Stefan Molyneux’s Libertarian Myths on the Great Depression

These myths can be seen in the video below of Stefan Molyneux’s interview of Lawrence W. Reed on the Great Depression.



A quick point that struck me: both seem oblivious to the fact that Keynesian economists do not advocate tax increases in a recession or depression. This doesn’t inspire much confidence in the quality of the analysis.

In what follows, I am using a Post Keynesian economic analysis to critique the economic theory underlying the discussion in this video, which seems to be some version of Austrian economics.

But let’s break down the libertarian propaganda and nonsense:

(1) yes, it is true that the Federal Reverse helped to blow the US asset bubble in the stock market in the 1920s by loose monetary policy, and to that extent helped cause the crisis.

But this was all in the context of a poorly regulated financial sector, and the truth is that asset bubbles are also endemic to laissez faire capitalism even in the absence of central banks. To see this, just look at the asset bubbles in America in the 19th century when (for most of the century) no US central bank existed. For example, devastating manufacturing recessions happened in the 19th century after US asset bubbles and financial crises, as in the 1870s and 1890s (e.g., see here).

Or take a look at Australia in the 1880s and 1890s, where a very poorly regulated financial sector and foreign capital inflow caused a massive asset bubble and financial crisis, which then induced a severe depression in the 1890s (here and here). Australia had no central bank at this time, was on a gold standard, and had virtually no banking regulation.

The more laissez faire capitalism is, the more prone to destabilising debt-financed asset bubbles and economic crises it is. The solution is not abolishing central banks (which are absolutely necessary for stabilising the fractional reserve banking system), but vigorous financial regulation to choke off the flow of credit to asset speculators on the secondary financial asset and secondary real asset markets.

Central banks and effective financial regulation largely cured capitalism of destabilising asset bubbles in the golden age of Keynesianism from the 1940s to the 1970s, and provided a degree of banking stability that can be seen here.

(2) Molyneux and Reed push the discredited Wicksellian loanable funds model of investment, which has long been used by Austrians in a crude form (for loanable funds see here). You cannot accurately model the level of aggregate investment in a capitalist society by the loanable funds model, which is hopelessly flawed by the empirical irrelevance of the natural rate of interest and complicating role of uncertainty and business expectations. The neoclassical version of the natural rate requires the Efficient Markets Hypothesis (EHM), which is a theory that belongs in Cloud Cuckoo Land (here).

The role of interest rates in determining investment is overrated at the best of times, and in times of crisis grossly overrated to the point of absurdity (see the devastating empirical evidence here).

Underlying this libertarian theology is the belief that fractional reserve banking and credit money are somehow alien to and fraudulent violations of laissez faire capitalism, which is total nonsense.

(3) Molyneux pushes some vulgar version of Austrian Business Cycle Theory (ABCT), but that theory can easily be totally debunked (see here, here, here, here, here).

(4) at 7.00, we get the typical libertarian nonsense about the US recession of 1920–1921, which is completely debunked here.

(5) Reed, quite laughably, admits that the liquidationist solution of Austrian economics (letting the money supply collapse) to the Great Depression was a bad idea, and proceeds to blame the Federal Reserve from 1929 to 1933 for letting the money supply collapse: so here the Fed is blamed for not engaging in evil intervention!

(6) Molyneux’s ranting (from 13.20 onwards) about central banks giving “free money” is rubbish. The banks created massive private debt (with an endogenous money accommodating their demand for reserves), not free money.

(7) Reed plunges into all sorts of libertarian myths about Herbert Hoover. The Smoot Hawley tariff was not a major cause of America’s Great Depression. Certainly, it hurt other countries, but one cannot invoke this as a fundamental cause of America’s depression.

Fundamentally, the fall in export demand caused by the Smoot Hawley tariff was offset by a rise in domestic demand, so that, as Temin argues, the net contractionary effect on the US domestic economy was probably small (Temin 1989: 46).

While Hoover did intervene in the economy in certain ways, this intervention was not the cause of the Great Depression either.

It is indeed true that Hoover was not, strictly speaking, a liquidationist, and attempted to fight the onset of the Great Depression with a number of limited interventions, but these were all ridiculously feeble and too small given the scale of the GDP collapse.

Some of Hoover’s actions was positively harmful, and clearly not in line with Keynesian economics:

(1) In fiscal year 1930, Hoover actually ran a federal budget surplus, not a deficit. Federal policy was contractionary in this fiscal year.

(2) The Federal Reserve raised the discount rate in 1931.

