Economic Depressions, Their Cause and Cure, by Murray N. Rothbard, narrated by Harold
L. Fritchie.
This essay was originally published as a mini-book by the Constitutional Alliance of Lansing,
We live in a world of euphemism. Undertakers have become morticians, press agents are now
public relations counselors, and janitors have all been transformed into superintendents.
In every walk of life, plain facts have been wrapped in cloudy camouflage. No less has
this been true of economics. In the old days, we used to suffer nearly periodic economic
Crises, the sudden onset of which was called a panic and the lingering trough period after
the panic was called depression.
The most famous depression in modern times, of course, was the one that began in a typical
financial panic in 1929 and lasted until the advent of World War II.
After the disaster of 1929, economists and politicians resolved that this must never
happen again.
The easiest way of succeeding at this resolve was simply to define depressions out of existence.
From that point on, America was to suffer no further depressions, for when the next
sharp depression came along in 1937-38, the economists simply refused to use the dread
name and came up with a new, much softer sounding word, recession.
From that point on we have been through quite a few recessions, but not a single depression.
But pretty soon the word recession also became too harsh for the delicate sensibilities of
the American public.
It now seems that we had our last recession in 1957-58, for since then we have only had
downturns or even better slowdowns or sidewise movements.
So be of good cheer.
From now on, depressions and even recessions have been outlawed by the semantic fiat of
economists.
From now on, the worst that can possibly happen to us are slowdowns.
Such are the wonders of the new economics.
For 30 years, our nation's economists have adopted the view of the business cycle held
by the late British economist John Maynard Keynes, who created the Keynesian, or the
New Economics in his book, The General Theory of Employment, Interest and Money, published in 1936.
Beneath their diagrams, mathematics and inchoate jargon, the attitude of Keynesians towards booms
and busts is simplicity, even naivete itself. If there is inflation, then the cause is supposed
to be excessive spending on the part of the public. The alleged cure is for the government,
The self-appointed stabilizer and regulator of the nation's economy to step in and force people to spend less, sopping up their excess purchasing power through increased taxation.
If there is recession, on the other hand, this has been caused by insufficient private spending, and the cure now is for the government to increase its own spending, preferably through deficits, thereby adding to the nation's aggregate spending stream.
The idea that increased government spending or easy money is good for business and that budget cuts or harder money is bad permeates even the most conservative newspapers and magazines.
These journals will also take for granted that it is a sacred task of the Federal Government to steer the economic system on the narrow road between the abyss of depression on one hand and inflation on the other,
for the free market economy is supposed to be ever liable to succumb to one of these evils.
All current schools of economists have the same attitude.
Note, for example, the viewpoint of Dr. Paul W. McCracken,
the incoming chairman of President Nixon's Council of Economic Advisers.
In an interview with the New York Times shortly after taking office, January 24, 1969,
Dr. McCracken asserted that one of the major economic problems facing the new administration
is how you cool down this inflationary economy without, at the same time, tripping off unacceptably
high levels of unemployment.
In other words, if the only thing we want to do is cool off the inflation, it could
be done.
But our social tolerances on unemployment are narrow, and again, I think we have to
feel our way along here.
We don't really have much experience in trying to cool an economy in orderly fashion.
We slammed on the brakes in 1957, but, of course, we got substantial slack in the economy.
Note the fundamental attitude of Dr. McCracken toward the economy, remarkable only in that
it is shared by almost all economists of the present day.
The economy is treated as a potentially workable but always troublesome and recalcitrant patient
with a continual tendency to hive off into greater inflation or unemployment.
The function of the government is to be the wise old manager and physician, ever watchful,
ever tinkering to keep the economic patient in good working order.
In any case, here the economic patient is clearly supposed to be the subject, and the
government as physician, the master.
It was not so long ago that this kind of attitude and policy was called socialism, but we live
We live in a world of euphemism, and now we call it by far less harsh labels such as moderation
or enlightened free enterprise.
We live and learn.
What then are the causes of periodic depressions?
Must we always remain agnostic about the causes of booms and busts?
Is it really true that business cycles are rooted deep within the free market economy
and that therefore some form of government planning is needed if we wish to keep the
The economy within some kind of stable bounds?
Do booms and then busts just simply happen, or does one phase of the cycle flow logically
from the other?
