalization Work (well, I critique three arguments he makes in the book, as a full-on critique of the entire book would require a book of my own).  You can expect something similar for this one.  Nevertheless, given his belief in Keynes’ Bretton Woods idea I am absolutely anxious to start reading The Stiglitz Report.

From the publisher:

The fact that our global economy is broken may be widely accepted, but what precisely needs to be fixed has become the subject of enormous controversy. In 2008, the president of the United Nations General Assembly convened an international panel, chaired by Nobel Prize–winning economist Joseph Stiglitz and including twenty leading international experts on the international monetary system, to address this crucial issue.

The Stiglitz Report, released by the committee in late 2009, sees the recent financial crisis as the latest and most damaging of several concurrent crises—of food, water, energy, and sustainability—that are tightly interrelated. The analysis and recommendations in the report cover the gamut from short-term mitigation to deep structural changes, from crisis response to lasting reform of the global economic and financial architecture.

The report establishes a bold agenda for policy change, both broad in scope and profound in its ambitions, that is sure to be the gold standard for understanding and contending with the international economy for many years to come. The Stiglitz Report is essential

Fears of deflation, prominent a month or two ago, are now rapidly subsiding, and soon may disappear entirely. Nevertheless, deflation is still a subject about which it is important to have a correct understanding.

Deflation is usually thought to be a synonym for falling prices. There could be no more serious error in all of economics. Calling falling prices “deflation” results in a profound confusion between prosperity and depression. This is because the leading cause of falling prices is economic progress, whose essential feature is an increasing production and supply of goods and services, which, of course, operates to make prices fall.

Yet the term deflation is also closely associated with the phenomena of a plunge in business profits and a suddenly and substantially greater difficulty of repaying debts, with the consequence of widespread insolvencies and bankruptcies. The plunge in profits and sudden sharp increase in the burden of debt are, of course, leading symptoms of a depression.

Hence, the proximate cause of prosperity, namely, increasing production and supply, comes to be confused with depression and the widespread impoverishment that accompanies depressions. This, of course, is closely related to the absurdities of the overproduction doctrine, which claims that we are poor because we are rich.

What needs to be realized is that there are two distinct causes of generally falling prices. One is the increase in production and supply, which should never, never be confused with deflation, depression, or poverty. The other is a decrease in the quantity of money and or volume of spending in the economic system. Falling prices is the only effect that they have in common. They differ profoundly with respect to their other effects.[1]

The essential things that need to be understood are that falling prices caused by increased production do not serve to reduce the general or average rate of profit in the economic system and do not make debt repayment more difficult. Indeed, to the extent that such falling prices take place in the face of an increasing quantity of money and rising volume of spending, and result merely from the fact that the increase in production and supply outstrips the increase in money and spending, they are accompanied by a positive elevation of the rate of profit and a greater ease of repaying debts.

Precisely this would be the case under a gold standard, inasmuch as the supply of gold modestly grows from year to year as the result of continued and expanded gold mining operations, and the volume of spending in terms of gold grows commensurately. In such circumstances, the average seller in the economic system would be in the position of selling at lower prices and at the same time have a supply of goods to sell at those lower prices that was larger in greater degree than prices were lower.

For example, if falling prices result from the fact that while the quantity of money and volume of spending in the economic system are rising at a two percent annual rate, production and supply are rising at a three percent annual rate, the average seller in the economic system is in the position of having three percent more goods to sell at prices that are only one percent lower. His sales revenues will be two percent higher, and that is what counts for his nominal profits and his ability to repay debts. His profits will be higher and his ability to repay debt will be greater. There are lower prices here, but absolutely no deflation.

What wipes out profits and makes debt repayment more difficult is not falling prices but monetary contraction, i.e., the reduction in the quantity of money and or volume of spending in the economic system. This is what serves to reduce sales revenues, and, in the face of costs determined on the basis of prior outlays of money, causes a corresponding reduction in profits. It is also what makes debt payment more difficult, in that there is simply less money available to be earned and thus available to be used for the repayment of debts. It is monetary contraction, and monetary contraction alone, which should be called deflation.

Moreover, in the face of any given monetary contraction, the reduction in profits and increase in the burden of debt would in no way be diminished if prices did not fall. Indeed, these phenomena would not be alleviated even if prices rose. Prices would not fall if production and supply fell to the same extent that money and spending fell. They would actually rise if production and supply fell to a greater extent than the quantity of money and volume of spending. But irrespective of what might happen to production, supply, and prices, the same monetary contraction would cause the same reduction in sales revenues and, in the face of the same prior outlays of money showing up as costs, the same reduction in profits. And it would cause the same increase in the burden of repaying debt.

The point is that falling prices are simply not the cause of a plunge in profits and increase in the burden of debt. At most they can be the accompaniment of these things, when all three result from monetary contraction. But they need not even be an accompaniment. For the phenomena of plunging profits and a rising burden of debt, as I’ve just shown, can also be accompanied by rising prices—to the extent that a reduction in production and supply were to outstrip the reduction in money and spending.

What deserves special stress is the fact that even when falling prices are the result of monetary contraction, rather than increases in production and supply, and are accompanied by actual economic hardship rather than by general prosperity, their specific contribution to the situation is not only not that of cause, but of remedy. Falling prices in response to monetary contraction are precisely what enable a reduced quantity of money and volume of spending to buy as many goods and to employ as many workers as did the previously larger quantity of money and volume of spending. Preventing the fall in prices, including a fall in wage rates, serves only to prevent the restoration of production and employment.

Let me put it this way. Deflation is not falling prices. It is monetary contraction. Falling prices are necessary as a response to deflation, which is prior, and which exists whether prices do or do not fall, and can exist even if prices rise. Falling prices in response to deflation are economically beneficial, in that they enable a reduced quantity of money and volume of spending to buy as much as the previously larger quantity of money and volume of spending bought.

