Recessions and Depressions in American History

Recessions and Depressions in American History
by Alex Merced

                A common narrative of depressions during the period on which the United States was on the classical gold standard (1873-1933)[1] is typically mischaracterized to be the fault of the gold standard itself. When given closer examination it’s easy to see that these downturns had less to do with the lack of an elastic money supply or central bank but more to do with structural changes in the economy and market corrections to speculative bubbles usually due to credit expansion. So what we’ll take a look reoccurring themes of economic downturns during and after the gold standard to see that no matter what is the monetary system the same factors play into recessions and depressions.

Abrupt Changes to the Monetary System

                In the history of the United States the monetary system has changed fairly regularly every 40-50 years. First major change is the ending of the First US bank in 1811 at the hands of Thomas Jefferson then only a few years later another major change with the Second US Bank which was then later also put to an end at the hands of Andrew Jackson. From 1936 to 1973 the United States was on a pseudo free banking system (still heavily regulated on the state level). From 1973-1933 the United State adopted a gold standard which was briefly abandoned in the 1933 – 1944 with a FIAT (paper) monetary system. In the 1944 the Bretton Wood Accord resulted in the Bretton Woods system which was a highly specialized gold standard. The Bretton Woods system eventually fell apart in 1971 and since we’ve been on a FIAT monetary system which has been able to sustain itself due to the reality that after the fall of Bretton Woods most nations found themselves which large reserves of US Dollars giving them a stake in the value of the US dollar despite US Domestic policy.

                This is all important since the years preceding many of the changes in the monetary system result in economic downturns which is to be expected. When the monetary system changes abruptly it’s reasonable to think that this may alarm the banking sector and they may withdraw from taking too much risk until comfort is developed in the monetary environment, this period of discomfort results in credit contraction. So downturns in the early 1870’s (transition to gold standard) and the double dip recession in the mid 1930s (transition off the gold standard) can be explained by this uncertainty in the environment.

Structural Changes from a Peace/War Economy

                If you follow the beginnings and ends of most wars, they are usually also marked by economic downturns which can be easily understood. When an economy must make the transition into a war economy the entire structure of production will have to retool itself to produce the goods needed for the war. This creates a massive demand for credit as factories shift from producing consumer goods to military goods. At the same time as people are sent off to fight in the war, this results in a huge drop of business for many consumer oriented businesses which are also suffering from increases in costs since so much of the productive capacity of the economy is being used military goods meaning the remaining capacity is more expensive to use. So with the reduction in consumer business many people end up decreasing their savings to compensate for higher prices and scarce production which means the available savings to be lent out drops while the demand for it is increasing (factories retooling). When the war is over, the opposite must happen causing another disruption in the economy.

                Taking this into consideration we see that World War I is perfectly bookended by recessions in 1913/14 and 1919/20 (note 1913 was also major change to the monetary system with the creation of the Federal Reserve).  World War II began at the end of the double dip recession in 1938, yet despite economic numbers this transition and the war period was not a period of great prosperity.[2] During this period of time there was rationing of consumer goods such as meats and fuels was rampant because government had got into the habit of price fixing to keep the inflation numbers from reflecting the economic reality of having less productive capacity to use on the goods people needed domestically. Wartime is not a good time for the economy and economist Robert Higgs has done great work explaining the problems with traditional economic statistics during a wartime economy. In the end, when World War II ended, sure enough a recession occurred in 1945.

                So whether it was during World War I which happened during the classical gold standard or World War II which occurred under a fiat paper system except in its last few years when the Bretton Woods System was put in place (1944), we see that economic downturns had no definitive tie to the gold standard as many mainstream economists try to make.

Other Trends

                If we take a look at other downturns during the classical gold standard we see that they are very similar to downturns in today’s world. For example the 1929 stock market bubble is quite similar to the dot com bubble in 2000 where expansion of credit from the central bank resulted in a bubble in stock prices.

                The panic of 1893 is quite similar to the housing crisis that began in 2008. The panic 1893 occurred due government favor when it came to railroad investment (similar to government with housing in modern times), thus many investors invested heavily in the production of railroads (similar to investment in housing over the last few decades). When the Reading Railroad failed it caused a stock market crash and a collapse of the financial system again very similar to the fallout of 2008.

Conclusion

                Economic Downturns as with any other economic event are the aggregated results of individual motivation and decisions. Modern day economist may spend much of their time claiming “when number x goes down economic consequence y occurs”, but what is it about individual motivation and decisions in the economy that cause variable x and y. luckily, economist that spend time looking at these human elements are becoming more influential everyday whether it be a Robert Murphy of the Mises Institute or a Dan Ariely of Duke University, economics is slowly but surely returning to where it began, studying how decision and choice create the world we see around us.

