7. Austrian Economic History

AUSTRIAN ECONOMIC HISTORY

Rothbard showed the illumination that Austrian theory could bring to economic history in America’s Great Depression (1963).⁹³ Far from being a proof of the failures of unregulated capitalism, the 1929 Depression illustrates rather the dangers of government interference with the economy. The economic collapse came as a necessary correction to the artificial boom induced by the Federal Reserve System’s monetary expansion during the 1920s. The attempts by the government to “cure” the downturn served only to make matters worse.

In arriving at his interpretation, an earlier work influenced him. He considered Lionel Robbins’s The Great Depression⁹⁴ to be “one of the great economic works of our time.... This is unquestionably the best work published on the Great Depression.”⁹⁵ In this evaluation, he differed from Robbins himself, who under the influence of Keynes repudiated his own book.

Robbins adumbrated a theme that Rothbard carried much further in his own book:

We see how bank credit expansion in the U.S.... generated by a desire to inflate in order to help Britain as well as an absurd devotion to a stable price level, drove the civilized world into a great depression.... He [Robbins] shows that the U.S. inflation in 1927 and 1928 when it was losing gold ... was in flagrant violation of the “rules” of the gold standard.⁹⁶

Robbins also prefigured a key point in Rothbard’s analysis of why the Depression lasted so long.

Robbins shows how the various nations took measures to counteract and cushion the depression that could only make it worse ... [e.g.,] keeping up wage rates (e.g., Hoover and his White House conferences).”⁹⁷

But all these basic Austrian points were carried to a new level of precision and depth in America’s Great Depression.

Rothbard began his work with a presentation of the Austrian theory of the business cycle. The key problem, he says, is

why is there a sudden general cluster of business errors? ... Business activity moves along nicely with most business firms making handsome profits. Suddenly, without warning, conditions change and the bulk of business firms are experiencing losses; they are suddenly revealed to have made grievous errors in forecasting.⁹⁸

A good theory must also explain why, over the course of the cycle, capital goods industries fluctuate more than do consumer goods industries. A third requirement is that it account for the increase in the quantity of money during the boom.

The Austrian theory permits us to account for all three of these conditions. The rate of interest is determined by the rate of time preference, i.e., the preference people have for present goods over future goods. The balance between consumers’ goods and capital goods depends on this rate. With a low rate of time preference, more investment in the “higher” stages of production will occur; if, however, people shift to preferring more immediate satisfaction, the structure of production will adjust accordingly. Investment will shift from capital goods to consumers’ goods industries.

So far, so good; but an infusion of bank credit can upset matters. The extra credit depresses the rate of interest below the “natural” rate, i.e., the rate in accord with peoples’ rate of time preference. With money available for loans at lower interest rates than before, projects in the higher stages that could not previously be undertaken become profitable.

Businessmen, in short, are misled by the bank inflation into believing that the supply of funds is greater than it really is .... Businessmen take their newly acquired funds and bid up the prices of capital and other producers’ goods, and this stimulates a shift of investment from the “lower” (near the consumer) to the “higher” orders of production (furthest away from the consumer)—from consumer goods to capital goods industries.⁹⁹

When the bank credit expansion ends, the money rate of interest rises to the natural rate; there is in general no reason to assume that the expansion has changed the rate of time preference. The rise in the interest rate now makes the expanded investments in the higher stages unprofitable. Consumers’ preferences require a shift from capital goods to consumer goods industries. The shift, i.e., the liquidation of the capital goods expansion, is precisely the depression.

In the Austrian view, the depression is the necessary phase of adjustment; the government must not try to maintain the level of spending, as this will serve only to prolong the process by which the economy achieves the balance between consumers and capital goods industries that consumers want.

Rothbard contrasts the Austrian theory of the cycle with competing accounts. Joseph Schumpeter’s “cycle theory is notable for being the only doctrine, apart from the Austrian, to be grounded on, and integrated with, general economic theory.”¹⁰⁰ In Schumpeter’s view, bank credit expansion also plays a crucial role. But here the mechanism differs from that in the Austrian theory. Schumpeter maintains that the credit expansion finances a cluster of innovations. When innovations decline, a depression ensues.

Rothbard finds this account unsatisfactory.

