In the briefest of terms, the Austrian Business Cycle Theory (ABCT) assesses that economic slowdowns are the result of governmental interference with the free-market economy. This interference is generally the result of malinvestment encouraged by central banks. The result of this malinvestment is a bubble, which, when it deflates, takes an economy with it. The causes of the Great Depression were no different.
The primary problem with producing a cohesive narrative that would outline the causes of the Great Depression according to ABCT is that the causes are Legion. The genesis of that Legion, though, can be directed back to the Federal Reserve. The influence that the Fed had on the economy and the downturn can be recognized in its influence over the banking sector primarily. Secondarily, the use of the Fed to prop up the economy would ultimately spiral the economy into depression, according to ABCT. This paper will attempt to outline the causes in two brief parts. The first being the build-up to the collapse during the 1920s. The second will be the response to the collapse following 1929.
Throughout the 1920s, private banks were permitted to speculate with the public’s deposits by the Federal Reserve. This was done by guaranteeing that they could engage in “’fractional-reserve banking’ (which) involves the issuance of receipts which (the banks) cannot possibly be redeemed.”[1] Permitting this practice helps contribute to currency inflation. When the American economy began to boom in June 1921, it had a money supply of $45.3 billion. When it busted in July 1929, that supply had increased to more than $73 billion. Much of that was injected in the form of “private loans and investments.”[2] This meant that “the most important element in the money supply is the commercial bank credit base.” Liabilities from banks and savings and loans were “redeemable in commercial bank deposits, as well as currency,” and all of their funds were deposited within the commercial banks.[3] When the banks were not required to maintain 100% of their reserves, the money supply increased.
The Federal Reserve had a hand in this in a variety of ways, but the two primary were by purchasing assets and by discounting bills. Regarding the former, the Fed purchased assets from banks and increased the deposits that the banks could fractionally lend. Toward the latter, the Fed essentially gave “advances to banks on their IOUs.”[4] The largest factor that played into the Federal Reserve’s drive to expand credit and the money supply was “a desire to speed recovery from the 1920-1921 recession.” To that end, a great deal of investments went toward the American agricultural sector and to foreign governments with the goal of assisting their recovery after World War I. Toward the latter goal, the hope was reinvigorating foreign markets to again assist “American exporters (particularly farmers).”[5]
Once these inflationary chickens came home to roost with the collapse of 1929, interventionism at the national level continued. The inspiration for these interventionist policies may have been President Hoover’s efforts to maintain lofty wages.[6] Rather than being a laissez-faire free-marketeer, Hoover believed that the state “could ‘achieve justice’ for American workers by increasing living standards.” The goal was to permit workers to be able to purchase the goods that they were manufacturing.[7] This was similar to the policy that he had crusaded for as Secretary of Commerce during the economic slump between 1920-1921. Then, he “blamed the crisis on difficulties associated with readjustment following the First World War.”[8]
When the depths of the 1929 collapse was understood, Hoover attempted to “maintain wages, stimulate counter-cyclical investments, and provide emergency relief.” To do this, he devised policies that were geared toward “mobilizing credit, maintaining wages, and constructing and maintaining plants and equipment.”[9] He was successful in pursuit of his goal of maintaining high wages. Indeed, when price deflation is factored in, wages rose by 12% in 1930.[10] Unfortunately for Hoover and the American public, that success was offset by significant unemployment figures. In 1929, unemployment numbers “started out in the low single digits, but had climbed to 9% by December.” These numbers would increase to 14% by the end of 1930 and swelled up to 25% in 1932.[11]
With this manner of interventionism potentially being a cause of the Great Depression, the source of its culmination should feel unclear. Few events required as much intervention than did World War II, which is generally considered the event that ended the Great Depression. If the Austrian Business Cycle Theory is correct, and slowdown are a result of malinvestment inspired by the central government, a war economy would have little effect on solving problems created by malinvestment.
Bibliography
MacKenzie, Douglas W. “Industrial employment and the policies of Herbert C. Hoover.” The Quarterly Journal of Austrian Economics 13, no. 3 (2010): 101+. Gale Business: Insights (accessed April 18, 2024).
Rothbard, Murray N. (Murray Newton). America’s Great Depression. 5th ed. Auburn, AL: Ludwig von Mises Institute, 2000.
[1] Murray Rothbard. America’s Great Depression (Auburn: Ludwig von Mises Institute, 2000), 24.
[2] Ibid, 92-93
[3] Ibid, 95
[4] Ibid, 103-104
[5] Ibid, 137-138
[6] Douglas MacKenzie. “Industrial Employment and the Policies of Herbert C. Hoover.” The Quarterly Journal of Austrian Economics Vol. 13, no 3 (2010), 102.
[7] Ibid, 105
[8] Ibid, 106
[9] Ibid 106-107
[10] Ibid, 108
[11] Ibid, 108
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