I am blaming Murray Rothbard for my writer’s block

I have promised to write an article about monetary explanations for the Great Depression for the Danish libertarian magazine Libertas (in Danish). The deadline was yesterday. It should be easy to write it because it is about stuff that I am very familiar with. Friedman’s and Schwartz’s “Monetary History”, Clark Warburton’s early monetarist writings on the Great Depression. Cassel’s and Hawtrey’s account of the (insane) French central bank’s excessive gold demand and how that caused gold prices to spike and effective lead to an tigthening of global monetary conditions. This explanation has of course been picked up by my Market Monetarists friends – Scott Sumner (in his excellent, but unpublished book on the Great Depression), Clark Johnson’s fantastic account of French monetary history in his book “Gold, France and the Great Depression, 1919-1932″ and super star economic historian Douglas Irwin.

But I didn’t finnish the paper yet. I simply have a writer’s block. Well, that is not entirely true as I have no problem writing these lines. But I have a problem writing about the Austrian school’s explanation for the Great Depression and I particularly have a problem writing about Murray Rothbard’s account of the Great Depression. I have been rereading his famous book “America’s Great Depression” and frankly speaking – it is not too impressive. And that is what gives me the problem – I do not want to be too hard on the Austrian explanation of the Great Depression, but dear friends the Austrians are deadly wrong about the Great Depression – maybe even more wrong than Keynes! Yes, even more wrong than Keynes – and he was certainly very wrong.

So what is the problem? Well, Rothbard is arguing that US money supply growth was excessive during the 1920s. Rothbard’s own measure of the money supply  apparently grew by 7% y/y on average from 1921 to 1929. That according to Rothbard was insanely loose monetary policy. But was it? First of all, money supply growth was the strongest in the early years following the near-Depression of 1920-21. Hence, most of the “excessive” growth in the money supply was simply filling the gap created by the Federal Reserve’s excessive tightening in 1920-21. Furthermore, in the second half of the 1920s money supply started to slow relatively fast. I therefore find it very hard to argue as Rothbard do that US monetary policy in anyway can be described as being very loose during the 1920s. Yes, monetary conditions probably became too loose around 1925-7, but that in no way can explain the kind of collapse in economic activity that the world and particularly the US saw from 1929 to 1933 – Roosevelt finally did the right thing and gave up the gold standard in 1933 and monetary easing pulled the US out of the crisis (later to return again in 1937). Yes dear Austrians, FDR might have been a quasi-socialist, but giving up the gold standard was the right thing to do and no we don’t want it back!

But why did the money supply grow during the 1920s? Rothbard – the libertarian freedom-loving anarchist blame the private banks! The banks were to blame as they were engaging in “pure evil” – fractional reserve banking. It is interesting to read Rothbard’s account of the behaviour of banks. One nearly gets reminded of the Occupy Wall Street crowd. Lending is seen as evil – in fact fractional reserve banking is fraud according to Rothbard. How a clever man like Rothbard came to that conclusion continues to puzzle me, but the fact is that the words “prohibit” and “ban” fill the pages of Rothbard’s account of the Great Depression. The anarchist libertarian Rothbard blame the Great Depression on the fact that US policy makers did not BAN fractional reserve banking. Can’t anybody see the the irony here?

Austrians like Rothbard claim that fractional reserve banking is fraud. So the practice of private banks in a free market is fraud even if the bank’s depositors are well aware of the fact that banks do not hold 100% reserve? Rothbard normally assumes that individuals are rational and it must follow from simple deduction that if you get paid interest rates on your deposits then that must mean that the bank is not holding 100% reserves otherwise the bank would be asking you for a fee for keeping your money safe. But apparently Rothbard do not think that individuals can figure that out. I could go on and on about how none-economic Rothbard’s arguments are – dare I say how anti-praxeological Rothbard’s fraud ideas are. Of course fractional reserve banking is not fraud. It is a free market phenomenon. However, don’t take my word for it. You better read George Selgin’s and Larry White’s 1996 article on the topic “In Defense of Fiduciary Media – or, We are Not Devo(lutionists), We are Misesians”. George and Larry in that article also brilliantly shows that Rothbard’s view on fractional reserve banking is in conflict with his own property right’s theory:

“Fractional-reserve banking arrangements cannot then be inherently or inescapably fraudulent. Whether a particular bank is committing a fraud by holding fractional reserves must depend on the terms of the title-transfer agreements between the bank and its customers.