The theory postulates a periodic cluster of innovations in the boom periods. But there is no reasoning advanced to account for such an odd cluster. On the contrary, innovations, technological advance, take place continually, and in most, not just a few, firms.¹⁰¹

Having dispatched Schumpeter’s account, as well as numerous others, Rothbard applies Austrian theory to the concrete events of the 1920s and early 1930s. As expected, he argues that during the 1920s, an inflationary boom occurred. To grasp his point clearly, it is essential to bear in mind what he means by “inflation.” He does not mean an increase in the level of prices. Rather, “inflation is not precisely the increase in total money supply; it is the increase in money supply not consisting in, i.e., not covered by, an increase in gold, the standard commodity money.”¹⁰²

Given this view, Chicago School criticisms of Rothbard that stress price level stability miss the mark. Rothbard is interested in the amount of bank credit expansion, which on the Austrian view generates the boom. The Chicago School monetarists, by contrast,

uphold as an ethical and economic ideal the maintenance of a stable, constant price level. The essence of the cycle is supposed to be the rise and fall—the movements—of the price level. Since this level is determined by monetary forces, the monetarists hold that if the price level is kept constant by government policy, the business cycle will disappear. [Milton] Friedman ... emulates his mentors in lauding Benjamin Strong for keeping the wholesale price level stable during the 1920s. To the monetarists, the inflation of money and bank credit engineered by Strong led to no ill effects, no cycle of boom and bust; on the contrary, the Great Depression was caused by the tight money policy that ensued after Strong’s death.¹⁰³

Ironically, in Rothbard’s historical account, the attempt by the Federal Reserve to maintain stable prices in part led to the inflationary bank credit expansion that caused the cycle. The Chicago cure is the Austrian disease. Rothbard documents in great detail the popularity of the stable price theory among American economists, with Irving Fisher leading the way.

The siren song of a stable price level had lured leading politicians, to say nothing of economists, as early as 1911. It was then that Professor Irving Fisher launched his career as head of the “stable money” movement in the United States.¹⁰⁴

Rothbard describes in careful detail the motives and policies of the Federal Reserve during the 1920s, stressing the cooperation between Benjamin Strong and “the Mephistopheles of the inflation of the 1920s,” Montagu Norman of the Bank of England.¹⁰⁵ His verdict is severe:

We may conclude that the Federal Reserve authorities, in promulgating their inflationary policies, were motivated not only by the desire to help British inflation and to subsidize farmers, but were also guided—or rather misguided—by the fashionable economic theory of a stable price level as the goal of monetary manipulation.¹⁰⁶

When disaster struck in October 1929, many economists, still under the delusion of price stability, urged increased government spending; and Rothbard devotes much attention to their views and activities. Unfortunately, President Hoover enthusiastically embraced their views. Although Hoover

was only a moderate inflationist relative to many others.... Seeing money-in-circulation increase by $800 million in 1931, Hoover engineered a coordinated hue-and-cry against “traitorous hoarding.” “Hoarding,” of course, meant that individuals were choosing to redeem their own property, to ask banks to transform their deposits into the cash which the banks had promised to have on hand for redemption.¹⁰⁷

Worst of all, Hoover’s constant efforts to prop up wages helped prolong mass unemployment.

Hoover had prevented “an immediate attack upon wages as a basis of maintaining profits,” but the result of wiping out profits and maintaining artificial wage rates was chronic, unprecedented depression.¹⁰⁸

In making this argument, Rothbard became a pioneer in “Hoover revisionism.” Contrary to the myths promoted by Hoover himself and his acolytes, Hoover was not an opponent of big government. Quite the contrary, the economic policies of the “Engineer in Politics” prefigured the New Deal, although he did not go to the lengths of his successor. “Yet, if New Deal socialism was the logic of Hoover’s policy, he cautiously extended the logic only so far.”¹⁰⁹ Rothbard’s view of Hoover is now widely accepted. Joan Hoff Wilson’s Herbert Hoover: Forgotten Progressive, is important in this connection.¹¹⁰

Rothbard displayed little patience for historians who perpetuated the old myths about Hoover. In a review of The Hoover Leadership¹¹¹ by Edgar Eugene Robinson, a Hoover stalwart, Rothbard remarks:

There is also the usual Hooverite complaining at FDR’s lack of “cooperation” in the Interregnum, and blaming the remainder of the depression on that; actually, it is rarely pointed out that the “cooperation” would have meant cooperation in New Deal inflationist measures ... Robinson ... virtually ignores any alternatives or criticism of the Hoover policies, except the extreme New Deal or socialist one.¹¹²

