The Skyscraper Curse: And How Austrian Economists Predicted Every Major Economic Crisis of the Last Century

In 2010, I argued in “America’s Second Great Depression”1 that the US economy was in an economic depression and that it would likely continue for some time until economic policy was reversed. This was one of six papers organized as a symposium in honor of the late Larry Sechrest at the Southern Economic Association’s 2009 convention. While this assessment is a matter of debate, there are plenty of important mainstream economists that agree that current conditions have much more in common with an economic depression than normal economic growth.

An economic depression is a multiyear contraction of economic activity noticeably below the economy’s potential. Great depressions are even longer and deeper and can be interspersed with periods of contraction and expansion. There is nothing in economic theory that can determine whether an economy is in a recession, depression, or great depression. These labels are a matter of assessment, opinion, and professional standards and are subject to change.

Instead of addressing how “great” current economic conditions are, this chapter examines theories of the business cycle and how well they appear to perform in light of economic policies that have been enacted since 2007 in the United States and the global economy.

The Great Depression was clearly a great depression in both its length and depth. In addition, it was a worldwide phenomenon. As Professor Higgs2 has shown, the United States never really recovered from the Great Depression until after World War II in terms of inflation-adjusted per capita consumption.

I have also suggested that the stagflation of the 1970s (1970–82) was an economic depression. It was certainly long enough, and it was not confined to the United States. Statistically, it might not have been as bad as the Great Depression. There were economic expansions during the period, but the economy failed to keep up with its potential. However, in contrast with the past, it did inflict both high inflation and high unemployment — that is, stagflation — on the population, simultaneously, really for the first time.

It might surprise you to learn that great depressions are not purely monetary phenomena. Throughout this book great attention has been paid to the phenomenon of central banks’ artificially low interest rate monetary policy causing a business cycle. However, business cycle expansions and contractions are typically of a much shorter time span than a great depression.

Depressions begin with a considerable period of monetary expansion followed by an economic crisis. Rothbard3 shows that there was a considerable period of monetary expansion prior to the stock market crash in 1929. Rothbard’s calculation of the money supply in the 1920s has been challenged by Timberlake.4 However, Salerno5 has shown that even if you remove the “offending” categories from calculations of the money supply — for example, the cash value of life insurance policies — monetary policy in the 1920s was still highly expansionary.

Turning the crisis into a depression or great depression requires a significant and sustained effort on the part of the government to use various policies in an attempt to stop and reverse the corrective market process — that is, the economic crisis. In other words, the dominant ideology is some variation of Keynesianism, and the government’s response to the crisis involves, among other things, an expansionary monetary and fiscal policy. Rothbard6 showed that President Hoover’s policies were intended to keep wages and prices high. This turned an ordinary economic crisis into the Great Depression. Hoover’s “New Deal-like” policies included maintaining high prices and incomes, stimulating the economy with public works projects, loans, bailouts, protectionism, and currency devaluation. Herbener7 shows that the Fed was interventionist, with a low interest rate monetary policy until 1937. Ohanian and Cole8 and Ohanian9 empirically verified the Rothbard hypothesis. Hoover’s and later Roosevelt’s policies became the basis of what would become Keynesian economics.10 Keynesian ideology was also the dominant force during the stagflation of the 1970s and in the Japanese economy from 1989 to the present.

The alternative approach to business cycle contractions is espoused by the classical economists, the Austrian-school economists, and the real business cycle theorists. This “do nothing” approach involves shrinking government and balancing the budget, expanding resources in the private sector, and a nonexpansionary monetary policy. This was employed by Presidents Woodrow Wilson and Warren G. Harding during the fifteen-month-long depression of 1920–21. This period was one of the most severely deflationary in US history, and yet it is hardly mentioned in history textbooks.

James Grant11 found that the reason this depression was so short was because it largely cured itself before government meddling could begin. Thomas Woods12 shows that Harding was really a “do something” liquidationist in the sense that he wanted to reduce the size of government and raise interest rates to actively stamp out the inflation from World War I. There has been some quibbling regarding the timing and effect of various policies and policy changes, but Patrick Newman13 has decisively shown that a liquidationist policy was dominant before the recovery began.

In the chapter to follow, I will present a simplified version of business cycle theories and discuss what those theories would recommend as policy remedies for economic crises, and how well those remedies worked in the wake of the financial crisis. See Bagus14 for a more in-depth Austrian critique of modern mainstream business cycle theories.

• 1Mark Thornton, “America’s Second Great Depression: A Symposium in Memory of Larry Sechrest,” Quarterly Journal of Austrian Economics 13, no. 3 (Fall 2010): 3–6.
• 2Robert Higgs, “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s,” Journal of Economy History 52, no. 1 (March 1992): 41–60.
• 3Murray Rothbard, America’s Great Depression, 5th ed. (Auburn, AL: Mises Institute [1963] 2000).
• 4Richard Timberlake, “Money in the 1920s and 1930s,” Freeman (April 1999): 37–42.
• 5Joseph Salerno, “Money and Gold in the 1920s and 1930s: An Austrian View,” Freeman (October 1999): 31–40. Reprinted in Joseph T. Salerno, Money Sound and Unsound (Auburn, AL: Mises Institute, 2010), pp. 431–49.
• 6Rothbard, America’s Great Depression.
• 7Jeffrey Herbener, “Fed Policy Errors of the Great Depression,” in The Fed at One Hundred: A Critical Review on the Federal Reserve System, edited by David Howden and Joseph T. Salerno (Springer, 2014), pp. 43–45.
• 8Lee E. Ohanian and Harold Cole, “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis,” Journal of Political Economy 112, no. 4 (August 2004): 779–816.
• 9Lee E. Ohanian, “What—or Who—Started the Great Depression?” Journal of Economic Theory 144 (October 2009): 2310–2335.
• 10Arthur Okun, The Political Economy of Prosperity (Washington, DC: Brookings Institution, 1970).
• 11James Grant, The Forgotten Depression: 1921: The Crash That Cured Itself (New York: Simon & Schuster, 2014).
• 12Thomas E. Woods, “Warren Harding and the Forgotten Depression of 1920,” Intercollegiate Review (Fall 2009): 22–29.
• 13Patrick Newman, “The Depression of 1920–1921: A Credit Induced Boom and a Market Based Recovery?” Review of Austrian Economics (January 2016): 1–28.
• 14Philipp Bagus, “Modern Business Cycle Theories in Light of ABCT,” in Theory of Money and Fiduciary Media: Essays in Celebration of the Centennial, edited by Jörg Guido Hülsmann (Auburn, AL: Mises Institute, 2012), pp. 229–46.