The currently fashionable attitude towards the business cycle stems, actually, from Karl
Marx.
Marx saw that before the Industrial Revolution, in approximately the late 18th century, there
were no regularly occurring booms and depressions.
There would be a sudden economic crisis whenever some king made war or confiscated the property
of his subject, but there was no sign of the peculiarly modern phenomena of general and
fairly regular swings in business fortunes of expansions and contractions.
Since these cycles also appeared on the scene at about the same time as modern industry,
Marx concluded that business cycles were an inherent feature of the capitalist market
economy.
All the various current schools of economic thought, regardless of their other differences
and the different causes that they attribute to the cycle, agree on this vital point, that
these business cycles originate somewhere deep within the free market economy.
The market economy is to blame.
Karl Marx believed that the periodic depressions would get worse and worse until the masses
would be moved to revolt and destroy the system, while the modern economist believes that the
The government can successfully stabilize depressions and the cycle.
But all parties agree that the fault lies deep within the market economy and that if
anything can save the day, it must be some form of massive government intervention.
There are, however, some critical problems in the assumption that the market economy
is the culprit.
For general economic theory teaches us that supply and demand always tend to be in equilibrium
in the Market and that therefore prices of products as well as the factors that contribute
to production are always tending towards some equilibrium point.
Even though changes of data, which are always taking place, prevent equilibrium from ever
being reached, there is nothing in the general theory of the market system that would account
for regular and recurring boom and bust phases of the business cycle.
Modern economists solve this problem by simply keeping their general price and market theory
and their Business Cycle Theory in separate, tightly sealed compartments with never the
twain meeting much less integrated with each other.
Economists, unfortunately, have forgotten that there is only one economy and therefore
only one integrated economic theory.
Neither economic life nor the structure of theory can or should be in watertight compartments.
Our knowledge of the economy is either one integrated whole or it is nothing, yet most
Most economists are content to apply totally separate and indeed mutually exclusive theories
for general price analysis and for business cycles.
They cannot be genuine economic scientists so long as they are content to keep operating
in this primitive way.
But there are still graver problems with the currently fashionable approach.
Economists also do not see one particularly critical problem because they do not bother
to Square Their Business Cycle and General Price Theories, The Peculiar Breakdown of
the Entrepreneurial Function at Times of Economic Crisis and Depression.
In the market economy, one of the most vital functions of the businessman is to be an entrepreneur,
a man who invests in productive methods, who buys equipment and hires labor to produce
something which he is not sure will reap him any return.
In short, the entrepreneurial function is the function of forecasting the uncertain future.
Before embarking on any investment line or line of production, the entrepreneur or enterpriser
must estimate present and future costs and future revenues, and therefore estimate whether
and how much profits he will earn from the investment.
If he forecasts well and significantly better than his business competitors, he will reap
profits from his investment.
The better his forecasting, the higher the profits he will earn.
If on the other hand he is a poor forecaster and overestimates the demand for his product,
he will suffer losses and pretty soon be forced out of the business.
The market economy then is a profit and loss economy in which the acumen and ability of
business entrepreneurs is gauged by the profits and losses they reap.
The market economy, moreover, contains a built-in mechanism, a kind of natural selection that
ensures the survival and the flourishing of the superior forecaster and the weeding out
of the inferior one.
For the more profits reaped by the better forecasters, the greater become their business
responsibilities and the more they will have available to invest in the productive system.
On the other hand, a few years of making losses will drive the poorer forecasters and entrepreneurs
If then the market economy has a built-in natural selection mechanism for good entrepreneurs,
this means that generally we would expect not many business firms to be making losses.
And in fact, if we look around at the economy on an average day or year, we will find that
losses are not very widespread.
But in that case, the odd fact that needs explaining is this.
How is it that, periodically, in times of the onset of recessions and especially in
steep depressions, the business world suddenly experiences a massive cluster of severe losses?
A moment arrives when business firms, previously highly astute entrepreneurs in their ability
to make profits and avoid losses, suddenly and dismayingly find themselves, almost all
of them, suffering severe and unaccountable losses.
How come?
Here is a momentous fact that any theory of depressions must explain.
An explanation such as underconsumption, a drop in total consumer spending, is not sufficient.
