Tuesday, May 19, 2015

Murray Rothbard vs. Jeffrey Herbener on the 1920-21 Depression

By Robert Wenzel

I'd give a lot to have the "do nothing" Warren Harding as president once again. As Lew Rockwell notes in an essay today, Harding did very little to get the United States out of the 19020-21 Depression, and that was, as Rockwell notes, brilliant.

However, the cheering on of the reaction by Harding to the 1920-21 Depression should not be continued to the actions of the Federal Reserve during the period.

The Fed reacted to the depression in typical central bank fashion and launched a new money printing scheme to goose the economy into another manipulated boom.

There is some confusion in Austrian school circles about this fact.

The Austrian school economist Jeffrey Herbener takes the view that the upturn in the economy was not the result of Federal Reserve activity. He writes:
The NBER dates the downturn as the 18 months from January 1920 to July 1921. 
Calculations from Friedman and Schwartz data sets show that high-powered money fell 17 percent from its peak in October 1920 to its trough in January 1922 and M2 fell 7% from its peak in September 1920 to its trough in January 1922. So, the economy was in recovery for six months while the Fed’s policy was contractionary.
But there are a few odd things about this observation that might raise eyebrows among Austrians carefully considering the data. The first curiosity regarding the data Herbener presents is with regard to the time frame of money growth he has under consideration.

If the downturn ended in July 1921, then the period you would want to look at with regard to Federal Reserve monetary operations is the period just before the downturn ended to see if indeed money growth had started to climb just before the upturn.

More curious for Austrians is that Herbener uses the data of the Chicago school economists Milton Friedman and Anna Schwartz, rather than the data compiled by the Austrian school economist Murray Rothbard. Rothbard's method of calculating money supply was decidedly different than  Friedman and Schwartz.

When Rothbard data is used along with the time period of the upward turn in the economy, we can see that the money supply growth dovetails extremely well with the upturn. In other words, the upturn was a typical Fed induced distorted recovery, as one would expect based on Austrian school business cycle theory.

Here is the data from Rothbard on money supply growth as he presented it in his book, America's Great Depression:

Click for larger view.

Notice two things about the data presented. First, Rothbard begins his data, with the June 1921 period, which makes more sense when trying to understand what occurred as the economy began to turn upward in July 1921, rather than examining money growth from the September and October 1920 periods, as Herbener does. Further, whereas Herbener, using Friedman-Schwartz for the odd period he chooses, proclaims that the Fed was not involved in the start of the upturn. Using Rothbard calculations, we see that money growth did start to turn upward, just before the start of the upward turn in the economy.

 Rothbard lists money supply growth of 4.1% from June 1921 to June 1922 and he shows that it jumped even higher the following 12 months to 9.8%. That's serious stimulus, especially after a period when money supply declined dramatically.

I believe the idea that Rothbard viewed the 1920-21 Depression differently than subsequent downturns comes about because of another point Rothbard made in America's Great DepressionRothbard  on page 185 quotes Benjamin Anderson calling the 1920-21 Depression "our last natural recovery to full employment." 

I believe some Austrians are taking this to mean that the Fed was not actively expanding the money supply as the economy turned upward.

But this is not what Anderson meant. It is clear, from the context around the quote, that Rothbard understood  that what Anderson was referring to was that 1920-21 was the last depression where wages weren't propped up, etc. by government

He wasn't talking about Fed operations.

Since the 1920-21 Depression, governments have attempted to prop up wages, prices etc. This did not occur in 1920-21, thanks to the do nothing response of Harding, but this did not include a do nothing response from the Fed. It was, indeed, a clear money printing boom that ultimately led to the Great Depression and all sorts of interventions on the economy.

 Robert Wenzel is Editor & Publisher at EconomicPolicyJournal.com and at Target Liberty. He is also author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics


  1. The historical Case-Shiller Housing Index hit bottom in 1921, and provides a different angle on this critical period of time before the Great Depression.

  2. This book lays a lot of the blame for the Great Depression on Fed actions beginning at or near the end of the
    1920-1921 depression.

    Banking And The Business Cycle: A Study Of the Great Depression In the United States, (C.A. Phillips; T.F. McManus; R.W. Nelson, The Ludwig Von Mises Institute 2014, Approx. orig. release February 28, 1937