In other words, the effect of falling prices is always positive. They should not be confused with deflation or depression and are certainly not their cause. On the contrary, as we have seen, they are a remedy for the effects of deflation. And this is true even for debtors. It is not the level of prices that makes it difficult to repay a debt, but the amount of money one can earn in relation to the size of the debts one must pay. If the average member of the economic system can no longer earn as much money as he used to, and thus finds it more difficult to repay any given amount of money debt, then the fact that prices fall does not make him earn still less. Rather it enables his reduced spending power to buy more. His problem is in the relationship between the amount of money he can earn and the amount of money he must repay. His problem is not caused by a greater buying power of that money.

(And here one can see the macroeconomic absurdity of the New Deal measures in the Great Depression to achieve recovery by compelling the burning of potatoes, the plowing under of cotton, and the slaughter of piglets. Such measures had no power to increase sales revenues, profits, or the ability to repay debt in the economic system. At most, they could increase the sales revenues of selected groups, to the extent that the demand for their specific products was inelastic, and equivalently reduce sales revenues elsewhere in the economic system. Their effect on sales revenues was comparable to that of the so-called “oil shock” of the early 1970s, in which the sales revenues of the oil and other energy-producing industries rose, but at the expense of the sales revenues of the rest of the economic system, which correspondingly suffered. They had no overall, economy-wide effect on sales revenues, profits, or the ability to repay debts. All they served to accomplish on net balance was to make prices higher and reduce the buying power of the funds available—in other words, just to make life more difficult.)

Nor should the prospect of a fall in prices in and of itself be taken as the cause of an increase in the desire to save, still less of an increase in the demand for money for holding and thus of a monetary contraction. To the extent that falling prices are the accompaniment of greater prosperity, the prospect of falling prices is accompanied by the prospect of greater prosperity. The prospect of greater prosperity in the future provides an inducement to greater consumption in the present.

It should be understood as operating in the same way on present consumption as the prospect of coming into an inheritance. It means that one’s future is better provided for and thus that one can afford to increase one’s consumption and enjoyment in the present. This offsets the fact that every dollar withheld from present consumption will have greater buying power in the future. In other words, the effect of falling prices caused by increased production on the degree of saving and provision for the future should be assumed to be neutral, because the prospect of greater future buying power of the monetary unit is offset by the prospect of greater future prosperity. In such circumstances, the prospect of falling prices does not provide a basis for a rise in the demand for money for holding.

The case is different when the need for the fall in prices is caused by monetary contraction. In this case, the failure of prices to fall, in the face of the anticipation that they will fall, to the extent necessary to clear the market of unsold supplies of goods and labor, leads to a speculative postponement of purchases, which increases the pressure on prices to fall.[2] Once prices do fall to the necessary extent, that is the end of the contraction. Indeed, given the existence of a speculative withholding of purchases in anticipation of prices and wages falling to some necessary level, once that level is achieved, the speculative withholding of purchases comes to an end and there is an increase in the volume of spending. In other words, the response to the necessary fall in prices and wages is economic recovery.

Provided the quantity of money in the economic system does not decrease, a rise in the demand for money for holding can have the very beneficial effect of increasing the degree of financial liquidity in the economic system, a valuable point which Rothbard made.[3] It serves to improve such vital measures of financial health as the cash balances businesses hold relative to their current liabilities. It accomplishes this to the extent that it serves to bring down wage rates and prices and thus the dollar amount of current liabilities, which fall as the result of smaller outlays being made and thus smaller bills having to be paid.

The higher is the degree of such financial liquidity, the less is the danger of insolvencies and bankruptcies and thus the greater is the security against any need for further increases in such cash holdings. The implication of this is that increases in the demand for money for holding are self-limiting, and that the demand for money for holding tends to stabilize at the higher level. There is no process of its feeding on itself and endlessly increasing.[4]

Indeed, what creates the need for a sudden, substantial increase in the demand for money for holding is the preceding artificial decrease in the demand for money for holding brought about by credit expansion. Credit expansion leads businessmen to believe that they can substitute for the holding of actual cash the prospect of easily and profitably borrowing the funds they might require. It also encourages a reduction in the demand for money for holding by means of the seeming ease with which inventories can be profitably sold in the face of the rising sales revenues it fuels, which makes it appear better to hold more inventory and less cash. The rise in interest rates that credit expansion serves to bring about in the course of its further progress, as rising sales revenues raise nominal profits and thus the demand for loanable funds, also serves to reduce the demand for money for holding. This is because the higher interest rates serve to make it worthwhile to lend out sums available for short periods of time that it would not have been worthwhile to lend out at lower interest rates. To these factors must be added the influence of any prospect of rising prices that credit expansion may create. And finally, the loss of capital that credit expansion engenders, as the result of the extensive malinvestment that it causes, serves to make credit less available and thus to create a still further demand for money for holding.[5]

Avoid inflation and credit expansion, let the demand for money for holding be high, let prices and wages be adjusted to that fact, and the economic system will be secure from sudden increases in the demand for money for holding thereafter.

Similarly, the best reason in favor of an actual decrease in the quantity of money is that suffering it may serve to avoid a greater, more severe decrease later on. This would be the case under a fractional-reserve gold standard that had not departed too radically from a one-hundred-percent-gold reserve. In such circumstances, a reduction in the quantity of money in the form of fiduciary media[6] could bring the quantity of money down to the supply of actual monetary gold and thus both retain the gold standard and avoid the need for a more severe and potentially catastrophic reduction in the quantity of money later on—the kind of reduction that occurred from 1929 to 1933, after decades of expanding the supply of fiduciary media relative to the supply of gold.

Deflation, which, it cannot be repeated too often, means monetary contraction, not falling prices, is at best in the category of a pain to be endured only in order to avoid greater pain later on. It should never be, and virtually never is, regarded as any kind of positive in its own right. Indeed, opposition to credit expansion, and to the fractional-reserve banking system that makes credit expansion possible, rests for the most part precisely on the fact they are responsible for deflation, which would not exist in their absence.

The most important point I have made, namely, that falling prices caused by increased production are not deflation and should never be confused with deflation, is illustrated by the following table, which can be taken as a summary of this article.

