Mises Daily Articles
The Austrian History of US Money and Banking
[Murray Rothbard • History of Money and Banking • Auburn, Alabama: Ludwig von Mises Institute • 490 pages]
Traditionally, the greatest and most complete history of American money is held to be Milton Friedman and Anna Schwartz's A Monetary History of the United States, 1867–1960. As a reservoir of statistics, Friedman and Schwartz's magnum opus is unrivaled. In terms of influence, there is no other book on the subject held in higher regard. Friedman and Schwartz challenge the conventional wisdom on American economic history, on the topics of the so-called Long Depression — a period which saw steadily falling prices, but unrivaled industrial growth — the "dangers" of secular price deflation,1 and the Great Depression.2 But their empirical and positivist approach to economic analysis often mars their accuracy.3
The Mises Institute offers A History of Money and Banking in the United States as the perfect (albeit not as statistically rigorous) Austrian substitute to Friedman and Schwartz's voluminous history. A History of Money, however, was not originally written as a book. Instead, it is a collection of five academic papers written by Murray N. Rothbard. The topics range from the monetary history of the early United States (colonial era to 1913), to the origins of the Federal Reserve, to the Great Depression and postwar monetary organization. While all five papers were written separately and published over many years, the fact that they mesh so well to provide a very complete monetary history of the United States is a testament to the depth of Rothbard's historical work.
Its value lies in the methodology Rothbard employs. The methodological differences between Rothbard and Friedman and Schwartz distinguish the two books, and put A History of Money and Banking squarely in a league of its own. It is precisely the methodology that makes A History of Money and Banking undeniably Austrian. Friedman and Schwartz attempt to derive theory and causation from statistics, often leading them to erroneous conclusions. By contrast, Rothbard's treatise is written to illustrate existing theory, not to gain additional insight.
Rothbard's approach to economic history allows him to focus on why certain events occurred. More often than not, one finds that economic events were preceded by specific political decisions. As such, Rothbard capably traces the reasons why these government decisions were made, and exactly who they were meant to benefit. This shifts the scope of Rothbard's history away from that of Friedman and Schwartz. Whereas Friedman and Schwartz focus on events as if they were solely the product of the market, with or without government influence, Rothbard instead sees much of economic history as a product of government interventions in the market.
Joseph Salerno, writing the introduction to the Mises Institute's edition of the book, clarifies the importance of Rothbard's methodology:
Now Friedman and Schwartz certainly do not, and would not, deny that movements in the money supply are caused by the purposeful actions of motivated human beings. Rather, the positivist methodology they espouse constrains them to narrowly focus their historical narrative on the observable outcomes of these actions and never to formally address their motivation.4
Needless to say, for Rothbard, history can never serve even as an imperfect laboratory for testing theory, because of his agreement with Mises that "the subject matter of history … is value judgments and their projection into the reality of change."5
The first part of the treatise, "The History of Money and Banking Before the Twentieth Century," exemplifies Rothbard's approach to economic history. For much of the first chapter, Rothbard spends time describing the structure of the different banking systems that existed up until the advent of our current Federal Reserve System. Instead of looking solely at the banking system and its economic consequences, Rothbard smartly looks at the bigger picture — the government behind the banking system.
The opening chapter is also regarded as the standard Austrian explanation for the myriad booms and busts that took place between US independence and 1913. The topic is of great importance, if only because recently Austrian business-cycle theory has focused largely on the effects of central banking. As such, many critics are left to wonder why the business cycle occurred prior to the creation of the Federal Reserve (and for the more learned critics, after the abolition of the Second National Bank of the United States). Rothbard's coverage of pre-1913 American economic history helps illustrate the real argument proposed by Austrian business-cycle theory — cyclical fluctuations are a product of intertemporal discoordination caused by inflationary monetary policy.
The centerpiece of Rothbard's writing, however, remains the Federal Reserve. He tackles this topic over the course of the following four chapters. In part 2, "The Origins of the Federal Reserve," he uses his distinct methodology to dissect the exact reasons behind the Federal Reserve's foundation, and in doing so illuminates the government's method of directing the economy. Rothbard writes,
A generation of research and scholarship, however, has now exploded that myth [that Progressivism was a popular uprising against monopoly] for all parts of the American polity, and it has become all too clear that the truth is the reverse of this well-worn fable. In contrast, what actually happened was that business became increasing competitive during the late nineteenth century, and that various big-business interests, led by the powerful financial house of J.P. Morgan and Company, had tried desperately to establish successful cartels on the free market.6
One of these cartels would soon become the Federal Reserve System. Rothbard alleges that there was a union between big-business and government to push through the legislation needed to cartelize the banking industry. The businesses were to profit by allowing them to inflate the money supply at will, without having to fear note redemption as a limitation. Government, on the other hand, saw the Federal Reserve as the perfect source of funding for big government programs, including war. As Rothbard concluded,
The financial elites of this country, notably the Morgan, Rockefeller, and Kuhn, Loeb interests, were responsible for putting through the Federal Reserve System, as a governmentally created and sanctioned cartel device to enable the nation's banks to inflate the money supply in a coordinated fashion, without suffering quick retribution from depositors or noteholders demanding cash.7
Rothbard's version of the origins of the Federal Reserve sits in stark contrast to that of Friedman and Schwartz. In A Monetary History, Friedman and Schwartz see the origins of the Federal Reserve instead in the Panic of 1907, and attribute to the Federal Reserve a benign role in increasing the elasticity of the money supply.