It is safe to say that Rothbard would have viewed another book with much more favor. In his A History of the American People,¹¹³ the world-renowned journalist and popular historian Paul Johnson adopts a thoroughly Rothbardian account of the onset of the 1929 Depression. Like Rothbard, he finds the source of the collapse in irresponsible credit expansion: “[D]uring the 1920s the United States, in conjunction with British and other leading industrial and financial powers, tried to keep the world prosperous by deliberately inflating the money supply.”¹¹⁴

The currency expansion owed much to the influence of John Maynard Keynes:

In fact Keynes’s Tract (on Monetary Reform) advocating “managed currency” and a stabilized price-level, both involving constant government interference, coordinated internationally, was part of the problem.¹¹⁵

The market crash of 1929 “ought to have been welcome.... Business downturns serve essential purposes. They have to be sharp. But they need not be long because they are self-adjusting.”¹¹⁶ Unfortunately, Herbert Hoover did not realize this essential truth. Far from being a supporter of laissez-faire, he was an ardent interventionist whose policies impeded recovery. “Hoover was a social engineer. Roosevelt was a social psychologist. But neither understood the Depression, or how to cure it.”¹¹⁷ The Rothbardian influence is evident, and Johnson scrupulously cites Rothbard’s works several times.¹¹⁸

In his Introduction to the fifth edition of America’s Great Depression, Johnson makes clear his admiration: “His book is an intellectual tour de force, in that it consists, from start to finish, of a sustained thesis, presented with relentless logic, abundant illustration, and great eloquence.”¹¹⁹

For Rothbard, banking policy was a key not only to the Great Depression but to the whole of American economic history. Like Michelet, he believed that history is a resurrection of the flesh; and his discussions are no dry-as-dust presentations of statistics. He was always concerned to identify the particular actors and interests behind historical decisions. The struggle between the competing Morgan and Rockefeller banking circles figures again and again in his articles in this field, collected in his A History of Money and Banking in the United States (1999).¹²⁰

In this book, he displays to the full his remarkable ability to throw unexpected light on historical controversies. Throughout his work, he pointed out factors that earlier authors had overlooked.

An example will illustrate Rothbard’s technique. Everyone knows Lenin’s theory of imperialism. Developed capitalist economies, Lenin maintained, characteristically produce more than they can sell domestically. To find an outlet for their surplus goods, capitalists seek markets abroad. Their endeavors bring about a struggle for colonies; the “highest stage” of capitalism is imperialism.

So much is well known; but how did Lenin arrive at this view? The standard accounts point to J.A. Hobson; earlier, Marx himself had suggested a version of the theory. He, in turn, was influenced by Edward Gibbon Wakefield. But Rothbard has unearthed another, and most surprising, source: capitalist supporters of imperialism.

By the late 1890s, groups of theoreticians in the United States were working on what would later be called the “Leninist”’ theory of capitalist imperialism. The theory was originated, not by Lenin but by advocates of imperialism, centering around such Morgan-oriented friends and brain trusters of Theodore Roosevelt as Henry Adams, Brooks Adams, Admiral Alfred T. Mahan, and Massachusetts Senator Henry Cabot Lodge.... The ever lower rate of profit from the “surplus capital” was in danger of crippling capitalism, except that salvation loomed in the form of foreign markets and especially foreign investments.... Hence, to save advanced capitalism, it was necessary for Western governments to engage in outright imperialist or neo-imperialist ventures, which would force other countries to open their markets for American products and would force open investment opportunities abroad.¹²¹

He does not confine himself to a general statement of the monopoly capitalist origins of the Leninist theory. He describes in great detail the activities of Charles Conant, a leading advocate of imperialism. Conant, it transpires, did much more than theorize. He actively worked to install the gold-exchange standard, a key tool of American monetary imperialism, in Latin America and elsewhere. Rothbard describes Conant’s activities in his unique style: “Conant, as usual, was the major theoretician and finagler.”¹²²

Neither as theorist nor practitioner did Conant act on his own, and to see why not enables us to grasp a central plank of Rothbard’s edifice.

Nor should it be thought that Charles A. Conant was the purely disinterested scientist he claimed to be. His currency reforms directly benefited his investment banker employers. Thus, Conant was treasurer, from 1902 to 1906, of the Morgan-run Morton Trust Company of New York, and it was surely no coincidence that Morton Trust was the bank that held the reserve funds for the governments of the Philippines, Panama, and the Dominican Republic, after their respective currency reforms.¹²³

Rothbard maintained that the House of Morgan held effective control of the American government for much of the late nineteenth and early twentieth centuries, down to the onset of Franklin Roosevelt’s New Deal in 1933. He traces in detail Morgan backing for a central bank, culminating in the creation of the Federal Reserve System in 1913. His Wall Street, Banks, and American Foreign Policy¹²⁴ and The Case Against the Fed are other presentations of his thesis.