____________________________________________________________

[1] This is something I’ve explained at length in my book Capitalism: A Treatise on Economics, pp. 544–46, 557–59, 573–80, 809–20 and in an article “The Goal of Monetary Reform,” The Quarterly Journal of Austrian Economics, Fall 2000, vol. 3, no. 3, pp. 3–18.

[2] Concerning this point, see Ludwig von Mises, Human Action 3rd ed. rev.  (Chicago: Henry Regnery Company, 1966),  pp. 568–70; Murray N. Rothbard,  Man, Economy, and State (Princeton, New Jersey: D. Van Nostrand Company, Inc., 1962), pp. 112–14, 673–75.

[3] Murray N. Rothbard, What Has Government Done to Our Money? (Novato, California: Libertarian Publishers, 1964), pp. 14–16.

[4] See Rothbard, Man, Economy, and State, p. 675.

[5] On this last point, see Mises, op. cit., pp. 550–66, p. 568.

[6] Fiduciary media are transferable claims to standard money, in this case gold, that are payable on demand by the issuer and accepted in commerce as the equivalent of standard money, but for which no standard money actually exists.

[7] This table is taken from my article “The Goal of Monetary Reform,” The Quarterly Journal of Austrian Economics, Fall 2000, vol. 3., no. 3, p. 14.

While reading, you often find yourself stopping and asking yourself what you had just read.  The sentence structure is poorly constructed, and the text is very unclear.  Unless you really take the time to go back, re-read and make sure you understand, it is extremely easy to take what Hayek wrote out of context.  Alternatively, it also rather easy to misinterpret what Hayek wrote.  The topic covered by Friedrich Hayek was controversial (it was, and it still is), and so the temptation to misinterpret him increases by that much more.

In Chapter 4, “The Fundamental Cause of Cyclical Fluctuations”, he re-interprets Ludwig von Mises’ conclusions that it was central banking which caused the business cycle.  He does this to correct the error in many critics’ writing that what was to be called the “Austrian theory of the business cycle” was not exogenous, but endogenous.  That is, cyclical fluctuations are not a product of outside influence (i.e. central banking), but of factors inherent in the “existing credit organization”.[1] In other words, he specifies that business cycle are not the product of central banking per sé, but of fractional-reserve banking; he, of course, concedes that central banks usually make credit expansion much more widespread than it would have otherwise been.[2] The point of controversy is in whether or not the business cycle is intrinsic in the capitalist system.

Many “Austrians” before and after Friedrich Hayek maintain that fractional-reserve banking is not of natural ilk of the market.  Economists such as Ludwig von Mises[3], Murray Rothbard and Jesús Huerta de Soto operate under the strong belief that in a free market in banking fractional-reserve banking would be eradicated.  Monetary Theory was published in 1929, and it is very possible that Hayek’s opinions on banking changed in the years after, but at least at the time Hayek disagreed with these economists.

He wrote:

The determining cause of the cyclical fluctuation is, therefore, the fact that on account of the elasticity of the volume of currency media the rate of interest demanded by the banks is not necessarily always equal to the equilibrium rate, but is, in the short run, determined by considerations of banking liquidity.

What he is saying is that the interest credit is lent at is not always the “equilibrium rate” (natural rate of interest), but an interest rate dictated by the expansion of fiduciary media as determined by the requirement of liquidity for each individual bank.  Unlike Mises, Hayek does not provide for natural limitations in credit expansion.  So, Hayek concludes later on:

If it were possible, as has been repeatedly asserted in recent English literature, to keep the total amount of bank deposits entirely stable, that would constitute the only means of getting rid of cyclical fluctuations.  This seems to us purely utopian.  It would necessitate the complete abolition of all bank money—i.e., notes and checks—and the reduction of the banks to the role of brokers, trading in savings.

He continues:

The stability of the economic system would be obtained at the price of curbing economic progress.

Certainly, Hayek provides much food for thought.  Previously, he asserted (not quoted above) that the existing “credit organization” was formed out of demand, and naturally.  This is a position held today by members of the so-called Free Banking school, which although defenders of a free market in the financial sector, maintain that fractional-reserve banking would be practiced. Now, there are several free bankers who disagree with the premise that credit expansion leads to business cycles; at least Hayek establishes that the business cycle is a product of fractional-reserve banking.  Nevertheless, Hayek’s beliefs as espoused in Monetary Theory and the Trade Cycle pose a dilemma.  Is the business cycle avoidable?

Given Hayek’s writing style—seemingly designed to confuse—it is not difficult to mistake his intentions.  However, it is possible that Friedrich Hayek wrote these words under the explicit intent to provide credibility to his argument by accepting the existing banking system.  So, rather than argue that the banking system could be reformed in such a way in which the business cycle would largely cease to exist, he conceded the point and simply focused on the topic of the monetary origins of such economic cycles.  Or, Hayek could have simply believed that fractional-reserve banking was a natural process of the market, and as such cyclic fluctuations were also natural processes of the market.

Certainly, Hayek makes some good points.  It is clear that by simply reading older generation of Austrian economists one cannot come to a suitable conclusion on whether or not fractional-reserve is “healthy”.  They provide good foundations to make one’s own deductions.  Hayek’s conclusions in Monetary Theory and the Trade Cycle make for good debate.  For example, Hayek believed that fractional-reserve banking sped up the process of economic progress.  If Hayek is right in his assertion that credit expansion makes capital-goods seem more profitable in relation to consumer-goods, and that this is the cause of malinvestment, he suggests that the majority of investment which takes place during a boom does not actually lead to economic progress.  Is he contradicting himself?  But, empirically, one can derive that during past booms there was plenty of economic progress.  Surely, after the necessary credit contraction stabilized, the economy was usually more advance than it was prior to the boom.  Does it follow that credit expansion leads to faster progress?  Or did the progress occur as a simultaneous phenomenon to the malinvestment created during the credit expansion?  These are examples of questions which must be debated if there is there ever to be consensus on whether or not fractional-reserve banking is healthy and is natural.

With the onslaught of Austrian literature on 100-percent reserve banking, mainly spearheaded by Hulsmann, Block and Huerta de Soto (all three influenced by Murray Rothbard), Hayek’s insights are surely important.  He brings to attention, to both the 100-percent reservists and the free bankers, several points which must be ironed out before an accurate theory on banking is completely laid out.