Contemporary criticism centered on the alleged "inelasticity" of the stock of money…. In a unit banking system with some 20,000 independent banks, the impact was bound to be uneven, to force some banks into suspension, and to threaten a chain reaction involving a cumulative increase in the desire on the part of the public to convert deposits into currency. Short-period "elasticity" in one component of the money stock — currency — was therefore desirable in order to prevent undesired "elasticity" in the total money stock.8
They elucidate the role of the Federal Reserve,
Effective interconvertibility could be fostered by action along any of three main lines. (1) The establishment of some central reserve of currency which would be made available to meet the demand for currency whenever it arose but would be held idle in ordinary times, which means that it would have to be held for the purpose other than currently profitable use….9
In retrospect, one can easily see the naïveté in Friedman and Schwartz's analysis and the superiority of Rothbard's methodology. It is unsurprising that late in life Friedman would express his frustration with the Federal Reserve, stating, "We said then and believed then, and I still do, that the Federal Reserve had failed to do what it was originally set up to do."10 Far from being politically neutral, the Federal Reserve turned into an important monetary tool for the United States government.
The Federal Reserve's political agenda was what Rothbard set out to chronicle in the third part of A History of Money and Banking, "From Hoover to Roosevelt: The Federal Reserve and the Financial Elites." Much like the pre–Federal Reserve decades of the 20th century, the next two decades also saw the domination of American politics and the Federal Reserve by the country's two largest banking organizations — Morgan and Rockefeller. As such, the great monetary boom of the 1920s was one largely orchestrated by the House of Morgan. Wrote Rothbard,
[Federal Reserve banker] Benjamin Strong's monetary policy, throughout his reign, was essentially a Morgan policy….
After the end of the war, Strong's monetary policy was deliberately guided by the prime objective of helping Great Britain establish, and impose upon Europe, a new and disastrous gold exchange standard.11
This policy of monetary inflation would ultimately conclude in the great crash of 1929, and consequently the Great Depression of 1929–1939. Despite attempts to reinflate the boom throughout the final months of 1929, and throughout Hoover's term, the Federal Reserve found itself incapable of inflating the economy out of depression; instead, it forced upon the country a four-year period of painful economic contraction.
In 1933, with Roosevelt came the rise of the House of Rockefeller as the leader in pulling the strings of America's central bank. It should come as no surprise that these banks also played a major role in designing the flutter of financial legislation made effective between 1933 and 1935, as each house attempted to gain an upper hand against the others.
Economic history is often portrayed as a battle between the benevolent and well-intentioned government and the free market guided by "animal spirits." While Hoover's presidency has already been marginalized in the historical mind as one dominated by a laissez-faire attitude, no matter how erroneous this opinion might be,12 Roosevelt's administration is considered one of economic sanity, marked by the steady return to prosperity — finally solidified by the "demand shock" caused by the Second World War.
Rothbard's presentation in A History of Money and Banking unveils the true story of the Great Depression. All actions, even those undertaken by bureaucrats, must necessarily be done "on the margin." They are a product of men weighing the costs and the benefits, and are taken only when the benefits justify the costs. Unlike the naïve focus on economic statistics of Friedman and Schwartz, Rothbard's distrust of politicians allows him to highlight the motivations behind the major legislative decisions made during the Great Depression. After reading A History of Money and Banking, one can conclude that neither the intentions behind nor the consequences of legislation of the era were as noble as many history books argue.
After dealing with the Great Depression, Rothbard goes back to the "Roaring Twenties," where he goes into depth on the interwar gold-exchange standard. He cites two primary reasons behind the United Kingdom's decision to opt for such a monetary system: the state's nostalgia for Britain's days as the world's leading economy, and the desire of London financiers to be repaid for their war loans in British pounds equal to their prewar value. The result was a very damaging monetary system that ended in global inflation and the interdependence of several of the world's leading central banks. As aforementioned, the result was a global financial crisis.
