The article overlooks one important factor which ostensibly nullifies its thesis, namely the carry trade funneled by Weimar Germany during the same period of time which effectively served as a source of copious free liquidity for the United States and the world, the ramifications of which eventually were hyperinflation, bankruptcy, and the decimation of the Germany economy and the morale of its people, leading to the populist rise of Hitler, and of course the greatest world war. There are always unintended consequences to unsound monetary policy and in this instance globalization ensured those would be felt everywhere and would be of the severest magnitude.

“Harding’s inchoate understanding of what was happening to the economy and why grandiose interventionist plans would only delay recovery is an extreme rarity among 20th-century American presidents.”

I gather that this has something to do with the fact that having had a successful career outside of government, as a newspaper publisher, he did not hate and fear the prospect of a smaller government. Whereas the rest of the sad sacks, hatchetmen and stooges occupying the presidency had little or no accomplishments or ability outside of government or government-controlled industries. For the latter type of president, sabotaging the economy is a boon, not a bane. Pursuing bad policies, while harming the public, is a completely rational act for someone whose living is made in the monopolistic “cleanup crew” of socialistic planners and fixers.

Here’s Joseph Schumpeter, who draws the same conclusions I do, on the 1920-21 depression: “[The case of 1920] also shows better than any theory could how the system pulls itself out of troughs under its own steam and how it succeeds in doing so while the price level is falling.”

Ash: I’ll have to dig around, but the prof’s explanation sounds fishy. Does the “end of the post-war recession” itself have any explanation, or is this “end” an extraneous force of some kind that simply occurred? This “end,” which has no apparent cause, is so powerful that it overrides and renders nugatory all competing fiscal and monetary policies?

G Plecki said:

“The article overlooks one important factor which ostensibly nullifies its thesis, namely the carry trade funneled by Weimar Germany during the same period of time which effectively served as a source of copious free liquidity for the United States and the world, the ramifications of which eventually were hyperinflation, bankruptcy, and the decimation of the Germany economy and the morale of its people, leading to the populist rise of Hitler, and of course the greatest world war.”

I don’t know what you’re talking about. The money supply crashed in 1920, as the United States went back on the gold standard, leading to massive liquidations and then a revival. There wasn’t plentiful liquidity for the United States whatsoever.

I have always hoped that the discussion on the 1920 depression would become less shallow.

The downturn was sharp, the turn around was quick – but perhaps the crucial question was what if the Fed did not allow the money supply to contract. My main problem with Rothbard is that he insists that this is the only feasible way to foster an economic recovery.

So among the Austrians, you have the Mises, Rothbard, Salerno et al. camp who are proponents of this approach. While the other camp – among them Hayek, Ropke, Garrison et al. – who would suggest that the money contraction should be arrested to prevent a “secondary deflation”, and government works might be necessary in that regard.

This is a worthy question to pursue i.m.o. – even if government policies will always be dictated by political considerations. Of course, the second camp’s views would present considerable difficulties – e.g. the mechanisms by which you prevent a monetary contraction is important (and you can never do this “correctly”), twiddling with the price mechanism etc.

But this crisis is of a far greater magnitude than the 1920 one – just look at the sheer amount of debt, and the Fed having weaker control over the money supply for a while now.

Some good discussions on the Austrian Economists blog – with emphasis on the 1920 depression:

http://austrianeconomists.typepad.com/weblog/2009/10/192021-and-the-great-depression.html

http://austrianeconomists.typepad.com/weblog/2009/10/hayek-on-deflation-and-the-great-depression.html

Anon Said:

“So among the Austrians, you have the Mises, Rothbard, Salerno et al. camp who are proponents of this approach. While the other camp – among them Hayek, Ropke, Garrison et al. – who would suggest that the money contraction should be arrested to prevent a “secondary deflation”, and government works might be necessary in that regard.”

I don’t know what you’re talking about. Nowhere does Hayek say that the money supply shouldn’t contract. He does say, in lecture four in Prices and Production, that if the banks could increase the money supply to satisfy the demand for money as money, and not as capital, then it would have positive effects. But he warns that it would be too difficult to do, and as such, shouldn’t really be attempted. Hayek was a liquidationist, just like Mises and Rothbard. Honestly, people try to turn Hayek into Keynes.