[1] Hayek (2008), pp. 75–78.

[2] For an explanation of credit expansion under different banking systems (single bank versus multiple banks versus a banking monopoly) see:  Huerta de Soto, Jesús, Money, Bank Credit and

[3] In Marxism Unmasked, Mises maintains that credit expansion would be kept to a minimum by natural means (fiduciary media would quickly be turned in to redeem their value in commodity money and the money supply restored to a stable volume).

One of the major disputes revolves around the question of whether or not the Federal Reserve took action to provide liquidity to failing banks.  In Free to Chose, Milton Friedman suggests that the decline in money stock between 1929 and 1933 represents the Federal Reserve’s inaction in the face of deflation.[1] Other economic historians have taken a similar stance.  For example, in his book on Roosevelt’s New Deal, Burton Folsom writes, “In the early 1930s, the Fed dithered and let the runs on banks continue.”[2] Murray Rothbard suggests something radically different, in America’s Great Depression, offering statistics on the expansion of controlled reserves by part of the Federal Reserve.  In fact, as early as the last week of October 1929 the Federal Reserve bolstered bank reserved by nearly $300 million, he claims and lowered the rediscount rate by 1½ percent by November.  He goes a long way in explaining why there was a general decrease in the money supply: “…controlled reserves increased by $359 million (with government securities the overriding factor), while uncontrolled reserves fell by $381 million.[3] Regardless if the Federal Reserve did, in fact, attempt to inflate the credit supply as early as late 1929, the fact of the matter that there was a deflation in the money supply between 1929 and 1932 due to a decrease in uncontrolled reserves, which outstripped any attempts to increase the Federal Reserve’s efforts.  The difference is that in the case of today’s recession, under Ben Bernanke the money supply has been growing at an accelerating pace.

Economist Jesús Huerta de Soto makes the argument that a recession can be temporarily avoided if the Central Bank creates money at an accelerating, or exponential, rate.[4] The ultimate conclusion to such a policy is still the inevitable reallocation of resources by the market, but only after a continued illusion of wealth—ultimately, such a policy will also lead to hyperinflation.  Therefore, unless the Federal Reserve suddenly ends the expansion of credit, there is the chance that the illusion of a recovery will be created.

As already explained, there are key differences between the Federal Reserve’s responses to either financial crisis; there is a minor similarity between the Federal Reserve’s policy between 1933 and 1936 and Ben Bernanke’s current fiscal policy.  It is generally accepted that in 1933 the United States economy had bottomed out.  At that time, the Federal Reserve continued its inflationary policy by expanding the money supply.  However, since the economy had bottomed out uncontrolled reserves were not decreasing at greater rates than controlled reserves, leading to a visible increase in the monetary base.  Simultaneously, Roosevelt continued and accelerated Hoover’s public works projects, sparking what was known as the New Deal.  Amongst the two, the latter has been at the forefront for explaining either why a recovery occurred at all after 1933, or why the recovery took so long to complete.  To a large degree, the former has been all but ignored.  However, the latter becomes more relevant when considering that in 1937 the economy suffered another downwards spike, which lasted for two years, largely undoing whatever recovery had taken place between 1933 and 1936 (although, this downturn was not as dramatic as the downturn of 1929–32).

The 1937 downturn, since then called Roosevelt’s Recession, has not been a major topic in any historical overview of the Great Depression.  The majority of books which deal with Roosevelt focus on the New Deal between 1933 and 1936, with only a scant look at the events of 1937 and 1938.  As it turns out, Roosevelt’s Recession of 1937 may be more relevant to the current financial situation in the United States than the Crash of 1929.  This is because we may be headed in the same direction.

Although the 1937 recession is only a minor focal point, that is not to say that economists have not drawn their own conclusions in regards to the causes of this event.  Keynesian economists, such as Paul Krugman and Jeff Madrick cite Roosevelt’s objective to balance the budget,[5] while Keynesians and Monetarists alike blame the Federal Reserves sudden tightening of the money supply.[6] Nevertheless, these opinions have drawn two inevitable conclusions: one, the government must (seemingly) perpetually provide public goods by spending more money than collected through tax receipts, and two, the Federal Reserve should not increase interest rates, or at least should better calculate when to finally allow an increase in interest rates.  Now, the relationship between the period marked between 1933 and 1936 and the current financial situation in the United States should be clear.  Currently, controlled reserves are rising at a rate at which despite any possible decreases in uncontrolled reserves the monetary base is growing exponentially.  Furthermore, there is the risk that Obama will actively support the largest deficit spending programs in the fiscal history of the United States government.  If the conclusions of the 1937 recession are that bringing these two policies to an end will only lead to another recession, the country currently runs a real risk of complete and utter collapse when the people lose faith in both their government and their currency.  Therefore, the recession of 1937 merits a closer look and the pervasive mistakes made by Keynesian and Monetarist economists should be corrected.

Admittedly, of the two schools of thought, the Monetarists are probably closer to the truth.  What they fail to realize is the impossibility of calculating when to end credit expansion.  In two occasions during the Great Depression a sudden end to credit expansion ended in recession: 1929 and 1937.  Furthermore, during other recessions, notably during that of 1921, increases in the reserve ratio requirement as set by the Federal Reserve did not end in a lengthened period of recovery.  Instead, the 1921 downturn was one of the worst in the economic history of the nation, but one of the quickest.[7] It becomes obvious that the issue is not related to the sudden increase in interest rates by the Central Bank.  And so, while the Monetarists remain half-right, an Austrian approach must be made to this era as to provide an accurate lesson to apply to the current recession, and most importantly to correct the dangerous and false lessons as extracted by the Keynesian and Monetarist schools of thought.

Austrian economists are fighting an uphill battle to end the monopoly on money commanded by the Federal Reserve and ever-growing government fiscal interventionism.  Their most powerful case, the 1937 recession, has largely been ignored.  Most publications have avoided the topic altogether, focusing instead on the New Deal.  The only Austrian explanations are largely as a result of the work of Benjamin Anderson, in Economics and the Public Welfare, and Vedder and Gallaway in Out of Work.  A dedicated Austrian explanation of 1937 is in order, as it would severely undermine any pro-centralization arguments provided by rival schools of thought.

