Final Comment on Salerno’s Monetary Program

Contractions and Depressions Are Avoidable

I am not going to re-argue the points of difference between Salerno’s arguments and mine in this final rejoinder. The reader must decide for himself which parts if any of our respective views are most logical and most useful in dealing with the events under scrutiny. I find that nothing in Salerno’s final account refutes anything I have argued. I must, however, correct a few of his fallacious notions.

Salerno and I share much common ground in our advocacy of free markets and other characteristics of a society ruled by individual preferences and minimal constitutional government. Clearly, however, we speak—perhaps imperfectly—for different tools and different approaches on how to analyze monetary disturbances, especially the “Big One” of 1929-1941. Salerno would even change the time of this disequilibrium to 1921 and on, perhaps to the present. Indeed, if his (and Rothbard’s) doctrine is to be consistent, financial markets have not been stable since 1858. For not since the Civil War has the money stock been ruled exclusively by, and based on, the presence of the precious metals. Thus the Great Contraction and Great Depression should have been one of only many great contractions and great depressions over the last five generations. So why was the period 1929-1941 unique? Why was this particular business depression so deep, so stubbornly protracted, and so resistant to the “therapy” of monetary authorities?

Salerno notes that I fail to mention that the increase in the money supply during the 1920s “also increased the prices of capital goods relative to the prices of consumer goods.” This disparity, he claims, set in motion a boom in real estate and stock market prices—the “Austrian Theory of the Business Cycle” (ATBC). Then, he adds, all interest rates “were driven down,” presumably by the “increase” in Fed money.

This compounding of assertions is wrong from beginning to end, and is not verified by any empirical studies. Fed-created money declined all through this period, while gold-based money increased nominally. And did the prices of consumer goods decrease relative to the prices of capital goods? Where is the empirical measurement of this phenomenon? What are the norms for judging the differences? When money has entered the economy from whatever sources during business fluctuations in the past, has there been a disparity between the increases in prices of capital and consumer goods?

I raise these questions because those who profess “Austrian” economics have largely, if not exclusively, failed to raise or answer them. They assert logical possibilities, such as the ATBC, but offer no empirical evidence to substantiate them. In spite of the many worthwhile values in Austrian doctrine, therefore, their stock among conventional thinking economists is not high, especially with reference to monetary affairs.

Salerno also claims that I and “the monetarists are oblivious to movements in real money prices.” How he can seriously make this charge is more than I can understand. In fact, the most important use of price indexes is to distinguish between money prices and real prices. Anyone who examines my work, or that of any monetarists, will see that real values bulk large in our writings.

In assessing the question of what to include in “the” stock of money, I offered the Yeager test: Do disruptions in the supply of the alleged money work themselves out in a particular market without macroeconomic disruptions, or does a large variation in the supply of the alleged money spread to all (or many) other markets? Clearly, this test washes out savings deposits, savings and loan share capital, and cash surrender values of life insurance companies as moneys. These items, while wealth, have no monetary properties—no more so than real estate and common stock holdings. Here again, however, is a question that can be tested empirically. I did so once upon a time, and established some answers. These answers were not written in stone; they can be altered or refuted, but not by laid-back theorizing from some supposedly “irrefutable” doctrine.

The three articles* I wrote for The Freeman: Ideas on Liberty last year concluded that the Great Contraction and Great Depression were results of badly conceived central bank and Treasury policies. A “good” central bank, such as the Federal Reserve System is today, would never have allowed that debacle. Nonetheless, this conclusion does not excuse the institution of central banking generally and its interference in the money-creating process. In other research I have done I have found that the privately designed and operated “central bank”—the informal system of clearinghouse associations—did much better in operating as a lender of last resort. In fact, the Federal Reserve System was meant to be the government designed clearinghouse system and failed because private incentives for doing the right thing at the right time were lacking.

*Money in the 1920s and 1930s

Gold Policy in the 1930s

The Reserve Requirement Debacle of 1935–1938

Yet again, the clearinghouse system only came into existence because of the rigidities and complications that government banking policies forced on the banking system. Were the money industry as free to innovate and produce as the computer industry, it is very probable that we would see the end not only of Great Contractions and Great Depressions, but also even those of minor magnitudes. I look forward to such a day.

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