For one thing, because what needs to be explained is why businessmen, able to forecast all manner
of previous economic changes and developments, prove themselves totally and catastrophically
unable to forecast this alleged drop in consumer demand.
Why this sudden failure in forecasting ability?
An adequate theory of depressions then must account for the tendency of the economy to
move through successive booms and busts, showing no sign of settling into any sort of smoothly
moving or quietly progressive approximation of an equilibrium situation.
In particular, a theory of depression must account for the mammoth cluster of errors
which appears swiftly and suddenly at a moment of economic crisis and lingers through the
And there is a third universal fact that a theory of the cycle must account for.
Invariably the booms and busts are much more intense and severe in the capital goods industries.
The industries making machines and equipment, the ones producing industrial raw materials
are constructing industrial plants than in the industries making consumer goods.
There is another fact of business cycle life that must be explained and obviously can't
be explained by such theories of depression as the popular under-consumption doctrine
that consumers aren't spending enough on consumer goods.
For if insufficient spending is the culprit, then how is it that retail sales are the last
and the least to fall in any depression, and that depression really hits such industries
as machine tools, capital equipment, construction and raw materials?
Conversely, it is these industries that really take off in the inflationary boom phase of
the business cycle, and not those businesses serving the consumer.
An adequate theory of the business cycle, then, must also explain the far greater intensity
of booms and busts in the non-consumer goods or producer goods industries.
Fortunately, a correct theory of depression and of the business cycle does exist, even
It is universally neglected in present-day economics.
It too has a long tradition in economic thought.
This theory began with the 18th century Scottish philosopher and economist David Hume and with
the eminent early 19th century English classical economist David Ricardo.
Essentially, these theorists saw that another crucial institution had developed in the mid-18th
century alongside the industrial system.
This was the institution of banking, with its capacity to expand credit and the money
supply, first in the form of paper money or banknotes, and later in the form of demand
deposits or checking accounts that are instantly redeemable in cash at the banks.
It was the operations of these commercial banks which, these economists saw, held the
key to the mysterious recurrent cycles of expansion and contraction, of boom and bust,
at Puzzled Observer since the mid-18th century.
The Ricardian analysis of the business cycle when something as follows.
The natural monies emerging as such on the world's free markets are useful commodities,
generally gold and silver.
If money were confined simply to these commodities, then the economy would work in the aggregate
as it does in particular markets.
A smooth adjustment of supply and demand and therefore no cycles of boom and bust.
But the injection of bank credit adds another crucial and disruptive element, for the banks
expand credit and therefore bank money in the form of notes or deposits which are theoretically
redeemable on demand in gold, but in practice clearly are not.
For example, if a bank has 1,000 ounces of gold in its vaults and it issues instantly
redeemable warehouse receipts for 2,500 ounces of gold, then it clearly has issued 1,500
Money Supply of the country by 1,500 gold ounces, more than it can possibly redeem.
But so long as there is no concerted run on the bank to cash in these receipts, its warehouse
receipts function on the market as equivalent to gold, and therefore the bank has been able
to expand the money supply of the country by 1,500 gold ounces.
The banks then happily begin to expand credit, for the more they expand credit the greater
will be their profits.
As the supply of paper and bank money in England increases, the money incomes and expenditures of Englishmen rise, and the increased money bids up prices of English goods.
The result is inflation and a boom within the country. But this inflationary boom, while it proceeds on its merry way, sows the seeds of its own demise.
and Demise
For as English money supply and incomes increase, Englishmen proceed to purchase more goods
from abroad. Furthermore, as English prices go up, English goods begin to lose their competitiveness
with the products of other countries which have not inflated or have been inflating to
a lesser degree. Englishmen begin to buy less at home and more abroad while foreigners buy
by Less in England and More at Home.
The result is a deficit in the English balance of payments with English exports falling sharply
behind imports, but if imports exceed exports this means that money must flow out of England
to foreign countries, and what money will this be?
Surely not English banknotes or deposits for Frenchmen or Germans or Italians have little
or no interest in keeping their funds locked up in English banks.
These foreigners will therefore take their banknotes and deposits and present them to
the English banks for redemption in gold.
And gold will be the type of money that will tend to flow persistently out of the country
as the English inflation proceeds on its way.