As with any historical study of a recession, explaining the downturn of 1937 requires a close examination of the fiscal policies which preceded it.  In this case, in order to show what made the crash of 1937 possible and to disprove Keynesian and Monetarist theories, we must put the events of 1933 through 1936 under a microscope.

Hoover’s response to the October 1929 crash

Although we are concerning ourselves with the events which took place between 1933 and 1936, a brief overview of Hoover’s response to the beginning of the recession in October 1929 is important.  It will show that Roosevelt’s New Deal was not unique, and that a nearly identical program was originally ignited under Hoover’s administration.  This is important because after one has an understanding of the true scale of Hoover’s fiscal spending figures one can deduct that if government spending did not work during the first three years of the 1930s, there is no reason that it should have worked during the next four, either.  In fact, in many ways Roosevelt’s New Deal damaged a recovery by forcing industry to comply with unnecessary restrictions and regulations, disallowing a serious effort to invest.  However, it is also worth noting that the Federal Reserve’s consistent attempts to counteract decreases in bank reserves due to uncontrolled withdrawals also hampered the quick liquidation of unhealthy assets, causing a longer than usual contraction.  Understanding the Federal Reserve’s actions during the first four years of the Great Depression will provide a historical background which explains why the monetary expansion during Roosevelt’s first term and beginning of his second term were not arbitrary.  In other words, the first four years of the Great Depression go a long way in explaining the trends which would continue to exist throughout the Roosevelt administration, up until the beginning of the Second World War in Europe (it was at this time that the United States Armed Forces began a massive mobilization effort to prepare themselves for eventual war across the Atlantic and Pacific Oceans).

The Federal Reserve responded to the bank’s loss of liquidity after the original crash of October 1929 by shoring up bank reserves by adding roughly $300 million to the money supply by November of that same year.  Between October and December controlled reserves had risen by $359 million, while uncontrolled reserves had fallen by $381 million.  As a result, there was an estimated $21 million decrease in bank reserves for the first three months of the Great Depression.[8] 1930 saw the beginnings of an even greater inflationary process, with the New York Federal Reserve reducing the rediscount rate from 4½% in February 1930 to 2% by the end of that same year.  However, again, despite the Federal Reserve’s inflationary measures, the money supply fell by roughly 250 million dollars.[9] Although the Central Bank continued in its effort to pump money into the system it failed in its efforts to create more money than was being lost through the decline in uncontrolled reserves, meaning that throughout 1931 and 1932 there was still a decline in the money supply.  The claim that the Federal Reserve did nothing to counteract the deflating effects of the bust bases its factual evidence on the general decrease in the volume of the money supply.  Monetarists need to take a closer look at the history of the United States’ money supply during this era, and need to account for why the decrease in the money supply was so gradual.

It was not only the Federal Reserve which quickly moved to impede a quick liquidation in 1929.  Hoover too took matters into his own hands, beginning a large fiscal spending program in an effort to relieve unemployment and bolster aggregate demand.[10] Total government outlays in 1932, for example, amounted to $4.659 billion, which was higher than the federal expenditure of 1933 under President Roosevelt ($4.598 billion).[11] During Roosevelt’s presidential campaign, the Democratic candidate consistently attacked Hoover for his high fiscal spending, considering Hoover’s decisions during his four-year term as “reckless and extravagant” and promoting his own objective of balancing the budget.[12] Hoover also did much to regulate the labor market, believing that by maintaining high wage rates the economy would recover.[13] Instead, high nominal wages—despite a decrease in the general price level—caused a massive loss of profit.  For example, the First National City Bank of New York reported that less than six percent of banks surveyed were reporting losses in mid-1929.  This percentage skyrocketed to 29 percent by the third-quarter of 1930.[14] Hoover’s high-wage policy backfired, as a decline in loanable funds helped gross private domestic investment fall by over 65 percent between 1929 and 1931.[15] Hoover’s intervention during his four year term as president served only to exacerbate the economic rut which would be known as the Great Depression.

Roosevelt’s New Deal, which unfolded mainly between 1933 and 1936, was not unique.  As aforementioned, Roosevelt had been an insistent critic of Hoover’s big-spending government programs during the 1932 election campaign.  In fact, Hoover’s final year of spending saw a higher amount of tax money spent than Roosevelt’s first year.  Although, ultimately, Roosevelt’s deficits would be much larger than those of Hoover, it would be fair to state that Hoover was no “laissez-faire” president.  Furthermore, it is clear that there was no lack of effort on part of the federal government and the Federal Reserve to actively intervene to stall the downward plunge the United States economy was experiencing.  Did this intervention help assuage the final effects of the depression?  One could certainly assume that the economy would have bottomed-out in worse condition.  However, when proponents of the New Deal argue that Hoover was laissez-faire they inadvertently recognizing that the economic condition of the country in 1933 was as bad as it could have been. Any attempts to protect Keynesian theory therefore must be subject to suspicion.  Besides, how does one quantify what the state of the economy would have been otherwise?  Indeed, empirically speaking, recessions tended to last for much shorter periods of time when there was a lack of intervention—the little spoken of recession of 1921–22 serves as the perfect example.

New Deal: Fiscal expenditure, money supply, and the Federal Reserve

The policies enacted and carried out by the Franklin Roosevelt administration between 1933 and 1936 had severe consequences on the state of the national economy during that same period and after.  Beforehand unforeseen and unimaginable levels of public spending, and accompanying high taxation, brought about four years of uncertainty, economic stagnation and individual poverty.  It was not until the National Industrial Recovery Act was overturned by the Supreme Court in 1935 that business investment would again pick up, leading to a short period of relatively high economic growth.  This growth spurt suddenly came to an end in the autumn of 1937.  In its place came a renewed period of decline in productivity and an increase in unemployment.  A number of theories have been developed in order to explain this sudden and unforeseen recession.  Most of them are wrong.  In order to understand why these theories are wrong one should have an elementary grasp on the policies of Roosevelt, why they did not help lift the United States out of depression and why they actually contributed to the causes of the 1937 downturn.

