To watch the webinar click here.

Set as an hour-long online lecture, “The Great Myths of the Great Depression” generated a lot of interest from the participants. Time limit didn’t allow for answers to all questions. Below are Mr. Reed’s answers to questions he did not have time to address during the webinar.

1. From Nikola: “Seeing as the 2008 crisis is Keynesian in nature, can it be solved by laissez faire/Austrian policy (non-interventionism), or should we paradoxically, seek Keynesian remedies?”

Answer: If you drink poison and it hurts you, you don’t drink another gallon of it to get better. I see nothing in the Keynesian formula of politicians squandering other people’s money and burdening future generations with unconscionable debt and tax burdens that could possibly fix the problem. We must unequivocally junk Keynesianism wholesale as bunk from its very inception. Henry Hazlitt’s classic, “The Failure of the New Economics” should have settled the question decades ago but Keynesianism remains popular with economists who don’t do their homework or think they can reduce human action to equations that some over-paid charlatan central planner flunkies can manipulate. It’s also popular with those politicians who seek a veneer of plausibility to gloss over their irresponsibility. When we learned that the sun didn’t revolve around the earth and the earth wasn’t flat, we set those failed theories aside. So it’s long past time to take the junk science that Keynesian represents and toss it on the compost pile.

2. From Abel: “If there were competition in money, what monetary policies would your money of choice follow?”

Answer: Competition in money. This is indeed the ideal we should seek. Money is an invention of the marketplace of exchange in the first place, not the invention of kings, queens, parliaments and presidents. The essential task of monetary reform today should be to take money out of the realm of politics and place it squarely in the realm of market forces, supply and demand, consumer choice and sound, unsubsidized banking. This is not so radical as it may sound. I would recommend precisely the same solution if we were talking about any other commodity or service. For example, if governments had produced our shoes for us, I would argue that the market should be in charge, that politicians have neither the knowledge nor the proper incentives to produce shoes that people want at prices they can afford. Some might say that money is different and too important. I believe money is too important to trust to politicians! Their track record really ought to speak for itself.

So to those who still cling to the voodoo of government monopoly money, I urge you to get over it. Look at the record. Question your misplaced, mystical faith. Trust the market. Wake up. And if your teachers in high school told you government must be in charge of money and never acquainted you with any other side of the debate, please consider filing an educational malpractice lawsuit.

This question also raises others about how do we get to where we ought to be with regard to money, what does the transition look like, what do we do with the money that government has already created and foisted on us, and how and when do we rid ourselves of those harmful government institutions like the Federal Reserve System and endless other bureaucracies and regulations that play God with our money? All good questions which I and others have addressed in many other venues, but beyond the scope of the question I am answering here or the time I have to answer. As an Austrian economist, let me say that I shy away from all attempts at central planning so I am not going to say that this or that should be our money.

I am very friendly to gold because it has passed the market test of reliability as a superb media of exchange through the centuries, but I also believe that no commodity should be granted any special privileges (legal tender laws, for example) that would bias its choice as money in the marketplace. I think there are strong and good reasons to assume that in a free and competitive market, gold would once again emerge as a dominant media of exchange but I would favor that only if the market were truly free and competitive so as to not prevent the emergence of other forms of money that market participants may choose.

3. From Scott: “As the money supply grows and malinvestments gather in the economy, what is the straw that breaks the camel’s back and causes the bust? As in, why do all the malinvestments collapse at one time?”

Answer: Let’s assume from the start that what you are referring to, Scott, is a growth in the money supply that occurs because of government policy, not natural forces in a free, healthy, responsive and competitive money market. I think that indeed is what you are implying because it is precisely that scenario that produces the subsequent “malinvestments” you are referring to.

Keep in mind that many different, usually unpredictable “straws” can break the camel’s back, so to speak, and cause a bust or downtown to begin. Monetary policy that is artificially inflationary and driven by government authorities certainly sets us up for that day to eventually happen, but the unsustainable directions that bad policy puts into place creates an inherent instability that can reverse because of any number of shocks that could take place, such as panics in other markets, wars, additional bad government regulatory policy, etc. But generally speaking, the bust commences after a period when monetary policy has reversed, that is, became less expansionary or even contractionary. The earlier, temporarily “stimulative” effect (especially in capital goods) of the expansionary policy wears off and dissipates throughout the economy, interest rates begin to rise, projects that seemed affordable but now become increasingly costly to continue to finance, and investors grow less confident of the future. The smart money sees these changes first and begin to sell and disinvest. Later, a stampede can begin as the masses of people sense change in the air.