A History of Money and Banking ends with coverage on the reformation of the global monetary system, which culminated with the conference at Bretton Woods. Rothbard records the series of events that saw the dollar manipulated from a form of monetary nationalism to a form of monetary imperialism. He concludes,
The Bretton Woods agreement established the framework for the international monetary system down to the early 1970s. A new and more restricted international dollar-gold exchange standard had replaced the collapsed dollar-pound–gold-exchange standard of the 1920s. During the early postwar years, the system worked quite successfully within its own terms, and the American banking community completely abandoned its opposition. With European currencies inflated and overvalued, and European economies exhausted, the undervalued dollar was the strongest and "hardest" of world currencies, a world "dollar shortage" prevailed, and the dollar could base itself upon the vast stock of gold in the United States, much of which had fled from war and devastation abroad.13
Even such a policy of monetary imperialism fell prey to the lure of inflation. While the dollar continued to be inflated during the 1950s and 1960s, European currencies began to gain in value relative to the dollar. The stress of the changing global economic order finally led to the United States's complete abandonment of the gold standard in 1971.
US economic history, as told by Murray Rothbard, is one in which the politically connected consistently attempted to gain advantages at the expense of others by using the state as a tool to intervene in the market. Some may find Rothbard's methodology biased, in the sense that one could easily manipulate historical data to fit any theory. Rothbard, like Mises, would argue that empiricism can neither validate nor refute theory — the validity of theory can be confirmed only through logical rigor. The reader of A History of Money and Banking in the United States should take this into consideration. Rothbard's book is not an attempt to prove Austrian economic theory. Rather, it is an interpretation of the history based on existing theory.
This makes A History of Money and Banking a very consistent history of the American economy. Its principle opponent, Friedman and Schwartz's A Monetary History of the United States, takes a positivist approach, and the result is a book with unclear and all-too-often erroneous conclusions. Yet one should not write off Friedman and Schwartz's magnum opus, because no other book contains the sheer amount of data Friedman and Schwartz labored to collect. Just the same, however, if the student is looking for history, then the ideal book is Rothbard's.
If there is one point the reader should walk away from A History of Money and Banking with, it is that power, not money, corrupts.
- 1. Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: Princeton University Press, 1963), p. 15. The authors write, "Finally, the price level fell to half its initial level in the course of less than fifteen years and, at the same time, economic growth proceeded at a rapid rate…. And their coincidence casts serious doubts on the validity of the new widely held view that secular price deflation and rapid economic growth are incompatible."
- 2. Paul Krugman, "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity 1998(2), p. 138. Krugman gives a brief history of the demise of liquidity trap theory during the late 1960s and throughout the 1970s, blaming Friedman and Schwartz's monetary history as an important factor. Krugman writes, "Emphasizing broad aggregates rather than interest rates or the monetary base, Friedman and Schwartz argue, in effect, that the Depression was caused by monetary contraction; that the Federal Reserve could have prevented it; and implicitly, that even the great slump could have been reversed by sufficiently aggressive monetary expansion. To the extent that modern macroeconomists think about liquidity traps at all (the on-line database EconLit lists only twenty-one papers with that phrase in title, subject, or abstract since 1975), their view is basically that a liquidity trap cannot happen, did not happen, and will not happen again."
- 3. For example, compare Friedman's conclusion that the Great Depression was caused by a contractionary Federal Reserve with Murray Rothbard's research presented in America's Great Depression. Friedman and Schwartz's limited utilization of economic theory and poor application of data to existing theory causes them to come to conclusions different from all other major schools of thought. Furthermore, when evidence conflicts with existing theory they simply express their confusion, rather than rethinking the theory. See for example their treatment of secular price deflation, in note 2.
- 4. Joseph Salerno, introduction to A History of Money and Banking in the United States (Auburn, Ala.: Ludwig von Mises Institute, 2002), p. 35.
- 5. Ibid., p. 39.
- 6. Murray N. Rothbard, A History of Money and Banking in the United States, pp. 183–84.
- 7. Ibid., p. 258.
- 8. Friedman and Schwartz, p. 169.
- 9. Ibid.
- 10. Friedman made this statement in an interview with The Region ("Interview with Milton Friedman"). This should not be confused with an admission on Friedman's part on the superiority of private currencies, as instead he continued to favor a government solution to this so-called "short-period" inelasticity.
- 11. Rothbard, p. 270.
- 12. See Robert P. Murphy's "Did Hoover Really Slash Spending?," "The Fake History of the Depression," and "Krugman's Hoover History."
- 13. Rothbard, pp. 486–487.