Perhaps the most damaging of economic policies—as far as industrial productivity is concerned—was the National Industrial Recovery Act (NIRA), enacted in 1933; it would later be renamed the National Recovery Act (NRA).[16] The NRA cartelized a large number of industries nation-wide and placed minimum prices for the goods and services provided by these industries.  The consequences were dire for those who could only manage to compete against larger companies by decreasing their prices; many small businesses were driven off the market.[17]

For example, under the legislation imposed by the NRA Goodyear, Goodrich and Firestone were able to organize and fix tire prices artificially high.  Since it was illegal to sell tires at a price lower than the price agreed upon in the code provided by the NRA (which was written by the three aforementioned national tire producers, as directed by the government), the large tire corporations did not have to risk losing some of their market share to local tire companies which competed by offering their product at cheaper prices.  For local and small businesses, the effects were incredibly damaging—they simply could not compete, as their product was now too expensive and they could not offer the same services that the larger firms had the infrastructure already built for.  Furthermore, artificially high tire prices also meant that foreign consumers simply substituted American tires for those of another foreign company.[18]

But, tires only constituted a fraction of what the NRA price-fixed.  In fact, the NRA intervened in almost every single major industry in the United States by dictating the prices of the goods being sold (not to go below “production costs”), the price of labor, how a company could conduct business, et cetera.  Small businessmen who tried to avert fiscal disaster by ignoring NRA code were oftentimes imprisoned.  Unsurprising, a large number of small businesses were forced to close, causing the unemployment rate to increase.  The NRA was little more than government-imposed monopolization and cartelization of the most important industries in the national economy.[19] It comes as little surprise that the Supreme Court deemed the NRA unconstitutional in 1935 (nine votes to none).[20] During the three years of its duration, the NRA would be a root cause of much of the uncertainty which precluded entrepreneurs from investing and stalled a systemic economic recovery in the United States.[21]

The New Deal programs were expensive, and this manifested itself in the annual increases in fiscal outlays.  For example, in 1933 the Federal Government spent 4.598 billion Dollars, while in 1934 this increased to 6.541 billion.  By 1936, government spending had soared to 8.224 billion.[22] This caused taxes to increase throughout the Great Depression.  In 1935, the top income bracket ($5,000,000 and above), in the state of New York paid roughly 69.9 of their income in taxes to the Federal Government.[23] By the late 1930s, the average income tax rate for the top income bracket was 79%.[24] As Henry Hazlitt eloquently pointed out in Economics in One Lesson, “taxes discourage production”.[25] High tax rates proved a burden on entrepreneurs, and went a long way in explaining why productivity growth in the United States was as low as it was for what turned out to be the entire length of the Great Depression.

All the while, despite the government-induced repression of entrepreneurship and investment, the Federal Reserve and the Federal Government continued with its expansionary fiscal policy.[26] Several events out of the control of the Federal Reserve also played a part.  Foreign events, such as the rise of Hitler in Germany, catalyzed the return of large gold stocks to the United States between 1934–41.  Member banks who originally imported the gold then sold it to the Federal Reserve for Federal Reserve notes, inflating their reserves and driving interest rates down.[27] It should be remembered, though, that in 1934 the price of gold was fixed at $35 per ounce, instead of the original price of $20.67.[28] Between 1933–37, the money stock increased by 46%, while wholesale prices rose by 31%.[29] Federal Reserve controlled interest rates, such as the rediscount rate, remained relatively level for nearly three and a half years, while credit outstanding remained at an average of $177 million.[30] The rise in the stock of money should be credited to the price-fixing scheme on gold, imposed by the government.  Despite low and constant interest rates,[31] stagnating investment prior to 1936 was due, almost exclusively, to the immense regulation imposed upon business by the NRA.[32]

1937 Recession: Expansion, Malinvestment, Uncertainty and Crash

If the Great Depression lasted as long as it did between 1933 and 1935, it was because of the interventionist policies adopted by the Roosevelt administration.[33] However, the Supreme Court’s decision to rule the NRA unconstitutional in 1935 caused resurgence in investment, and a period of quick growth.  By 1937, gross real domestic product had recovered 96-percent of its pre-1929 value and gross real investment 64-percent.[34] Production of durable goods increased, seeing its first sustained positive growth trend, and the gap between the production of durable and non-durable goods began to close.  The Federal Reserve’s Index of Production (using 1923–25 as the base years) rose to 104 by December 1935, which was a record high since 1930, and remained at over 115 throughout the middle and end of 1936, sometimes shooting even beyond 120.  Industrial production rallied until the third quarter of 1937.[35]

Although the recovery had already taken place for quite some time, 1935 and 1936 signaled the final years of this continuous recovery, and there was a drop in uncertainty.  However, this growth in productivity was outstripped by growth in nominal and real wages, thanks largely to the Supreme Court’s decision to uphold the National Labor Relations Act of 1935 and to the introduction of the Wagner Act.[36]

Real wages had, in fact, decreased sharply in 1935 and 1936, largely aided by the Supreme Court’s decision to overturn the NRA.  This trend proved short lived.  In 1937, for example, wages increased by 11.6-percent, thanks to the Supreme Court’s defense of the National Labor Relations Act, and also to the influence of the Social Security Act.[37] To illustrate the impact of the latter, fringe benefits, or supplements to standard wage bills, rose from 1.4-percent in 1935 to 4.2-percent in 1937.  Accounting for the majority in the rise of the cost of supplements was the required employers’ contributions towards social insurance, which rose from 25 to 71-percent of the total cost of the supplements, by 1938.[38] This was all complemented by the effects of the Wagner Act, which instigated a rise in union activity since 1936.[39]