In hindsight, the malinvestments seem to have occurred at about the same time period, as you suggest. This very fact is evidence of a systemic problem, not a particular economic sector problem—which is to say, it’s evidence that unwise monetary policy (which affects everything) is the culprit, not cycles peculiar to particular industries (there’s a natural boom and bust in tomatoes, for instance—lots of activity at planting time, a little less during growth, lots of activity again during harvest time, then nothing until the winter’s over, but that doesn’t produce economy-wide swings). Malinvestments are fostered in the first place by the false signals sent by inflationary monetary policy that suggest—falsely through low interest rates—that people’s time preferences have changed when they may really haven’t, that it will pay to borrow money now at artificially low interest rates to finance long-term, capital-intensive projects that will yield sufficient happy, paying customers down the road. But that’s a short-term phenomenon. It sends business in directions they wouldn’t have gone without the falsification of interest rates and relative prices caused by the monetary policy. When that policy changes, or wears off, or is reversed, it knocks the bottom out from the house of cards and many business plunge at about the same time.

This seeming failure of a primary entrepreneurial function—anticipating future market conditions—cannot be explained by casually asserting that a lot of business people at about the same time suddenly became bad planners. At any given time in even the freest and healthiest economies, some entrepreneurs will get it wrong or be overtaken by events or smarter competition or surprisingly reluctant customers, and they will go bust. That’s healthy. But when great numbers of them at about the same time fail, that’s evidence of something exogenous, namely the falsification of interest rates and relative prices caused by the systemic, economy-wide manipulation of money and credit.

4. From Alejandro: “How did the Wagner Act affect the rights of individual workers during the 1930s and how does it affect workers rights as of now?”

Answer: The Wagner Act took labor disputes out of the ordinary courts of law and put them under jurisdiction of a national, presidentially-appointed board called the National Labor Relations Board. That in itself was revolutionary. It has meant that the settlement of labor disputes now are far more subject to the whims of a handful of political cronies and much less predictable than a true rule-of-law approach (a fair field and no favors with the rules spelled out clearly in advance and just for all parties’ rights). The Wagner Act also empowered organized labor, under certain conditions, to possess exclusive rights for organized labor to represent workers collectively at a work site, even if large numbers of those workers might not want a union’s representation or actually be harmed by it. It replaced individual bargaining with collective bargaining when those conditions are present (such as 50% +1 voting for the union and then being able to impose it on the remaining, reluctant work force). It has resulted in less freedom in the worker marketplace, less freedom for managers to manage, higher costs of labor and therefore fewer jobs offered in those industries.

It must be understood that ultimately, productivity is what determines wages (wages can only be paid out of what is produced) and most of the time, unions empowered by the Wagner Act are not involved in boosting productivity; through strikes, threats and work rules, they can force some wages up but it means lower wages elsewhere, and fewer workers employed in those very unionized industries than would otherwise be the case. Fortunately, later additions to the law, such as Taft-Hartley, gave state governments the right to enact “right-to-work” laws which mean that in those states (22 of the 50 at the moment), no worker can be compelled to join or pay dues to a labor union as a condition of employment. In right-to-work states, wages have been rising faster, jobs have been growing faster, costs of living have risen more slowly, and employers have opened more work sites than has been the case in typically rust-belt non-right-to-work, high cost union states like Michigan, New York and California. Businesses and job creators are moving far more decisively to right-to-work states than they are to the compulsory-union states.

5. From Efrem: “How did the economy recover after World War II with the high income tax rates, which were maintained until the 1960s, still in place?”

Answer: Personal income tax rates did indeed remain high for a while after the war. Eisenhower cut the top rate a mere 1% from 92% to 91% in the 1950s. But by 1960, John Kennedy, a Democrat, campaigned on a platform calling for more robust growth. He rightly asserted that the economy of the 1950s was more sluggish than it needed to be and part of his solution to it was to bring that top rate down to 70%. Later, under Reagan, who rightly argued that 70% was way too high and a massive disincentive, cut the top rate down to 50% and then down to just 28%, a big reason for the sustained economic boom and remarkable innovations and entrepreneurship of the 1980s.