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[1] http://www.midasletter.com/index.php/timeline-history-of-the-gold-standard/

[2] http://mises.org/daily/5069/World-War-II-Did-Not-End-the-Great-Depression

The Money Problem

The Money Problem
by Alex Merced

 While people like me definitely see the virtue of a gold standard, even a gold standard in any of it's historical incarnations still have one fundamental problem, they are a monopoly. I can discuss how the gold standard restrains government which promotes peace and limited government, or that the problem with previous attempts at the gold standard was allowing fractional reserve banking which many see as fraud.

 Although, all of this is only a band aid on the greater problem of money traditionally being a monopoly product of a government, and like any legally protected monopoly results in drops of quality and increases in prices, in this case the increases cost being the extra labor needed to earn enough money to retain purchasing power as the currency is devalued by it's monopolistic issuer.

 Money, like any good needs to be allowed to have a market and competition. While many think you have competitions between nations, politics of government leads to a race to the bottom like you see now where every government compete to see who can provide the worst product instead of the best like when enterprise competes.

 An important aspect of developing such a market is the ability to use multiple currencies and goods as legal tender, instead of the ultimate legal control of legal tender laws which even on it's worst day force people to have some level of demand for some currency. If people could have multiple goods that they could use as legal tender, they could diversify their monetary portfolio like one diversifies their stock portfolio.

 For example, if the US dollar were to collapse owning other currencies and goods would be meaning less since they can't be legally used to tender debts. So at the end of the day, a sound money is great but would probably naturally occur in a competitive market for currency separated from politics (business issued money, not government issued).

Addendum to Robert Murphy's Lecture by Alex Merced

Addendum to Robert Murphy's Lecture 
by Alex Merced

This is just some comments to add my two cents to Robert Murphys Responses to Critics of Austrian Economics.

Critic: How come unemployment wasn't the worst in the states that had the worst housing busts if it's a mal-investment problem?

RPM: The data actually is more in line with the Austrian Theory if you widen the time frame for calculation from the peak of bubble.

My Response: Just cause unemployment doesn't follow the size of the local busts means nothing, the mal-investment is only the seed who's roots implant itself all over the economy in different ways. Since wages increases due to the bubble, industries grow in areas not related to the bubble industries cause all industries suffer a mini bubble from the consumption boom from the high wages that originate in the bubble industry and spread elsewhere (how I'll explain in my response to the next critic). Another factor for differing state data is state and local legislation and culture which might magnify or dampen the effect of the bust.

Critic: If Mal-Investment is the problem during the bust why do consumption and investment move together during the bust and boom, why isn't their unemployment during the boom?

RPM: Murphy does a great refute explaining how people who take on these new higher wage jobs in the bubble sector don't realize it's bubble sector so they consume with the assumption that they'll make those wages forever. He also makes an amazing point that you don't have unemployment during a boom cause no one is losing their jobs but instead leaving their jobs for "seemingly" better ones, while during the bust people are losing their jobs and try to find another at a similar level so it takes time before they adjust their expectations. (I elaborated a little on RPMs response, listen to the lecture itself, it's really good)

My Response: The Only thing I would add it that when people leave their jobs for higher wage jobs in the bubble sector, to attract replacement labor all other sectors will raise their wages making it seem like the economy as a whole is doing well. Although, these wage rises are not cause of productivity gains, but because labor supply issues so this puts more pressure on the price inflation seen on the bubble as businesses charge more for their goods and services to pay these higher wages. So this wage competition aspect of the bubble is what helps systematize the bubble and dig it's root into the rest of the economy, cause now all jobs are paying unsustainable wages to compete with the bubble sectors wages.

Critic: Can the ABCT occur absent of central bank, and during a 100 percent Gold Reserve system?

RPM: Murphy Wrote an article which I read, which he brings back up here during the lecture. Basically he doesn't come down on either side of the question but instead makes Rothbardian arguments for both sides. Read the article to see both his arguments.

My Response: What I want to say that the Austrian business cycle as it's commonly thought about can't happen in a 100% reserve gold standard system cause of one crucial element... expectations. One thing that drives bust from low rates is the expectation of those rates persisting or the money supply continuing to increase. In Murphys example, someone comes upon a huge cache of gold, but this is a one time injection of money and yes there will be price adjustments to all goods from the increased money supply, but I doubt mal-investment will occur because the expectation that he'd continually find huge deposits regularly isn't a logical expectation. Under our current system, it's very logical to conclude the fed will continue to prime the pump, so these expectations drive the bubble behavior. In the end, with 100% reserve banking there is no way to expect a predictable trend of money supply growth to allow the bubble expectations/speculations to be held long enough for a large systematic collapse.