The House of Morgan was by no means the first group in American history to seek the ill-gotten gains of centralized banking. Rothbard discusses in great detail, e.g., the struggles over the First and Second Banks of the United States.

The Federal Reserve System, Rothbard makes clear, was the culmination of efforts that continued throughout the nineteenth century to centralize banking.

By the 1890s, the leading Wall Street bankers were becoming increasingly disgruntled with their own creation, the National Banking System ... while the banking system was partially centralized under their leadership, it was not centralized enough.¹²⁵

As he describes the movement to cartelize banking, Rothbard introduces a dominant theme in his interpretation of twentieth-century American history: the struggle of competing groups of bankers for power.

From the 1890s until World War II, much of American political history ... can be interpreted not so much as “Democrat” versus “Republican,” but as the interaction or conflict between the Morgans and their allies on the one hand, and the Rockefeller-Harriman-Kuhn, Loeb alliance on the other.¹²⁶

In the agitation to establish a central bank, the House of Morgan was in the ascendant; and Rothbard stresses the importance of the conference held at Jekyll Island, Georgia, under Morgan control, in planning for the Federal Reserve System.

Throughout his narrative, Rothbard stresses a point vital to the understanding of monetary history. A popular belief holds that poor people, likely to be in debt, favor easy money, while their rich creditors oppose it.

Often, this turns out to be the reverse of the truth.

Debtors benefit from inflation and creditors lose; realizing this fact, older historians assumed that debtors were largely poor agrarians and creditors were wealthy merchants and that therefore the former were the main sponsors of inflationary nostrums. But, of course, there are no rigid “classes” of creditors and debtors; indeed, wealthy merchants and land speculators are often the heaviest debtors.¹²⁷

Here Rothbard continued the work of his mentor Joseph Dorfman.

Dorfman, in the mid-1940s, arrived at the conclusion that the Beardian class-struggle thesis—the old debtor vs. creditor, East-West, farmer-merchant, interpretation of all the struggles of American economic policy (e.g., over cheap money) was complete nonsense.... Dorfman’s thesis was that on each side of every economic dispute were merchants, respectable men, farmers, etc.¹²⁸

Investment bankers profit by encouraging debt. Rothbard maintains that investment bankers are especially likely to form alliances with the government; hence their activities must be viewed with the greatest suspicion.

Investment bankers do much of their business underwriting government bonds, in the United States and abroad. Therefore, they have a vested interest in promoting deficits and in forcing taxpayers to redeem government debt. Both sets of bankers [i.e., commercial and investment], then, tend to be tied in with government policy, and try to influence and control government actions in domestic and foreign affairs.¹²⁹

He applies this thesis to interpret American foreign policy:

The great turning point of American foreign policy came in the early 1890s, during the second Cleveland Administration. It was then that the U.S. turned sharply and permanently from a foreign policy of peace and non-intervention to an aggressive program of economic and political expansion abroad.¹³⁰

The turn came at the behest of the House of Morgan, which had already obtained the controlling influence on American foreign policy it was to retain until the onset of the New Deal.

Under the new activist policy, the United States vigorously sought to wrest control of the Latin American market from Great Britain. In spite of the later partnership between the Morgan interests and Britain, the United States was very far indeed from alliance with Britain during most of the 1890s.

But a British-American partnership was not long in coming, and Rothbard finds in the close ties between the House of Morgan and British financial interests an underlying cause of American entry into World War I. Because of Morgan investments in allied war bonds and in the export of war munitions, “J.P. Morgan and his associates did everything they possibly could to push the supposedly neutral United States into the war on the side of England and France.”¹³¹ Further, “Benjamin Strong obligingly doubled the money supply to finance America’s role in the war effort.”¹³²

Rothbard’s last point serves to introduce a story within the larger story of Morgan influence. Benjamin Strong, the Governor of the New York Federal Reserve Bank, was by far the most influential figure in the entire Federal Reserve System from its inception until his death in 1928. He entered into close association with Montagu Norman, Governor of the Bank of England. Both men had enlisted in the Morgan camp.