(3) In fiscal year 1933, total federal spending was cut in relation to fiscal year 1932. Hoover introduced the Revenue Act of 1932 (June 6) which increased taxes across the board and applied to fiscal year 1932 and subsequent years. These were contractionary measures, and these two policies are the very antithesis of Keynesian stimulus.

Regarding Hoover’s idea of maintaining high wages, he was not simply forcing this policy on huge numbers of unwilling corporate leaders: first, it was mostly a voluntary policy and, secondly, the idea had permeated the corporatist thinking of many business people in the 1920s.

Many influential industrialists actually supported it; Hoover was basically articulating an influential opinion they already held, and whatever harm it did as prices fell, one must blame the private sector just as much as Hoover (see here).

On Hoover, see here, here, here, here, here, here, here.

(8) That claim that the Depression was “prolonged” under Roosevelt from 1933 to 1937 (before Roosevelt’s turn to austerity) is nonsense. Under Roosevelt real GDP growth rates recovered to a very great extent.

Here is real GNP in billions of chained 2005 Dollars from U.S. Department of Commerce data:

Year | GNP* | Growth Rate
1929 | $984.60
1930 | $900.00 | -8.59%
1931 | $840.70 | -6.58%
1932 | $730.50 | -13.10%
1933 | $720.30 | -1.39%
1934 | $797.70 | 10.74%
1935 | $868.90 | 8.92%
1936 | $981.10 | 12.91%
1937 | $1032.50 | 5.23%
1938 | $997.40 | -3.39%
1939 | $1077.80 | 8.06%
1940 | $1170.80 | 8.62%
* Billions of chained 2005 Dollars

http://wikiposit.org/a?uid=FRED.GNPCA

In reality, the average annual real GDP growth rate from 1934 to 1940 was 6.511%, the second highest average growth rate ever seen amongst all coherent and historically relevant periods in modern American history here.

We can see the very significant fall in unemployment under Roosevelt here. When Roosevelt turned to budget balancing and austerity in 1937–1938, the US plunged back into recession and sharply rising unemployment. This blatantly contradicts Austrian and libertarian myths about the benefits of austerity.

(9) It is true that there were destructive aspects to the New Deal, such as the National Industrial Recovery Act (NIRA), which even John Maynard Keynes condemned (see here). But it is important to remember the thinking behind some of these New Deal Programs: America’s price system had become grossly distorted by the disparity between relatively inflexible cost-based mark-up prices and the collapse of flexprices (often in primary industries). See this post here. As Keynes argued, the National Industrial Recovery Act (NIRA) should never have been done, and agricultural prices increased by stimulus of aggregate demand (perhaps even with temporary subsidies to farmers as well).

(10) The Wagner Act (or National Labor Relations Act of 1935) was not a fundamental cause of the US recession of 1937 to 1938, which was caused by Roosevelt’s budget balancing, austerity, monetary tightening and Roosevelt’s tax hikes of 1936 to 1937, namely, the undistributed profits tax (March 1936), and Social Security payroll tax (1937).

(11) Unsurprisingly, Molyneux and Reed never bother to look outside the United States at depression history. Those nations that recovered from the Great Depression or its aftermath rapidly and successfully – New Zealand, Japan and Germany – used large-scale Keynesian fiscal stimulus:

“Keynesian Stimulus in New Zealand: 1936–1938,” September 23, 2011.

“Takahashi Korekiyo and Fiscal Stimulus in Japan in the 1930s,” August 27, 2011.

“Fiscal Stimulus in Germany 1933–1936,” September 3, 2011.

But of course this doesn’t fit the libertarian narrative.

Nor is the disastrous failure of austerity in 1930s Austria or Weimar Germany mentioned:

“Liquidationism and early 1930s Germany: Not a Good Mix!, August 15, 2014.

“Keynesianism could probably have prevented World War II,” January 15, 2016.

“Mises and the Great Depression in Austria,” May 12, 2014.

(12) The recovery in the US economy by 1940 was very real, despite the implied nonsense in his video that no recovery occurred, even if it was not complete.

Furthermore, there was a sense in which the Second World War did aid and complete the recovery as described here, but the war was hardly necessary for this.

(13) regarding the post-WWII boom in America, a number of Keynesian economists did not predict long-term unemployment or stagnation after the post-war correction, contrary to Reed (see here and here), and even Paul Samuelson’s views on the post-WWII economy have been reduced to a caricature by libertarians (see here).

Moreover, government interventions did prevent US mass unemployment by means of the G.I. Bill of 1944.

BIBLIOGRAPHY
Temin, P. 1989. Lessons from the Great Depression, MIT Press, Cambridge, Mass.