But the economy after the war did benefit from some major, positive things that allowed for a post-war boom: a) in 1945, the top corporate income tax rate was lowered massively, from 90% to just 38%; b) we had the greatest reduction in federal spending in U.S. history (largely because of war demobilization), which meant that resources tied up by government were now released to be deployed more efficiently for consumers (we started making refrigerators and cars instead of tanks and guns); c) war-time price controls and rationing were abolished; d) the “regime uncertainty” as Prof. Robert Higgs would put it, was substantially relieved when FDR checked in at the pearly gates for whatever reward awaited him and there was much less “attack business” demagoguery spewing forth from incompetents in Washington.

6. From Andrew: “How did they get away with the gold seizures?”

Answer: The “state of emergency” during the several depressed economy provided an atmosphere wherein such unwarranted and totalitarian measures could be imposed with little public opposition. Moreover, as a sad commentary on judicial independence, wisdom and constitutional fealty, no court ever reversed the action and ruled that seizing our gold was unconstitutional. It was finally undone by Congress and private gold ownership was once again permitted in 1974.

7. From Hilmar: “The European Union intends to regulate speculation of agricultural goods in order to decrease prices now. What do you think of that?”

Answer: Not much. Speculation has long been a bogeyman to ignorant and demagogic politicians. They fail to understand that speculators perform valuable functions in a free market. For instance: If there’s good reason to expect that future supplies of something will be more or less plentiful relative to demand than is the case now, the action of speculators tends to smooth out price swings. If it looks like a freeze in Florida might cut the orange crop in a few days, for instance, speculators push up prices right now. Some say, “That’s awful because it doesn’t reflect current supply demand. The speculators are profiting off of the future misfortune of others!” But by boosting prices today for today’s supply, it tends to curtail today’s demand and push some of today’s abundant supply into the future when it will keep prices lower than would be the case if the freeze does happen. And of course, speculators are assuming risk here than many of us are not willing to take, and if the speculator’s speculations prove wrong, they will suffer the losses.

Beyond that, I have utterly no confidence in the silly central planners of the European Union. They are pretentious politicians who respond to political pressures, charlatans who fall for fallacies that keep themselves busy and holding jobs while others labor to overcome their stupid policies. Many of them, like our own politicians, might even be unemployable in the absence of a government sinecure. They should be fired and the market should be allowed to work.

8. From Constantin: “What are some of the primary causes of the upcoming depression? What can be done to avoid it”

Answer: If another Great Depression comes, it will be once again because we have allowed politicians and their appointees to possess a commanding height of the economy, namely, control of our money and credit supply. Secondarily, another Great Depression could also come, or be exacerbated by, extraordinary uncertainty and high costs (taxes, regulations, tariffs) imposed by politicians and the rapacious, largely unaccountable bureaucracies they create. There may be no way to completely avoid a serious downturn in the future even if we pursued the proper policies of ending the Federal Reserve System and massively cutting the spending and intrusions of government, unleashing the entrepreneur and reviving civil society and personal character. You can’t get drunk without a hangover, but at least you can stop imbibing the intoxicants, dry out, and get a new, sound, and sustainable foundation for growth, sound money and honest living.

For the video file of this lecture click here.

Paul Krugman's Chart Explaining How Deficits "Saved the World"

Last week, I wrote about the crudeness of so-called Keynesian economic theory in which one assumes that all assets and capital “investment” are “homogeneous” in character, which means that their only contribution to the economy is from the money that is spent in their creation and continued operation. This view contrasts with the Austrian paradigm, which emphasizes the structure of production within an economy and the unsustainability of capital that is malinvested during a boom.

Unfortunately, too many people in high places are prone to believe what on its face is unbelievable: running huge federal deficits somehow is a good thing for the economy. The latest outburst comes from Paul Krugman, who recently claimed that deficits “have saved the world.”

Krugman reports a quote from a Goldman Sachs analyst who pointed out that at the present time, private savings is greater than private investment. In his July 15, 2009, New York Times blog, the 2008 Nobel Prize winner writes:

That’s an interesting way to think about what has happened — and it also suggests a startling conclusion: namely, government deficits, mainly the result of automatic stabilizers rather than discretionary policy, are the only thing that has saved us from a second Great Depression.

He concludes by stating,

… absent the absorbing role of budget deficits, we would have had a full Great Depression experience. What we’re actually having is awful, but not that awful—and it’s all because of the rise in deficits. Deficits, in other words, saved the world.

Unfortunately, Krugman has confused cause with effect. The supposed imbalance between savings and planned investment is not causing an economic downturn; it is the result of the downturn. Likewise, the reluctance of people to spend as they did before is not causing a recession, but rather is occurring because of the recession.