The article states that “Harding cut the government’s budget nearly in half between 1920 and 1922.” Since he wasn’t President until March 4, 1921, was he just continuing Wilson’s policies or did his policies actually result in visible signs of recovery within six months?

to eis:
i think anon is right on the money here. you’ve got to look beyond p&p. hayek was not always consistent on deflation, as you’ll see in bagus’ analysis (p. 11 onwards).

http://mises.org/journals/qjae/pdf/qjae6_4_3.pdf

this is the faultline that divides the gmu/ money equilibrium/ freebanking camp and the opponents of frb, notably the mises institute, and anon does well to highlight it.

to eis:
did you actually read the article? here’s an excerpt:

“In other lectures that same year, Hayek makes more interesting comments about his new attitude towards deflation (Hayek 1979). There he explicitly confesses that he has changed his opinion about it. A threatening deflation must be stopped because due to the disappointment of expectations, it tends to induce a “secondary deflation,” that “performs no steering function” (p. 15). Hayek states that were he responsible for monetary policy, he would prevent deflation by announcing that he would fight deflation
with all means. This very announcement, he believes, would help to stave off a deflation. And he again shows his new inflationary bias by pointing out that “monetary policy must prevent wide fluctuations in the quantity of money or in the income stream”

if bagus were a keynesian and not an austrian, then i’d not be interested in his critique.

Newson,

You’re misunderstanding Hayek. He’s talking about the demand for money as money, and not as capital. The latter is what causes inter-temporal disequilibrium. The aggregate price levels is not what’s important; the focus must be placed on the market rate of interest relative to the natural rate (increasing the supply of money as capital causes a divergence between the two). The free-bankers have to show how this happens, how the money supply could be controlled and funneled to actors to serve its purpose as money and not as capital (I’m not saying money is capital, just that it can act as capital temporarily).

Also, I have some questions about that article.

Bagus writes:

“In other words if there is a deflation during the depression, it should not be prevented. That seems to contradict his statement, that the money supply should be invariable.”

Hayek never says that the money supply should be invariable. He says that it’s merely one condition theoretically needed to end trade cycle’s. Hayek explicitly states that the trade cycle can never be eliminated, but that free market policies can serve to reduce their duration and severity. I think this is the quote he’s referring to:

“It is quite conceivable that a distortion of relative prices and a misdirection of production by monetary influences could only be avoided if, first, the total money stream remained constant, and second, all prices were completely flexible, and, third, all long term contracts were based on a correct anticipation of future price movements. This would mean that, if the second and third conditions are not given, the ideal could not be realized by any kind of monetary policy.” –Page 304, Prices and Production.

Furthermore, Bagus writes:

“He (Hayek) fails to see that deflation is not depressing to all businesses and does not necessarily decrease overall production. Only the business owners who depend on further inflation will get into serious trouble, while those entrepreneurs who correctly anticipate the deflation will receive gains. The ownership of companies can change but the “real rate of return remains the same” (Rothbard 1993, p. 696).”

I don’t understand what he’s trying to say here. Is he saying that Hayek believed falling prices are a problem? Or that profits have anything to do with the price level? Prices and Production explains why falling prices are not a problem, and why “voluntary savings” is something all dynamic economies depend on for growth.

to eis:
in regard to this hayek quote (which to me seems unequivocal):
“monetary policy must prevent wide fluctuations in the quantity of money or in the income stream” (p.17)

again from bagus:
In 1975, after having received the Nobel prize he mentions the “secondary depression”
in which unemployment leads to a decrease in aggregate demand and therefore
more unemployment. “Such a ‘secondary depression’ caused by an induced deflation
should of course be prevented by appropriate monetary countermeasures” (Hayek
1985, p. 210).

1985. “Speech at the East Leeds Labour Club” (1975). In New Studies in Philosophy, Politics,
Economics and the History of Ideas. Chicago: University of Chicago Press.

the boldface is mine.

newson,

Because some deflation, according to the free-banker’s is bad. I’m not entirely familiar with their positions, but I think it’s this: if the money supply falls below the demand for cash holdings, individuals will begin selling goods in order to achieve the level of cash they deem necessary for transactions (prices for consumer goods will fall), but that this will push the market rate of interest above the natural rate—that is, individuals will save less without a change in their their time preference. If money is created in order to satiate its demand as money, that is, as cash holdings, then it will lessen the fall in the prices of consumer goods, maybe even entirely prevent it, but it won’t prevent a fall in the price of producer goods. The price of producer goods must fall if there is to be a correction (liquidation). (This is my interpretation of their argument, from what I’ve read Hayek’s work).

So it’s not the case that Hayek thought the general price level shouldn’t fall–the price of producer goods have to fall (money as capital); but I guess the price of consumer goods don’t have to fall too dramatically. Again, it’s all about the position of the market rate relative to the natural rate.

Furthermore, to say that Hayek thought the general price level determined profit would mean that he rejected the Bohm-Bawerkian framework–in essence making him a Marxian.

There are a lot of questions unanswered though..

newson,

“if you look at what hayek says here, the implication is unambiguous, that hayek saw deflation as bad (though not worse than inflation)”

I think we’re using two different definitions of deflation. Deflation, according to Hayek, is a fall in the money supply below the demand for cash holdings, and not just a fall in the general price level.

