The Mysteries of the Great Depression; M. Skousen

Prior to the Great Depression, most West ern economists accepted the classical virtues of thrift, limited government, balanced bud gets, the gold standard, and Say's Law. While most economists continued to defend free enterprise and free trade on a microeconomic scale, they rejected traditional views on a macroeconomic level in the postwar period, advocating consumption over saving, fiat money over the gold standard, deficit spend ing over a balanced budget, and active state interventionism over limited government. They bought the Keynesian argument that a Dr. Skousen is an economist at Rollins College, Department of Economics, Winter Park, Florida 32789, and editor of Forecasts & Strategies, one of the largestinvestment newslettersin the country. free market was inherently unstable and could result in high levels of unemployed labor and resources for indefinite periods. They blamed the Great Depression on laissez-faire capital ism and contended that only massive govern ment spending during World War II saved the capitalist system from defeat. In short, the depression opened the door to widespread collectivism in the United States and around the world.

Fortunately, free-market economists have gradually punctured holes in these arguments and the pendulum has slowlyshifted toward a re-establishment of classical free-market eco nomics. Three questions needed to be ad dressed: What caused the Great Depression? Why did it last so long? Did World War II restore prosperity? Economic historian Rob ert Higgs had dubbed these three arenas of debate the Great Contraction, the Great Duration, and the Great Escape. The Cause of the Great Contraction Many free-market economists had at tempted to answer the first question, includ ing Benjamin M. Anderson and Murray N. Rothbard, 2 but none had the impact equal to Milton Friedman's empirical studies on money in the early 1960s. His was the first effective effort to destroy the argument that the Great Depression was the handiwork of an inherently unstable capitalistic system. Friedman (and his coauthor, Anna J.

Schwartz) demonstrated forcefully that it was 447 448 THE FREEMAN • JULY 1997 not free enterprise, but rather government specificallythe Federal Reserve Systemthat caused the Great Depression. In a single sentence underlined by all who read it, Fried man and Schwartz indicted the Fed: "From the cyclicalpeak in August 1929 to a cyclical trough in March 1933,the stock of money fell by over a third.,,3 (This statement was all the more shocking because until Friedman's work, the Fed didn't publish money supply figures, such as M1 and M2!) Friedman and Schwartz also proved that the gold standard did not cause the depr~s sion, as some Keynesian economists have alleged. During the early 1930s,the U.S. gold stock rose even as the Fed perversely raised the discount rate and allowed the money supply to shrink and banks to collapse.4 The Prolonged Slump Economic activity and employment stag nated throughout the 1930s, causing a par adigm shift from classical economics to Keynesianism. Friedrich Hayek, the Austrian economist who challenged Keynes in the thirties, was so disheartened about the state of the free-world economy that he abandoned the study of economics in favor of political philosophy.

Why did the depression last so long? Many free-market economists have picked up where Murray Rothbard's America's Great Depres sion left off, at the time Franklin Delano Roosevelt took office in 1933. Gene Smiley (Marquette University) attempted an "Aus trian" perspective on the perverse role of fiscal policy in the 1930s. I summarized the causes of stagnation and persistent unemploy ment, such as the Smoot-Hawley Tariff, tax increases, government regulation and con trols, and pro-labor legislation.5 More recently, Robert Higgs of the Inde pendent Institute has made an in-depth study of the 1930s' malaise and focused on the lack of private investment during this period. Ac cording to Higgs, private investment was greatly hampered by New Deal initiatives that destroyed investor and business confidence, the key to recovery.6In short, the New Deal prolonged the depression. What Got Us Out?

In another brilliant study, Higgs attacked the commonly held view that World War II saved us from the depression and restored the economy to full employment. The war gave only the appearance of recovery, when in reality private consumption and investment declined while Americans fought and died for their country. A return to genuine prosperi ty-the true Great Escape-did not occur until after the war ended, when most of the wartime controls were abolished and most of the resources used in the military were re turned to civilian production. 7 Only after the war did private investment, business confi dence, and consumer spending return to form. In sum, it has been a long and hard-fought war to restore the case for free-market cap italism. Finally, through the pathbreaking work of Friedman, Rothbard, Smiley, Higgs, and other scholars, we can now say the battle has been won. 0 1. David C. Colander and Harry Landreth, eds., The Coming of Keynesianism to America (Edward Elgar, 1996), p. 16.

2. Benjamin M. Anderson, Economics and the Public Welfare (Indianapolis: Liberty Press, 1979 [1949]) and Murray N. Roth bard, America's Great Depression (Princeton: D. Van Nostrand, 1963). 3. Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960 (Princeton: Princeton University Press, 1963), p. 229. 4. Friedman and Schwartz, Monetary History, pp. 360-361. See also my May 1995 Freeman column, "Did the Gold Standard Cause the Great Depression?" , 5. Gene Smiley, "Some Austrian Perspectives on Keynesian Fiscal Policy and the Recovery of the Thirties, " Review ofAustrian Economics (1987), 1:146-79, and Mark Skousen, "The Great Depression," in Peter Boettke, ed., The Elgar Companion to Austrian Economics (Edward Elgar, 1994), pp. 431-439. 6. Robert Higgs, "Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War," The Independent Review (Spring 1997), 1:4, pp.

561-590. 7. Robert Higgs, "Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s," Journal of Economic History 52 (March 1992), pp. 41-60. See also Richard K. Vedder and Lowell Gallaway, "The Great Depression of 1946," Review of Austrian Economics 5:2 (1991), pp. 3-31.