In the Keynesian world, it is all so simple. People spend and the economy does well. However, if people don’t spend money like before, then the economy is in the doldrums and needs to be bailed out by government spending.

Once upon a time, people would have seen through this nonsense, but since Keynesian theory dominates the academic world and, unfortunately, the investment world, too many people are beguiled by such beliefs. However, for all of its supposed simplicity, the Keynesian theory is loaded with fallacies and just plain bad ideas.

First, and most important, deficits have not “saved the world.” They only have extended the unsustainable “boom” (or, more appropriately, what is left of the boom) and are postponing the day of reckoning. Second, they are guaranteeing that future generations are going to be faced with the devil’s bargain of either having to tax themselves mightily to pay off the debt or to repudiate it with inflation. Neither is a satisfactory outcome.

Keynesians seem to believe that a boom can be sustained forever, providing that governments fill in with extra spending. However, that is extremely unsound thinking. As Ludwig von Mises and the Austrians long ago noted, the very nature of the crisis at the end of a boom is built upon the fact that a boom cannot be sustained because the longer the boom goes on, the greater the malinvestments.

Indeed, the only way out of the crisis is for the malinvestments to be liquidated or diverted to other, more sustainable, uses. Once the fundamentals of an economy are put back into balance, a recovery can begin.

Unfortunately, because of the action taken by presidents Bush and Obama, as well as the Federal Reserve System, the excesses of the original boom still have not been fully shaken from our economy. That means that the recession still has a way to go before it hits bottom, which means bad news for a lot of Americans.

One wishes that the nation’s policymakers would realize that their actions to sustain the boom not only are ineffective, but downright harmful. Likewise, the “second stimulus” only would keep the malinvestments from liquidating and put off that awful day of fiscal reckoning in the future. And it will arrive, and Washington cannot do anything about it.

Commentators on the present financial crisis have noted some interesting parallels to the Great Depression of the 1930s. Even if we survive Washington’s spending spree, Congress and the Obama administration could still tip us into catastrophe if they sharply raise taxes or tariffs as Congress did in 1930 and ’32. But more ominous parallels to an earlier age should not escape our notice.

Monumental sums for bailouts. Staggering increases in public debt. Concentration of power in the central government. A mad scramble by interest groups with endless claims on the treasury. Demagogic class warfare appeals. These things ring familiar in the ninth year of 21st century America just as surely as they dominated the ill-fated Roman welfare state of two millennia ago.

In the waning years of the Roman republic, a rogue named Clodius ran for the office of tribune. He bribed the electorate with promises of free grain at taxpayer expense and won. Thereafter, Romans in growing numbers embraced the notion that voting for a living could be more lucrative than working for one. This set into motion Kershner’s First Law, named for the late economist Howard E. Kershner: “When a self-governing people confer upon their government the power to take from some and give to others, the process will not stop until the last bone of the last taxpayer is picked bare.”

Candidates for Roman office spent huge sums to win public favor, then plundered the population afterwards to make good on their promises to the rent-seekers that elected them. As the republic gave way to dictatorship, a succession of emperors built their power on the huge handouts they controlled. Nearly a third of the city of Rome itself received public relief payments by the time of the birth of Christ.

In response to a severe money and credit crisis in 33 A.D., the central government extended credit at zero interest on a massive scale. Government spending in the wake of the crisis soared. 

In 91 A.D., the government became deeply involved in agriculture. Emperor Domitian, to reduce the production and raise the price of wine, ordered the destruction of half the provincial vineyards.

Following the lead of Rome, many cities within the empire spent themselves deeply into debt. Beginning with Emperor Hadrian early in the Second Century, municipalities in financial difficulty received aid from Rome and lost a substantial measure of their political independence in the bargain.

The central government also assumed the responsibility of providing the people with entertainment. Elaborate circuses and gladiator duels were staged to keep the people happy. The equivalent of a hundred million dollars per year in the city of Rome alone is one modern historian’s estimate of what was poured out on the games.

Under Emperor Antoninus Pius, who ruled from 138 to 161 A.D., the Roman bureaucracy reached mammoth proportions. Eventually, according to the historian Albert Trever, “the relentless system of taxation, requisition, and compulsory labor was administered by an army of military bureaucrats. . . .Everywhere were the ubiquitous personal agents of the emperors” employed to crush tax evaders.