The 1937–38 recession was catalyzed by a bear market rally in the stock market, starting on 27 August 1937.  The market closed on 26 August at 190.38, falling to 175.09 by the end of 27 August.  By 31 March 1938, the market had fallen to a low of 97.46.  Surprisingly, weekly business figures still pointed towards a positive direction, and sales and productivity figures did not match the worsening situation at Wall Street.[40] What explains this break in the market was ever increasing taxes on profit, reducing incentives to invest in the stock market, as well as the elimination of inside trading, which disallowed quick readjustments to real market values for relevant stocks.  The result was a very “thin” market, where relatively minor decreases in purchasing and selling could cause very dramatic changes in prices.[41] Thus, increases in uncertainty caused by a retreat in the Supreme Court’s fight against Roosevelt’s labor programs managed to instigate an extraordinary fall in the price of stocks.  With the downward market trend and increasing uncertainty, it was due time that the effect of high real wages finally began to set in.  Despite an increase in commercial loans during the onset of the recession, business began to waver due to a decrease in profitability.[42]

We come to find that the main contributing factor behind “Roosevelt’s Recession” was a substantial increase in real wages in 1937, to a large extent caused by increased union activity and by national legislation (such as minimum wage laws).  However, Benjamin Anderson upholds that businesses continued to attempt to maintain these high wages by reducing costs elsewhere.  The growth in industry also continued for quite some time, despite the high wages.  Therefore, although the loss in profitability was what caused a sharp decline in industrial production, gross domestic product and real investment, the direct catalyst for the downturn was uncertainty amongst market investors.  Further, it is difficult to believe that there was such a dramatic drop in industrial output simply as a result of the high costs in labor.  It becomes evident that the money supply played a bigger role in the ensuing recession than is previously accepted.  Although, as explained above, there was limited monetary expansion done by the Federal Reserve System, there was a tremendous increase in the money supply thanks to the government’s decision to increase the fixed price of gold.  The Federal Reserve facilitated the conversion of gold into bank notes for recipient member banks.  The result was a swelling in the size of bank reserves.  This monetary inflation ultimately did create extensive malinvestments, which were kept up even during the initial months of the recession.  But, what seemed profitable during times of low interest rates would no longer after banks began to retract their loans.

There was a substantial decrease in the money supply between late 1937 and the end of 1938.[43] This has been attributed to an increase in reserve requirements by the Federal Reserve.[44] Although Kenneth Roose’s thesis that the increase in the reserve requirements led to a decrease in the price of government bonds,[45] the theory that the increase in reserve requirements led to a contraction of the money supply is much less empirically satisfying.  This was not the first time the Federal Reserve had increased reserve ratio requirements; indeed, they had done so in 1922, and that recession was over with fairly quickly.[46] Joseph Salerno suggests that the monetary contraction was a result of the recession, not a factor of, explained by the idea that banks began to retract on their loans due to increased uncertainty after the initial decline in the stock market and because of falling business profits, due to high artificial wages.[47] In light of evidence provided by Benjamin Anderson, it seems as if Salerno’s explanation is more appealing.  As aforementioned, the volume of commercial loans increased despite an increase in the reserve ratio requirement, as did the volume of brokers’ loans and the total amount of securities being sold.[48] It was only after the initial crash that total amounts of loan began to contract from the peak established in the middle of 1937.[49]

Increasing reserve ratio requirements did not play a major role in influencing the beginning of the 1937 recession.  Rather, as already conclude, it was an increase in the price of labor and in uncertainty due to several decisions being made congruently by the Supreme Court.  It was only after the initial shock of a declining stock market that banks began to curtail the volume of loans pending and the money supply began to contract, revealing a large amount of malinvestments and disallowing businessmen from continuing to pay such high wages to their employees.  The result was a very severe contraction, flying in the face of the vaunted “recovery” taking place between 1933 and 1936.

Dangerous lessons

There are two major alternative theories of what caused the 1937 recession.  Both of them were alluded to in the opening paragraphs of this essay, and one of them was expounded directly above.  The theory of doubling reserve ratio requirements has already been refuted.  The danger of the continued perpetuation of that theory is clear.  We can see the results of the continued widespread belief in the validity of said theory in the actions currently being undertaken by the Federal Reserve, led by Chairman Ben Bernanke.  In an effort to supposedly avoid such an event of occurring again, the Federal Reserve is intent on stimulating the money supply for as long as possible, until the economy fully recovers.  If Austrian theory is correct, however, this will simply cause more malinvestment, cause a secondary dip in productivity and prolong the recession.  The effects of this can already be seen in the Great Depression, where despite great pressure against entrepreneurship by the Federal government there was still growing investment (and malinvestment).  An increase in uncertainty and a resulting contraction of the money supply, along with a loss in profitability due to high wages, led to a major contraction in wealth in late 1937 and 1938.  The effects of the 1937 recession were limited to the limited recovery which had taken place up to that date.  Without such restrictions (at least, the same degree of restrictions) in place today, we may find that the level of malinvestment will much greater than that of 1935–36.  We are risking a much more dangerous “second recession” (otherwise known as the infamous “double dip”).

The second alternative cause was a decrease in the government deficit.[50] Apart from the fact that a drop in government spending did not result in widespread recession after the Second World War, and the fact that Herbert Hoover’s deficits did nothing to assuage the great contraction which took place between late 1929 and 1932, this theory is unsound.  First of all, a reduction in government deficit does not immediately mean that there was an equal reduction in government spending.  In 1936, the annual government deficit stood at $4.3 billion, in contrast to the deficit of $2.193 billion ran during 1937.  However, total government outlays decreased only from $8.228 to $7.580 billion.  Interestingly, the deficit in 1935 was at $2.803 billion, while total federal spending was actually lower than both 1936 and 1937.  Meanwhile, while the economy managed to begin recovery anew by late 1938, the fact remains that the government deficit for 1938 was only 89 million!  What explains a decrease in the deficit between 1935 and 1936 was an immense increase in total receipts; from almost four billion in 1936 to $5.3 billion in 1937.[51] If this is not enough, month by month government expenditures during 1937 and 1938 did not change wildly, and unsurprisingly, the months of surplus saw hikes in expenditures.  The surpluses owed their existence entirely to the fact that these months fell in line with tax months.[52] Given these statistics, it cannot follow that the decrease in the deficit is at fault for the contraction of 1937.  The entire position, in fact, is untenable.