Rothbard (1983a, p. 142) in The Ethics of Liberty gives two examples of fraud, both involving blatant misrepresentations (in one, “A sells B a package which A says contains a radio, and it contains only a pile of scrap metal”). He concludes that “if the entity is not as the seller describes, then fraud and hence implicit theft has taken place.” The consistent application of this view to banking would find that it is fraudulent for a bank to hold fractional reserves if and only if the bank misrepresents itself as holding 100percent reserves, or if the contract expressly calls for the holding of 100 percent reserves.’ If a bank does not represent or expressly oblige itself to hold 100 percent reserves, then fractional reserves do not violate the contractual agreement between the bank and its customer (White 1989, pp. 156-57). (Failure in practice to satisfy a redemption request that the bank is contractually obligated to satisfy does of course constitute a breach of contract.) Outlawing voluntary contractual arrangements that permit fractional reserve-holding is thus an intervention into the market, a restriction on the freedom of contract which is an essential aspect of private property rights.”

Another thing that really is upsetting to me is Rothbard’s claim that Austrian business cycle theory (ABCT) is a general theory. That is a ludicrous claim in my view. Rothbard style ABCT is no way a general theory. First of all it basically describes a closed economy as it is said that monetary policy easing will push down interest rates below the “natural” interest rates (sorry Bill, Scott and David but I think the idea of a natural interest rates is more less useless). But what determines the interest rates in a small open economy like Denmark or Sweden? And why the hell do Austrians keep on talking about the interest rate? By the way interest rates is not the price of money so what do interest rates and monetary easing have to do with each other? Anyway, another thing that mean that ABCT certainly not is a general theory is the explicit assumption in ABCT – particularly in the Rothbardian version – that money enters the economy via the banking sector. I wonder what Rothbard would have said about the hyperinflation in Zimbabwe. I certainly don’t think we can blame fractional reserve banking for the hyperinflation in Zimbabwe.

Anyway, I just needed to get this out so I can get on with writing the article that I promised would be done yesterday!

PS Dear GMU style Austrians – you know I am not talking about you. Clever Austrians like Steve Horwitz would of course not argue against fractional reserve banking and I am sure that he thinks that Friedman’s and Schwartz’s account of the Great Depression makes more sense than “America’s Great Depression”.

PPS not everything Rothbard claims in “America’s Great Depression” is wrong – only his monetary theory and its application to the Great Depression. To quote Selgin again: “To add to the record, I had the privilege of getting to know both Murray and Milton. Like most people who encountered him while in their “Austrian” phase, I found Murray a blast, not the least because of his contempt for non-Misesians of all kinds. Milton, though, was exceedingly gracious and generous to me even back when I really was a self-styled Austrian. For that reason Milton will always seem to me the bigger man, as well as the better monetary economist.”

PPPS David Glasner also have a post discussing the Austrian school’s view of the Great Depression.

Update: Steve Horwitz has a excellent comment on this post over at Coordination Problem and Peter Boettke – also at CP – raises some interesting institutional questions concerning monetary policy and is asking the question whether Market Monetarists have been thinking about these issues (We have!).

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Gustav Cassel foresaw the Great Depression

I might be a complete monetary nerd, but I truly happy when I receive a new working paper in the mail from Douglas Irwin on Gustav Cassel. That happened tonight. I have been waiting for the final version of the paper for a couple weeks. Doug was so nice to send me a “preview” a couple a weeks ago. However, now the paper has been published on Dartmouth College’s website.

Lets just say it at once – it is a great paper about the views and influences of the great Swedish economist and monetary expert Gustav Cassel.

Here is the abstract:

“The intellectual response to the Great Depression is often portrayed as a battle between the ideas of Friedrich Hayek and John Maynard Keynes. Yet both the Austrian and the Keynesian interpretations of the Depression were incomplete. Austrians could explain how a country might get into a depression (bust following an investment boom) but not how to get out of one (liquidation). Keynesians could explain how a country might get out of a depression (government spending on public works) but not how it got into one (animal spirits). By contrast, the monetary approach of economists such as Gustav Cassel has been ignored. As early as 1920, Cassel warned that mismanagement of the gold standard could lead to a severe depression. Cassel not only explained how this could occur, but his explanation anticipates the way that scholars today describe how the Great Depression actually occurred. Unlike Keynes or Hayek, Cassel explained both how a country could get into a depression (deflation due to tight monetary policies) and how it could get out of one (monetary expansion).”