While the close personal relations between Strong and Norman were of course highly important for the collaboration that formed the international monetary world of the 1920s, it should not be overlooked that both were intimately bound to the House of Morgan.¹³³

At Norman’s behest, Strong during the 1920s inflated the U.S. monetary supply, in order to enable Britain to maintain in operation the gold-exchange standard. By doing so, Rothbard claims, Strong bears heavy responsibility for the onset of the 1929 stock market crash and the ensuing depression.

The United States inflated its money and credit in order to prevent inflationary Britain from losing gold to the United States, a loss which would endanger the new, jerry-built “gold standard” structure. The result, however, was eventual collapse of money and credit in the U.S. and abroad, and a worldwide depression. Benjamin Strong was the Morgans’ architect of a disastrous policy of inflationary boom that led inevitably to bust.¹³⁴

The book’s narrative is a complex one, and it by no means reduces to an account of the vicissitudes of the House of Morgan. A rival banking group, consisting most importantly of Rockefeller interests, challenged it for supremacy. For Rothbard, the New Deal can best be viewed as the victory of the Rockefeller group; he cites in this connection the political scientist Thomas Ferguson. Although the Morgans recovered some of their influence after the mid-1930s, they henceforward occupied a subordinate position.

Throughout the book, Rothbard pursues with tenacity a biographical method of analysis that stresses the ties of influential figures to central financial groups, such as the Morgans. In his intricate tracing of patrons and clients, Rothbard brings to mind the great works of Ronald Syme and Lewis Namier. But Rothbard has the advantage over these renowned historians in that he does not restrict himself to the amassing of biographical detail. He has in addition a carefully worked out theory, Austrian economics, to guide him.

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⁹³America’s Great Depression, 5th ed. (1963; Auburn, Ala.: Ludwig von Mises Institute, 2000).

⁹⁴Lional Robbins, The Great Depression (London: Macmillan, 1934).

⁹⁵Letter to Ivan Bierly, November 14, 1959; Rothbard Papers.

⁹⁶Ibid.

⁹⁷Ibid.

⁹⁸America’s Great Depression, p. 8.

⁹⁹Ibid., pp. 10–11.

¹⁰⁰Ibid., pp. 72–73.

¹⁰¹Ibid., p. 74.

¹⁰²Ibid., p. 94.

¹⁰³Ibid., p. xxxiii.

¹⁰⁴Ibid., p. 174.

¹⁰⁵Ibid., p. 154.

¹⁰⁶Ibid., p. 181.

¹⁰⁷Ibid., p. 306.

¹⁰⁸Ibid., p. 322.

¹⁰⁹Ibid., p. 323.

¹¹⁰Joan Hoff Wilson, Herbert Hoover: Forgotten Progressive (New York: Little Brown, 1975).

¹¹¹Edgar Eugene Robinson, The Hoover Leadership, 1933–1945 (New York: Lippincott, 1955).

¹¹²Letter to Kenneth Templeton, August 19, 1961; Rothbard Papers.

¹¹³Paul Johnson, A History of the American People (New York: Harper Collins, 1997).

¹¹⁴Ibid., p. 727.

¹¹⁵Ibid., p. 729.

¹¹⁶Ibid., pp. 734–35.

¹¹⁷Ibid., p. 736.

¹¹⁸Ibid., pp. 733–35.

¹¹⁹Quoted in America’s Great Depression, pp. xv–xvi.

¹²⁰A History of Money and Banking in the United States: The Colonial Era to World War II (Auburn, Ala.: Ludwig von Mises Institute, 2002).

¹²¹Ibid., pp. 209–10.

¹²²Ibid., p. 226.

¹²³Ibid., pp. 232–33.

¹²⁴Wall Street, Banks, and American Foreign Policy (1984; Burlingame, Calif.: Center for Libertarian Studies, 1995).

¹²⁵Case Against the Fed, p. 79; emphasis in the original.

¹²⁶Ibid. p. 92.

¹²⁷A History of Money and Banking in the United States, p. 58.

¹²⁸Letter to Ivan Bierly, November 14, 1959; Rothbard Papers.

¹²⁹Wall Street, Banks, and American Foreign Policy, p. 1.

¹³⁰Ibid., p. 4.

¹³¹Ibid., p. 16.

¹³²A History of Money and Banking in the United States, p. 270.

¹³³Ibid., p. 374.

¹³⁴Ibid., p. 271.