Though Herbert Hoover was a pioneer among presidents in getting the government to “do something” about a depression, he was no maverick. He had the support of distinguished court economists who promoted the idea that stable prices were the key to lasting prosperity.
Common sense tells us that if we walk into a store and find prices consistently lower than they had been, we are better off, other things equal, because our money buys more. As Rothbard wrote, “Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the standard of living of all consumers. Forcible propping up of the price level prevents this spread of higher living standards.”
While the concept “stable price level” may not sound menacing, the mechanism for achieving it was. The theory’s proponents, which included such economics luminaries as Irving Fisher and John Maynard Keynes, weren’t too concerned with price stability when prices tended to rise during a boom, especially if prices were rising on the stock market where they were heavily invested. The price stability priests were mostly concerned with falling prices during a bust, and for that they relied on government’s creature, the central bank. Falling prices, in fact, were regarded as the cause of depressions. Using enlightened “monetary policy,” central banks needed to keep prices from falling to keep economies from collapsing.
Yale and Harvard Go Boom and Bust
Yale professor Irving Fisher helped popularize the view that the “new era” economy of the 1920s would last indefinitely. With the exception of stocks and real estate, prices were fairly level, and since the mainstream definition of inflation was and still is “a general and progressive increase in prices,” the 1920s were and still are said to be a period of inconsequential inflation. Rothbard tells us that,
Fisher was particularly critical of the minority of skeptical economists who warned of over-expansion in the stock and real estate markets due to cheap money, and even after the stock market crash, Fisher continued to insist that prosperity, particularly in the stock market, was just around the corner.
Beginning in 1923, Fisher wrote a syndicated column, carried by leading newspapers, in which he discussed relevant economic issues of the day. Fisher’s column was Yale’s answer to the Harvard Economic Service. A 1986 paper issued by the National Bureau of Economic Research (NBER) says that,
Fisher’s predictions in the period before and after the crash, were no closer to the mark than those of his Harvard brethren.
“In two months I expect to see the stock market much higher than today,” Fisher said on October 15, 1929. Economist Hernán Cortés Douglas tells us that,
Days after the crash [on October 29], the Harvard Economic [Service] informed its subscribers: “A severe depression such as 1920-21 is outside the range of probability. We are not facing a protracted liquidation.”
After repeated forecasts of optimism, the Harvard Economic Service folded in 1932. Fisher’s professional reputation gradually collapsed. Fisher’s son estimates his father lost $10 million during the Depression (roughly $241 million in 2026 dollars). Yale had to buy Fisher’s house and rent it back to him to keep him from being evicted. When he died in 1947 he left an estate so small it wasn’t taxed.
Interestingly, the authors of the NBER paper applied “modern statistical techniques” to analyze the data Fisher and the Harvard service used in their forecasts. The result: “The statistical findings mirror the verbal pronouncements’ systematic over-prediction of economic activity.” In other words, both Fisher and Harvard were sound methodologically; it was just unfortunate that reality led them astray.
(NBER, it should be mentioned, runs a dating service—it dates when recessions begin and end. For example, its Business Cycle Dating Committee announced in December, 2008 that the US economy was in a severe recession that began a year earlier, in December, 2007. In September, 2010 they announced that the recession had ended 15 months earlier, in June, 2009. As top-tier economic scientists they avoid rushing to conclusions, so we can be sure of their results. Given that the last one has officially ended, there will be no continuity between it and the one to follow.)
Keynes was no less a forecasting bungler. An avid speculator, he saw nothing but good times ahead during the 1920s boom:
He met the Swiss banker, Felix Somary and was begging Somary to give him some great stock picks. When Somary said he couldn’t recommend any stocks right now because he was expecting a crash, Keynes responded infamously, “We will not see another crash in our lifetimes.” (Somary once said, correctly: “the state alone is responsible for inflation: inflation without government . . . is impossible.”)
Keynes lost a fortune but went bargain-hunting in the early 1930s, putting aside his loathing of the barbarous relic and buying up gold stocks and managing money for insurance companies. He recovered handsomely until he was wiped out again when an incipient recovery collapsed in 1937. When he died of a heart attack in April, 1946 he had once more accumulated an impressive fortune.
Austrians Explain the Crisis—and the Cure
Ludwig von Mises and F. A. Hayek were among the few economists to identify the economy of the 1920s as a credit bubble. Their crystal ball was the economic theory they had developed, known today as the Austrian Theory of the Trade Cycle. It says bank credit expansion based on money created out of nothing generates booms that eventually go bust.
Activities that were profitable when money was made cheap are revealed as unsustainable when low-interest loans are no longer available. Economist Roger Garrison explains:
Mises showed that an artificially low rate of interest, maintained by credit expansion, misallocates capital, making the production process too time-consuming in relation to the temporal pattern of consumer demand. As time eventually reveals the discrepancy, markets for both capital goods and consumer goods react to undo the misallocation.
The market reaction is the bust phase of the business cycle, as producers attempt to bring production in alignment with actual consumer demands. Hans Sennholz has written,
Economic booms and busts occur in every case of fiat expansion, whether the expansion is one percent or hundredths of a percent. The magnitude of expansion. . .merely determines the severity of the maladjustment and the necessary readjustment.
Even if most prices should decline while monetary authorities expand credit at a modest rate, the injection of fiat funds falsifies interest rates and thereby causes erroneous investment decisions.
“Credit expansion” is another name for a policy of inflation. Inflation creates “the illusion of profit,” as Mises noted in Socialism; inflation “discourages saving, and thereby prevents the formation of fresh capital.” It is this “rottenness”—inflation—that must be extirpated along with all the bad bets, but—since Fisher and Keynes—it is considered the cure.
For further discussion see The Jolly Roger Dollar.
