Time is nearly up for Ben Bernanke, the chairman of the Federal Reserve who supposedly applied his scholarly knowledge of the Great Depression to steer the U.S. to safety after the financial crisis.
In truth, Bernanke navigated a monetarist course that favored intensive intervention, following in the footsteps of many mainstream economists who grossly misunderstood the lessons of the Crash of 1929 and the ensuing malaise.
That lesson is that when corrective crashes occur, intervention is far from the cure — it is the cause.
Until we learn from the past, we will continue to expose ourselves to devastating booms and busts. The Bernanke-led Fed has only exacerbated the problem, leading us to the brink of an even worse correction.
To capture the lessons learned, we turn to a scholar of the Great Depression: Murray Rothbard of the Austrian School of Economics, who refutes the common misconception that “laissez-faire capitalism was to blame.”
His contrarian and far less popular — yet more accurate — view is that the booms and busts of the business cycle result from shocks to the system caused by monetary intervention.
Specifically, Rothbard blames the 1929 Crash on loose monetary policy during the 1920s. For Rothbard, the boom was the problem; once the Fed pushed asset prices up to unsustainable levels, a crash was inevitable.
Without the meddling of central-bank intervention, the market — like any natural homeostatic system — can reestablish equilibrium on its own by allowing its natural entrepreneurial “governors” to work. Greater savings prompts longer-term production for future greater consumption (and the inverse). The natural order trumps intervention every time.
Laissez-faire, however, gets a bad rap because it has been erroneously attributed to President Hoover, who supposedly did little or nothing to “save” the U.S. after the Crash of 1929.
In this popular and convenient narrative, Hoover sat back and did nothing as the U.S. sunk into the depths of the Depression, while the activist Franklin Delano Roosevelt finally “got us out of the Depression” with the New Deal.
Hoover, however, was nothing if not an interventionist — and his actions prevented what could have been the “downturn of 1929-30” from resolving itself, just as the recession of 1920-21 had.
Instead, it was the government to the rescue, and the downturn became a depression.
The events leading up to the Crash and Depression form an incriminating trail. The Federal Reserve expanded bank reserves and its holdings of government securities, creating excess liquidity that flowed into a land boom in Florida followed by a stock bubble — the signature traits of mal-investment.
In 1930, Hoover enacted the Smoot-Hawley Tariff Act, which had the disastrous unintended consequence of impeding the importation of goods into the U.S. and obliterating the export market for agricultural products. Farm prices fell and rural banks that held agricultural assets failed.
Herein the great lies of the Keynesians are exposed — that capitalism cannot control itself. If Americans would simply Google the relevant figures, they would see that what they have been taught about government intervention is a myth.
Nominal federal spending rose from $3 billion in fiscal 1929 to more than $4.7 billion in 1932. Hoover had inherited a government surplus of about 0.5% of GDP, which had become a deficit of 4% of GDP by 1932. This increase in federal spending and the deficit went hand in hand with skyrocketing unemployment, which by 1932 stood at 23.6%.
At best, Keynesians can argue that Hoover did “the right thing,” only not enough of it. (Sound familiar?)
Hoover didn’t view himself as a disciple of laissez-faire either. In his acceptance speech at the 1932 Republican Convention, he boasted that “we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic.”
History would show he was half right — gigantic, yes, but defensive counterattack, no. The dismal results of Hoover’s policies and Roosevelt’s New Deal for creating employment are arguments against intervention, which does nothing but flood the system with liquidity, like fertilizer for unhealthy growth.
Our fear of corrective crashes is misplaced. They are necessary purges to clear the financial system of unhealthy mal-investment and to allow the redistribution of resources to stronger industries. I would argue that had the government followed this path in 1929, there would have been a garden-variety recession — not a Depression.
Unfortunately, we have labored under faulty assumptions and failed logic, particularly since 2008-2009. This is the legacy that Bernanke leaves not only to his successor, but to all of us.
What we must learn from history is that the government should stop suppressing the natural, homeostatic functions of the market. Otherwise, the “cure” will prove deadlier than the disease.