But this means that English bank credit money will be, more and more, pyramiding on top of
a dwindling gold base in the English bank vaults.
As the boom proceeds, our hypothetical bank will expand its warehouse receipts issued
from say 2,500 ounces to 4,000 ounces while its gold base dwindles to say 800.
As this process intensifies, the banks will eventually become frightened, for the banks
after all are obligated to redeem their liabilities in cash and their cash is flowing out rapidly
as their liabilities pile up.
Hence, the banks will eventually lose their nerve, stop their credit expansion, and in
in order to save themselves, contract their bank loans outstanding.
Often, this retreat is precipitated by bankrupting runs on the banks touched off by the public
who had also been getting increasingly nervous about the ever more shaky condition of the
nation's banks.
The bank contraction reverses the economic picture.
Contraction and bust follow boom.
The banks pull in their horns and businesses suffer as the pressure mounts for debt repayment
and Contraction.
The fall in the supply of bank money in turn leads to a general fall in English prices.
As money supply and incomes fall and English prices collapse, English goods become relatively
more attractive in terms of foreign products and the balance of payments reverses itself
with exports exceeding imports.
As gold flows into the country and as bank money contracts on top of an expanding gold
Base, the condition of the banks becomes much sounder.
This then is the meaning of the depression phase of the business cycle.
Note that it is a phase that comes out of, and inevitably comes out of, the preceding
expansionary boom.
It is the preceding inflation that makes the depression phase necessary.
We can see, for example, that the depression is the process by which the market economy
adjusts, throws off the excesses and distortions of the previous inflationary boom, and reestablishes
a sound economic condition.
The depression is the unpleasant but necessary reaction to the distortions and excesses of
the previous boom.
Why then does the next cycle begin?
Why do business cycles tend to be recurrent and continuous?
When the banks have pretty well recovered and are in a sounder condition, they are then in a confident position to proceed to their natural path of bank credit expansion and the next boom proceeds on its way, sowing the seeds for the next inevitable bust.
But if banking is the cause of the business cycle, aren't the banks also a part of the private market economy?
And can't we therefore say that the free market is still the culprit, if only in the banking segment of that free market?
The answer is no, for the banks for one thing would never be able to expand credit in concert were it not for the intervention and encouragement of government.
For if the banks were truly competitive, any expansion of credit by one bank would quickly pile up the debts of that bank and its competitors,
and its competitors would quickly call upon the expanding bank for redemption in cash.
In short, a bank's rivals will call upon it for redemption in gold or cash in the same
way as do foreigners, except that the process is much faster and would nip any incipient
inflation in the bud before it got started.
Banks can only expand comfortably in unison when a central bank exists, essentially a
government bank enjoying a monopoly of government business and a privileged position imposed
by government over the entire banking system.
It is only when central banking got established that the banks were able to expand for any
length of time and the familiar business cycle got underway in the modern world.
The central bank acquires its control over the banking system by such governmental measures
as making its own liabilities legal tender for all debts and receivable in taxes, granting
the central bank monopoly of the issue of bank notes as contrasted to deposits.
In England, the Bank of England, the governmentally established central bank, had a legal monopoly
of banknotes in the London area, or through the outright forcing of the banks to use the
central bank as their client for keeping their reserves of cash, as in the United States
in its Federal Reserve system.
Not that the banks complain about this intervention, for it is the establishment of central banking
that makes long-term bank credit expansion possible, since the expansion of central bank
Notes provides added cash reserves for the entire banking system and permits all the
commercial banks to expand their credit together. Central banking works like a cozy compulsory
bank cartel to expand the bank's liabilities and the banks are now able to expand on a
larger base of cash in the form of central bank notes as well as gold. So now we see
at last that the business cycle is brought about not by any mysterious failings of the
of the Free Market Economy, but quite the opposite, by systematic intervention by government
in the market process.
Government intervention brings about bank expansion and inflation, and when the inflation
comes to an end, the subsequent depression and adjustment comes into play.
The Ricardian Theory of the Business Cycle grasps the essentials of a correct cycle theory.
The recurrent nature of the phases of the cycle, depression as adjustment, intervention
in the Market rather than from the free market economy.
But two problems were as yet unexplained.
Why the sudden cluster of business error, the sudden failure of the entrepreneurial
function and why the vastly greater fluctuations in the producer's goods than in the consumer's
goods industries.