Although it is easy to see that a decrease in government spending, or deficits, was not the cause of the contraction, the belief that it was proves a very dangerous threat.  Christina Romer used the explanation in support of her agenda to keep the current government’s fiscal stimulus rolling.  These gargantuan fiscal packages require the exact same amount in receipts, even if the government operates at a deficit over the short-run.  An increase in government spending will lead to an increase in taxation, which will lead to a decrease in investment and the introduction of economic stagnation.  The myth that a decrease in government spending will lead to economic collapse must be firmly corrected; all empirical evidence suggests that economies run much more smoothly when there is less government spending, in fact.  What these stimulus packages really represent is dirty money being funneled to government cronies, while conveniently stolen from taxpayers blind to the true intent behind the government’s action.

The facts outlined in this essay only lead to one sensible deduction.  A true recovery will only take place in an economy free of the shackles of government intervention and central monetary control.  These tyrannical institutions consistently publish counterfactual evidence in an attempt to solidify their purpose and legitimacy.  They are greatly helped by a vast armada of historians and economists who are either on their payrolls or for some reason have fallen to their false ideas.  Over the long-run, “perfect” (perfect in the sense that the maximization of utility for each individual will be allowed to be sought, not perfect in the sense of maximum efficiency) economic growth is only possible in a society free of coercion; that is, free of government.

It remains important to separate the truth from fallacies.  The events of 1937 prove to be the perfect case study against current institutional programs to aid an “economic recovery”.  This essay has shown how greater government spending will not cause economic growth, while most importantly, a decrease in government spending will not catalyze economic contraction.  Finally, this essay also makes apparent that the Federal Reserve’s monetary policies lead to the creation of illusionary wealth and real destruction of wealth.  Continued easy money schemes will not lead to recovery, only to greater pain.

[2] Folsom Jr., Burton, New Deal or Raw Deal?  How FDR’s Economic Legacy Damaged America, Threshold Editions, New York: 2008; p. 33.

[3] Rothbard, Murray, America’s Great Depression, BN Publishing: 2008; p. 191–192.

[4] Huerta de Soto, Jesús, Money, Bank Credit, and Economic Cycles, Ludwig von Mises Institute: 2009: pp. 404–405.

[5] Murphy, Robert and Madrick, Jeff, Was the New Deal a Raw Deal?

[6] Roose, Kenneth D., Federal Reserve Policy and the Recession of 1937–1938, The Review of Economics and Statistics, Vol. 32, No. 2: May 1950; p. 178.

[7] Vedder, Richard K. and Gallaway, Lowell E., Out of Work: Unemployment and Government in Twentieth-Century America, New York University Press, New York: 1993; p. 61.

[8] Rothbard (2008), pp. 191–192.

[9] Rothbard (2008), pp. 212–213.

[10] Rothbard (2008), p. 193.

[11] Statistics provided by the Government Printing Office.

[12] Folsom (2008), p. 40.

[13] Murphy, Robert P., The Politically Incorrect Guide to the Great Depression and the New Deal, Regnery, Washington, D.C.: 2009; pp. 32–34.

[14] Vedder and Gallaway (1993), p. 113.

[15] Vedder and Gallaway (1993), pp. 122–123.

[16] Folsom (2008), p. 43.

[17] Murphy (2009), pp. 130–131.

[18] Folsom (2008), pp. 49–51.

[19] DiLorenzo, Thomas J., How Capitalism Saved America: The Untold History of our Country, From The Pilgrims to the Present, Three Rivers Press, New York City, New York: 2004; pp. 186–189.

[20] Folsom (2008), pp. 57–58.

[21] Higgs, Robert, Depression, War and Cold War: Challenging the Myths of Conflict and Prosperity, Independent Institute, Oakland, California: 2006; pp. 11–13.

[22] Statistics provided by the Government Printing Office.

[23] Anderson, Benjamin M., Economics and the Public Welfare, LibertyPress, Indianapolis, Indiana: 1979; p. 375.

[24] Folsom (2008), p. 140.

[25] Hazlitt, Henry, Economics in One Lesson, Ludwig von Mises Institute, Auburn, Alabama: 2008; p. 23.

[26] Salerno, Joseph T., Money and Gold in the 1920s and 1930s: An Austrian View, The Freeman: October 1999 (Vol. 49, No. 10).

[27] Anderson (1979), pp. 401–403.

[28] Anderson (1979), p. 346.

[29] Friedman, Milton and Schwartz, Anna, A Monetary History of the United States, Princeton University Press, Princeton: 1963; pp. 497–498.  On p. 500, Friedmand and Schwartz claim that between March 1933 and May 1937, the money stock actually grew by 51%.

[30] Friedman and Schwartz (1963), p. 512.

[31] Anderson (1979), p. 403.

[32] Friedman and Schwartz (1963), pp. 496–497.

[33] Higgs (2006), pp. 11–13.

[34] Higgs (2006), p. 5.

[35] Anderson (1979), p. 427.

[36] Salerno (1999).

[37] Vedder and Gallaway (1993), pp. 130–131.

[38] Vedder and Gallaway (1993), pp. 140–141.

[39] Anderson (1979), p. 437.

[40] Anderson (1979), p. 440.

[41] Anderson (1979), pp. 441–442.

[42] Anderson (1979), pp. 432–433 and p. 440.

[43] Timberlake, Richard H., The Reserve Requirement Debacle of 1935–1938, The Freeman: June 1999 (Vol. 49, No. 6).

[44] Roose (1950), p. 182 and Timberlake (1999).

[45] Roose (1950), p. 178.

[46] Murphy, Robert and Madrick, Jeff, Was the New Deal a Raw Deal?

[47] Salerno (1999).

[48] Anderson (1979), pp. 432–433.

[49] Anderson (1979), p. 434.

[50] This theory was recently restated by Christina Romer in an article for The Economist.  Robert Murphy restated the thesis in his Mises Daily, Christina Romer’s Faulty Depression History.

[51] Statistics provided by the Government Printing Office.

[52] Anderson (1979), pp. 434–435.