“”it is, however, rather doubtful whether, from a long-term point of view, deflation is really more harmful than inflation””

I don’t know what he means. He was old, who knows?

I think we’re using two different definitions of deflation. Deflation, according to Hayek, is a fall in the money supply below the demand for cash holdings, and not just a fall in the general price level.

“”it is, however, rather doubtful whether, from a long-term point of view, deflation is really more harmful than inflation””

so many diefinitions of inflation or deflation,whatever.

if just before i died, i destroyed all my cash..lets say it was 1000 dollars…a reduction in the money supply, iow..is that deflation of cash??? would the remaing cash in the economy have a teensy bit more purchsaing power??

if cash deposits stop making there way into credit expanding type accounts ( i have been told this is what really occurs) and cash or currency inflation ceases…i assume the rate of credit growth would slow and eventually, as loans are repaid credit-money would also disappear…would this be credit-borne money deflation??? is that correct when discussing any type of deflation that occurs?

Hayek in a 1979 interview:

“I agree with Milton Friedman that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation. So, once again, a badly programmed monetary policy prolonged the depression.”

Quoting Mario Rizzo:

“So now we have not only the logic of Hayekian economics (both micro and macro) and the words of the man himself that deflation (of the increase in the relative demand to hold variety) should be avoided. I claim infallibly that this is the Hayekian position. We can argue about whether he was right but we cannot profitably argue about whether this was his position. QED.”

http://austrianeconomists.typepad.com/weblog/2009/10/hayek-on-deflation-and-the-great-depression.html

No one’s pronouncements deserve to be taken authoritatively, for that matter. Once that happens, you get dogma – and you certainly can be dogmatic even about the truth.

But if someone is posturing that Hayek didn’t support the notion of stabilizing the money supply – it’s an indefensible position because it contradicts fact.

Newson,

Hayek, Prices and Production pp 275

“In theory it is at least possible that, during the acute stage of the crisis when the capitalistic structure of production tends to shrink more than will ultimately prove necessary, an expansion of producers’ credits might have a wholesome effect. But this could only be the case if the quantity were so regulated as exactly to compensate for the initial, excessive rise of the relative prices of consumers’ goods, and if arrangements could be made to withdraw the additional credits as these prices fall and the proportion between the supply of consumers’goods and the supply of intermediate products adapts itself to the proportion between the demand for these goods. And even these credits would do more harm than good if they made roundabout processes seem profitable which, even after the acute crisis had subsided, could not be kept up without the help of additional credits. Frankly, I do not see how the banks can ever be in a position to keep credit within these limits.”

Reading “Prices and Production” and “Monetary Theory and the Trade Cycle” – indeed you get a glimpse of a younger Hayek, with less consolidated views.

Deflation is when the market rate of interest is above the natural rate, it’s a disequilibrating position. When is the market rate above the natural rate? Practically never. Never during the boom, and during the bust it’s rising back to the natural rate; but, it may rise above the natural rate if the deflationary correction is extremely dramatic or too abrupt. Hayek was insinuating that if this is the case, there may be some kind of room for monetary expansion in order to ease this transitional phase, but nowhere does he ever mention preventing liquidations, or stabilizing prices. Furthermore, he says that this would be too difficult to do, and shouldn’t really be attempted. I don’t care what Hayek said in the 60′s or 70′s, his work speaks for itself.

The effects of an elevated market rate of interest (above the natural rate) is interesting, and should be explored. But today, it’s pretty irrelevant. The free bankers have to show how this situation could be remedied without pushing the market rate below the natural rate, causing misdirections, and altering the capital structure.

Alex,

“Any Austrian here want to tell me exactly what Obama and the Fed should be advised to do right now, Nov. 29, 2009?”

They should stand down, and face the calamity they created.

@Nikolaj

“Early Hayek clearly and unequivocally rejected the stabilization of money supply as appropriate policy. Period. Rizzo is wrong, clearly and unequivocally. stabilization was not a Hayek’s position in the 1930s.”

I agree with you on the first part. Rizzo’s point was that Hayek thought otherwise- clearly and unequivocally – later in life.

“Any Austrian here want to tell me exactly what Obama and the Fed should be advised to do right now, Nov. 29, 2009?”

We would probably need a debt jubilee of some sort.

Greg Ransom (hayekcenter.org) probably has done the most research on Hayek’s beliefs concerning this matter.

There are bound to be disagreements within any group of individuals – which is perhaps why it can be dangerous to label a particular view (or a particular prescription) as being “Austrian”. There can be issues on which there are no consensus.

Thomas Woods however seems to be the public face of Austrian economics nowadays.

“Who cares? If you want to understand Hayek go read him; it’s in English. You don’t have to take Greg Ransom’s word for it.”

I certainly don’t care about yours.

1920/1929 = 2000/2009

There are plenty of similarities.