The Ricardian theory only explained movements in the price level in general business.
There was no hint of explanation of the vastly different reactions in the capital and consumer's
The correct and fully developed theory of the business cycle was finally discovered and set forth by the Austrian economist Ludwig von Mises when he was a professor at the University of Vienna.
Mises developed hints of his solution to the vital problem of the business cycle in his monumental Theory of Money and Credit, published in 1912 and still nearly 60 years later, the best book on the theory of money and banking.
Mises developed his cycle theory during the 1920s, and it was brought to the English-speaking world by Mises' leading follower, Friedrich A. von Hayek, who came from Vienna to teach at the London School of Economics in the early 1930s, and who published, in German and in English, two books which applied and elaborated the Mises cycle theory, Monetary Theory and the Trade Cycle, and Prices and Production.
Since Mises and Hayek were Austrians, and also since they were in the tradition of the great 19th century Austrian economists, this theory has become known in the literature as the Austrian, or the monetary overinvestment theory of the business cycle.
Building on the Ricardians on general Austrian theory and on his own creative genius, Mises developed the following theory of the business cycle.
Without bank credit expansion, supply and demand tend to be equilibrated through the free-price system and no cumulative booms or busts can then develop.
But then government, through its central bank, stimulates bank credit expansion by expanding central banks' liabilities and therefore the cash reserves of all the nation's commercial banks.
The banks then proceed to expand credit and hence the nation's money supply in the form of check deposits.
As the Ricardians saw, this expansion of bank money drives up the prices of goods and hence causes inflation, but, Mises showed, it does something else and something even more sinister.
Bank credit expansion by pouring new loan funds into the business world artificially lowers the rate of interest in the economy below its free market level.
On the free and unhampered market, the interest rate is determined purely by the time preferences of all the individuals that make up the market economy, for the essence of a loan is that a present good, money which can be used at present, is being exchanged for a future good, an IOU which can only be used at some point in the future.
Since people always prefer money right now to the prospect of getting the same amount
of money sometime in the future, the present good always commands a premium in the market
over the future.
This premium is the interest rate, and its height will vary according to the degree to
which people prefer the present to the future, that is, the degree of their time preferences.
People's time preferences also determine the extent to which people will save and invest
as compared to how much they will consume.
If people's time preferences should fall, that is, if their degree of preference for
present over future falls, then people will tend to consume less now and save and invest
more.
At the same time and for the same reason, the rate of interest, the rate of time discount,
will also fall.
Economic growth comes about largely as a result of falling rates of time preference, which
which lead to an increase in the proportion of savings and investment to consumption and
also to a falling rate of interest.
But what happens when the rate of interest falls not because of lower time preferences
and higher savings, but from government interference that promotes the expansion of bank credit?
In other words, if the rate of interest falls artificially due to intervention rather than
and naturally as a result of changes in the valuations and preferences of the consuming
public.
What happens is trouble.
For businessmen, seeing the rate of interest fall, react as they always would and must
to such a change of market signals.
They invest more in capital and producer goods.
Investments, particularly in lengthy and time-consuming projects, which previously looked unprofitable,
In short, businessmen react as they would react if savings had genuinely increased.
They expand their investment in durable equipment, in capital goods, in industrial raw material,
in construction as compared to their direct production of consumer goods.
Businesses in short happily borrow the newly expanded bank money that is coming to them
at cheaper rates.
They use the money to invest in capital goods and eventually this money gets paid out in
higher rents to land and higher wages to workers in the capital goods industries.
The increased business demand bids up labor costs, but businesses think they can pay these
higher costs because they have been fooled by the government and bank intervention in
the loan market and its decisively important tampering with the interest rate signal of
the marketplace.
The problem comes as soon as the workers and landlords, largely the former since most gross
business income is paid out in wages, begin to spend the new bank money that they have
received in the form of higher wages, for the time preferences of the public have not
really gotten lower.
The public doesn't want to save more than it has, so the workers set about to consume
most of their new income, in short, to reestablish the old consumer savings proportions.
This means that they redirect the spending back to the consumer goods industries and
they don't save and invest enough to buy the newly produced machines, capital equipment,
industrial raw materials and so forth.
