"The time to worry about depressions," F.A. Hayek once wrote, "is, unfortunately, when they are furthest from the minds of most people." He's right, of course: imagine trying to tell a house flipper in 2004 that the housing market was a giant bubble that was going to burst. At best he'd smile politely, and then roll around in his fresh pile of Federal Reserve Notes.
It's during an artificial, unsustainable boom like the one we've just lived through that, unbeknownst to most people, the real damage is done to the economy. But that's when they're least likely to listen or care.
Now that we're living through the bust, on the other hand, many people are listening. That's why it's so important for economists of the Austrian School to redouble their efforts, whether in terms of writing, public speaking, media, or indeed whatever platform they can get, to promote a sound, free-market interpretation of what's happening. The drones who exist to repeat clichés about market failure need a robust and energetic reply from people who know what they're talking about.
Murphy and I corresponded regularly late last year as we worked on our respective books. He got a kick out of the realization that he, the economist, was writing a work of history, and I, the historian, was writing a book (Meltdown) that gave the Austrian perspective on the current economic crisis. But he is a perfect fit for a study like this. Although many economists know little history, historians' knowledge of economics is confined, with few exceptions, to a catalogue of primitive fallacies. This episode in American history has needed the careful, book-length attention of a good economist – that phrase, sadly, is practically an oxymoron in the Age of Krugman, is it not? – for a long time now.
And it isn't just the court historians or the left-wing economists who need straightening out, either. Even otherwise free-market scholars of the Great Depression and the New Deal have a fatal soft spot for the Fed – whose failing, they tell us, was its failure to pump enough money into the system. Murphy will have none of this.
Thus, for example, the Chicago School has been critical of the Fed, but for the wrong reasons: the Fed supposedly failed to create enough money when the money supply began falling. This is not exactly a free-market criticism, but (surprise!) it's the only one the mainstream has bothered to acknowledge. As a matter of fact, in the nearly two years following the 1929 stock-market crash the Fed engaged in what were at that time the most aggressive rate cuts in its history. (This is in contrast to the Fed's rate increases during the 1920–1921 downturn, which was over quickly but which by Chicago's reasoning ought to have been more severe and persistent.) Milton Friedman and Anna Schwartz, Murphy concludes, gave birth to
a myth, namely that the Federal Reserve sat idly back and allowed the economy to implode. That myth – like the myth that Herbert Hoover sat idly back and watched the Depression unfold – is continuing to drive misguided policies today.
Murphy also includes in this chapter a very useful section on deflation, a subject nearly impossible to find treated without breathless hysteria. To blame the Depression on a decrease in the supply of money is to get the relationship exactly backward. Moreover, the money supply fell by the same percentage between 1839 and 1843 that it did between 1929 and 1933, but robust increases in real consumption and real GNP followed. Under the heat of Murphy's magnifying glass throughout this much-needed chapter, the arguments of the deflationphobes melt away.
Naturally, Murphy devotes considerable attention to the interventionist program of Herbert Hoover, the president whom most Americans, if they have heard of him at all, associate with laissez-faire. According to Paul Krugman, for example, "the federal government tried to balance its budget in the face of a severe recession." Murphy, in response, says "it would be difficult to render a more misleading account of Hoover's policies without actually lying." In Fiscal Year (FY) 1933, which ran from mid-1932 to mid-1933, the federal government ran a $2.6 billion deficit – at a time when it took in only $2 billion in tax receipts. So the deficit that Krugman represents as wild slash-and-burn budget cutting was in fact greater than the federal government's entire tax haul that year. That would be equivalent, Murphy observes, to a $3.3 trillion deficit in FY 2007, as opposed to the actual figure of $162 billion.