Douglas Irwin has written a great paper on Cassel and for those who do not already know Cassel’s important contributions not only to the monetary discussions in 1920s and 1930s, but to monetary theory should read Doug’s paper.

Cassel fully understood the monetary origins of the Great Depression contrary to the other main players in the discussion of the day – Hayek and Keynes. From the perspective of today it is striking how we are repeating all the discussions from the 1930s. To me there is no doubt Gustav Cassel would have been as outspoken a critique of both Keynesians and Austrians as he was in 1930s and I am pretty sure that he would have been a proud Market Monetarist. In fact – had it not been for the fantastic name of our school (ok, I got a ego problem…) then I might be tempted to say that we are really all New Casselian economists.

Cassel clearly explained how gold hoarding by especially the French and the US central banks was the key cause for the tightening of global monetary conditions that pushed the global economy into depression – exactly in the same way as “passive” monetary tightening due to a sharp rise in money demand generated deflationary pressures that push the global economy and particularly the US and the European economies into the Great Recession. I my mind Cassel would have been completely clear in his analysis of the causes of the Great Recession had he been alive today.

In fact even though I think Market Monetarists tell a convincing and correct story of the causes for the Great Recession and I also sure that Gustav Cassel would have helped Market Monetarists in seeing the international dimensions of the crisis – particular European demand for dollars – better.

Douglas Irwin has written an excellent paper and it should be read by anyone who is interested monetary theory and monetary history.

Thank you Doug – you did it again!


See a couple of previous comments on Doug’s work and on Cassel:

Hawtrey, Cassel and Glasner

“Our Monetary ills Laid to Puritanism”

“Calvinist economics – the sin of our times”

“Gustav Cassel on recessions”

“France caused the Great Depression – who caused the Great Recession?”

Hawtrey, Cassel and Glasner

Recently I have been giving quite a bit attention to the writings Gustav Cassel (and I plan more…), but I have failed to give any attention to the great British monetary economist Raplh G. Hawtrey. That is not really fair – Hawtrey and Cassel lived more or less at the same time and both played important roles in the debate and formulation of monetary policy and monetary thinking around the world in 1920s and 1930s.

Long ago David Glasner – one of my big heros and the blogger on uneasymoney.com – and Ronald W. Batchelder long ago wrote a paper on the monetary economics of both Cassel and Hawtrey – “Pre-Keynesian monetary theories of the Great Depression”. You should all read it.

“Our Monetary ills Laid to Puritanism”

Douglas Irwin has been so nice to send me an article from the New York Times from November 1 1931. It is a rather interesting article about the Swedish monetary guru Gustav Cassel’s view of monetary policy and especially how he saw puritanism among monetary policy makers as the great ill. I had not read the article when I wrote my comment on Calvinist economics, but I guess my thinking is rather Casselian.

The New York Times article is based on an article from the Swedish conservative Daily Svenska Dagbladet (the newspaper still exists).

Professor Cassel claims that overly tight US monetary policy in the early 1930s is due to two “main ills”: “deflation mania” and “liquidation fever”.

NYT quote Cassel: “The deeper psychological explanation of this whole movement..can without doubt be found in American Puritanism. This force assembled all its significant resources in what was considered a great moral attack on the diabolism of speculation. Each warning against deflation has stranded on fear on the part of Puritanism that a more liberal monetary policy might infuse new vigor in the spirit speculation.”

It isn’t it scary how much this reminds you about how today’s policy makers are scared of bubbles and inflation? I wonder what Gustav Cassel would tell the ECB to do today?

Maybe here would just say: “That the deflation has meant the ruin of one business after another and forced many banks to suspend payments is a matter that little concerns the stern Puritan”…”on the contrary, it is highly approves proper punishment of speculation and thorough cleaning out of questionable business projects. It totals disregards the fact that deflation in itself by degrees adversely affects the finances of any enterprise and forces even sound business to ruin”. 

Wouldn’t it be a blessing if Cassel was around today to advise central bankers? And that they actually would listen…but of course if you are a puritan or what I termed a believer on Calvinist economics then you don’t have to listen because all you want it just doom and pain to punish all the evil speculators.





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