This all reveals itself as a sudden, sharp and continuing depression in the producer's
goods industries.
Once the consumers reestablish their desired consumption investment proportions, it is
Mises thus revealed that business had invested too much in capital goods and had under-invested
in consumer goods.
Business had been seduced by the government tampering and artificial lowering of the rate
of interest and acted as if more savings were available to invest than were really there.
As soon as the new bank money filtered through the system and the consumers re-established
their old proportions, it became clear that there was not enough savings to buy all the
of Producers' Goods and that business had misinvested the limited savings available.
Business had over-invested in capital goods and under-invested in consumer products.
The inflationary boom thus leads to distortions of the pricing and production system.
Prices of labor and raw materials in the capital goods industries had been bid up during the
boom too high to be profitable once the consumers reassert their old consumption investment
The Depression is then seen as the necessary and healthy phase by which the market economy
sloughs off and liquidates the unsound, uneconomic investments of the boom, and reestablishes
those proportions between consumption and investment that are truly desired by the consumers.
The Depression is the painful but necessary process by which the free market sloughs off
the excess and errors of the boom, and reestablishes the market economy in its function of efficiency,
Efficient Service to the Mass of Consumers
Since prices of factors of production have been bid too high in the boom, this means
that prices of labor and goods in these capital goods industries must be allowed to fall until
proper market relations are resumed.
Since the workers receive the increased money in the form of higher wages fairly rapidly,
how is it that booms can go on for years without having their unsound investments revealed,
Where errors due to tampering with market signals become evident, and the depression
adjustment process begin its work?
The answer is that booms would be very short-lived if the bank credit expansion and subsequent
pushing of the interest rates below the free market level were a one-shot affair.
But the point is that the credit expansion is not one-shot.
It proceeds on and on, never giving consumers the chance to re-establish their preferred
Proportions of Consumption and Saving, never allowing the rise in costs in the capital
goods industries to catch up to the inflationary rise in prices.
Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable
comeuppance by repeated doses of the stimulant bank credit.
It is only when bank credit expansion must finally stop, either because the banks are
are getting into shaky condition or because the public begins to balk at the continuing
inflation that retribution finally catches up with the boom.
As soon as credit expansion stops, then the piper must be paid and the inevitable readjustments
liquidate the unsound over-investments of the boom with the reassertion of a greater
proportionate emphasis on consumer goods production.
Thus, the Misesian theory of the business cycle accounts for all of our puzzles.
The repeated and recurrent nature of the cycle, the massive cluster of entrepreneurial error,
and the far greater intensity of the boom and bust in the producers' goods industries.
Mises then pinpoints the blame for the cycle on inflationary bank credit expansion propelled
by the intervention of government and its central bank.
What does Mises say should be done, say by government, once the depression arrives?
What is the governmental role in the cure of depression?
In the first place, government must cease inflating as soon as possible.
It is true that this will inevitably bring the inflationary boom abruptly to an end and
commence the inevitable recession or depression.
But the longer the government waits for this, the worse the necessary readjustments will
have to be.
The sooner the depression readjustment has gotten over with, the better.
This means also that the government must never try to prop up unsound business situations.
It must never bail out or lend money to business firms in trouble.
Doing this will simply prolong the agony and convert a sharp and quick depression phase
into a lingering and chronic disease.
The government must never try to prop up wage rates or prices of producer goods.
Doing so will prolong and delay indefinitely the completion of the depression adjustment
process.
It will cause indefinite and prolonged depression and mass unemployment in the vital capital
goods industries.
The government must not try to inflate again in order to get out of the depression, for
even if this reinflation succeeds, it will only sow greater trouble later on.
The government must do nothing to encourage consumption and it must not increase its own
and Expenditures, for this will further increase the social consumption investment ratio.
In fact, cutting the government budget will improve the ratio.
What the economy needs is not more consumption spending, but more saving, in order to validate
some of the excessive investments of the boom.
Thus, what the government should do according to the Misesian analysis of the Depression
is absolutely nothing.
should, from the point of view of economic health and ending the Depression as quickly
as possible, maintain a strict hands-off laissez-faire policy.
Anything it does will delay and obstruct the adjustment process of the market.
The less it does, the more rapidly will the market adjustment process do its work and
sound economic recovery ensue.