There were plenty of taxes to evade. Emperor Nero is said by Roman historian Gaius Suetonius in De Vitae Caesarum to have once rubbed his hands together and declared, “Let us tax and tax again! Let us see to it that no one owns anything!” Taxation ultimately destroyed the wealthy first, followed by the middle and lower classes. “What the soldiers or the barbarians spared, the emperors took in taxes,” according to historian W. G. Hardy. 

Late in the Third Century, Emperor Aurelian declared government relief payments to be a hereditary right. He provided recipients government-baked bread (instead of the old practice of giving them wheat and letting them bake their own bread) and added free salt, pork, and olive oil. 

Rome suffered from the bane of all welfare states, inflation. The massive demands on the government to spend and subsidize created pressures for the multiplication of money. Roman coinage was debased by one emperor after another to pay for expensive programs. Once almost pure silver, the denarius by the year 300 was little more than a piece of junk containing less than five percent silver. 

Prices skyrocketed and savings vanished. Businessmen were vilified even as government continued its spendthrift ways. Price controls further ravaged a battered and shrinking private economy. By 476 A.D. when barbarians wiped the empire from the map, Rome had committed moral and economic suicide.

Another Great Depression should indeed concern us. The one that followed the Roman welfare state is known as the Dark Ages and it lasted for several hundred years.

The New Deal did not end the Great Depression. This statement will come as no shock to FEE supporters, but it will to the many people who never encountered it before. Now people are encountering it — in newspaper columns and news-talk shows.

Why, after years of being taught that Franklin Roosevelt’s economic intervention saved the country from disaster, is the general public now being told — by FDR fans, not critics — that this is not the case?

It’s the Rooseveltians’ way of helping President Obama get over any fear he has of deficit spending. Paul Krugman, the newest Nobel laureate, a Keynesian, and a New York Times columnist, is explicit about this. “[H]ow much guidance does the Roosevelt era really offer for today’s world?” Krugman asks. “The answer is, a lot. But Barack Obama should learn from F.D.R.’s failures as well as from his achievements: the truth is that the New Deal wasn’t as successful in the short run as it was in the long run. And the reason for F.D.R.’s limited short-run success, which almost undid his whole program, was the fact that his economic policies were too cautious.”

By “too cautious” Krugman means that FDR’s deficits were too small. Roosevelt ran deficits (except for one year), but they were about the same size as those run by his predecessor, Herbert Hoover. Roosevelt’s biggest deficit, in 1936, was “only” 4.4 percent of GDP, Jim Powell points out in FDR’s Folly. Both Hoover and Roosevelt were big spenders — FDR doubled spending by 1940 — but they were also big taxers, which kept the deficit from growing. This is confirmed by University of Arizona economist Price Fishback, who wrote, “Once we take into account the taxation during the 1930’s, we can see that the budget deficits of the 1930’s and one balanced budget were tiny relative to the size of the problem….”

Roosevelt was quite a tax enthusiast. He levied or raised taxes on liquor, tobacco, gasoline,  corporate dividends, estates, incomes (top rate 75 percent versus Hoover’s 63), “excess” profits, and undistributed profits. (The last tax was repealed in 1939.) And then there was the payroll tax that came in with Social Security. All in all, the New Deal more than tripled the tax burden from 1933 to 1940: $1.6 billion to $5.3 billion. Serious deficit-spenders don’t raise taxes. But Roosevelt did. Is it any wonder that net investment dropped $3.1 billion during the decade or that unemployment was about as high in 1939 as it was in 1932?

Would Bigger Deficits Have Worked?

This raises the question of whether big-time deficit spending would have ended the Depression. Krugman and others think so. But how could it? Deficits are financed either by borrowing or by creating money out of nothing. When the government borrows money, that’s money no one else can borrow and invest. Where’s the gain? Moreover, the money is put to purposes selected by politicians, not entrepreneurs trying to please consumers.

When the government creates money, three things happen. First, the new money lowers interest rates below the level justified by society’s time preference; that produces perverse incentives to invest in longer-term projects far from the consumer-goods level. Second, the money early on changes relative prices (rather than raising prices evenly) because particular economic interests get it sooner than everyone else. Third, prices later rise generally, reducing everyone’s purchasing power. The result is a distorted structure of production and a boom that is unsustainable because it’s based not on real savings but on fiat money. When the inflation stops, the bust follows.

Since the New Deal didn’t end the Depression and a New Deal on steroids wouldn’t have done so, President Obama should pay no heed to Krugman and his Keynesian economic advisers. The way to wake up the economy is reduce the total government burden on producers and consumers by, among other things, slashing spending, taxes, and borrowing.