The Misesian prescription is thus the exact opposite of the Keynesian.
It is for the government to keep absolute hands off the economy and to confine itself to stopping
its own inflation and to cutting its own budget.
It has today been completely forgotten, even among economists, that the Misesian explanation
and analysis of the Depression gained great headway precisely during the Great Depression
of the 1930s, the very Depression that has always held up to advocates of the free market
Economy as the greatest single and catastrophic failure of laissez-faire capitalism.
It was no such thing.
1929 was made inevitable by the vast bank credit expansion throughout the Western world
during the 1920s, a policy deliberately adopted by the Western governments and most importantly
by the Federal Reserve system in the United States.
It was made possible by the failure of the Western world to return to a genuine gold
Everyone now thinks of President Coolidge as a believer in laissez-faire and an unhampered
market economy.
He was not, and tragically, nowhere less so than in the field of money and credit.
Unfortunately, the sins and errors of the Coolidge intervention were laid to the door
of a non-existent free market economy.
If Coolidge made 1929 inevitable, he would not have been able to do so in 1929.
If Coolidge made 1929 inevitable, it was President Hoover who prolonged and deepened the Depression,
transforming it from a typically sharp but swiftly disappearing Depression into a lingering
and near-fatal malady, a malady cured only by the Holocaust of World War II.
Hoover, not Franklin Roosevelt, was the founder of the policy of the New Deal, essentially
is clearly the massive use of the state to do exactly what Misesian theory would most
warn against, to prop up wage rates above their free market levels, prop up prices,
inflate credit, and lend money to shaky business positions.
Roosevelt only advanced to a greater degree what Hoover had pioneered.
The result for the first time in American history was a nearly perpetual depression
and nearly permanent mass unemployment.
The Coolidge Crisis had become the unprecedentedly prolonged Hoover-Roosevelt Depression.
Ludwig von Mises had predicted the Depression during the heyday of the great boom of the
1920s, a time, just like today, when economists and politicians, armed with a new economics
of perpetual inflation and with new tools provided by the Federal Reserve System, proclaimed
a perpetual new era of permanent prosperity guaranteed by our wise economic doctors in
Washington.
Ludwig von Mises, alone armed with the correct theory of the business cycle, was one of the
few economists to predict the Great Depression, and hence the economic world was forced to
listen to him with respect.
F. A. Hayek spread the word in England, and the younger English economists were all, in
the early 1930s, beginning to adopt the Misesian cycle theory for their analysis of the depression,
and also to adopt, of course, the strictly free-market policy prescription that flowed
with this theory.
Unfortunately, economists have now adopted the historical notion of Lord Keynes, that
no classical economist had a theory of the business cycle until Keynes came along in
1936.
There was a theory of the Depression.
It was the classical economic tradition.
Its prescription was strict, hard money and laissez-faire, and it was rapidly being adopted
in England and even in the United States as the accepted theory of the business cycle.
A particular irony is that the major Austrian proponent in the United States in the early
and mid-1930s was none other than Professor Alvin Hansen, very soon to make his mark as
the outstanding Keynesian disciple in this country.
What swamped the growing acceptance of Misesian cycle theory was simply the Keynesian Revolution,
The amazing sweep that Keynesian theory made of the economic world shortly after the publication
of the General Theory in 1936.
It is not that Misesian theory was refuted successfully, it was just forgotten in the
rush to climb on the suddenly fashionable Keynesian bandwagon.
Some of the leading adherents of the Mises theory, who clearly knew better, succumbed
to the newly established winds of doctrine and won leading American university posts
as a consequence.
But now, the once arch-Keynesian London economist has recently proclaimed that Keynes is dead.
After over a decade of facing trenchant theoretical critiques and refutation by stubborn economic
facts, the Keynesians are now in general and massive retreat.
Once again, the money supply and bank credit are being grudgingly acknowledged to play
a leading role in the cycle.
The time is ripe for a rediscovery, a renaissance of the Mises theory of the business cycle.
It can come none too soon.
If it ever does, the whole concept of a council of economic advisors would be swept away and
we would see a massive retreat of government from the economic sphere.
But for all this to happen, the world of economics and the public at large must be made aware
of the existence of an explanation of the business cycle that has lain neglected on
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The Theory of Money and Credit