"I have no reason to suppose there was any
over-investment boom ... during the 1920s. "
Milton Friedman
In my continuing exchange of letters with Professor
Milton Friedman, the freemarket economist challenged followers of the
Austrian school to provide evidence of an over-investment boom in the
1920s. He reiterated what he and Anna Schwartz concluded in A Monetary
History of the United States: the 1920s was the "high tide" of Federal
Reserve policy, inflation was virtually non-existent, and economic
growth was reasonably rapid. Monetarists even deny that the stock market
was overvalued in 1929! In short, "everything going on in the 1920s was
fine."1 The problem, according to Friedman, was not the
1920s, but the 1930s, when the Federal Reserve permitted the "Great
Contraction" of the money supply and drove the economy into the worst
depression in U.S. history.
In contrast to Friedman and the Monetarists, the
Austrians argue that the Federal Reserve artificially cheapened credit
during most of the 1920s and orchestrated an unsustainable inflationary
boom. The stock market crash of 1929 and subsequent economic cataclysm
were therefore inevitable.
An interesting historical sidelight is the fact that
Irving Fisher, the principal Monetarist of the 1920s, completely failed
to anticipate the crash, while Austrian economists Ludwig von Mises and
Friedrich Hayek predicted the economic crisis, although they did not
pinpoint an exact date. Ever since then, Monetarists have argued that
the 1929-33 debacle was unforecastable and have made every effort to
show that there were few if any signs of trouble during the 1920s. The
Austrians, in contrast, have attempted to confirm Mises-Hayek's view
that the government created an inflationary boom that could not last,
especially under an international gold standard.2
Was there an over-investment boom in the 1920s? The
answer depends on which statistics you examine. The "macro" data favors
the Monetarists' thesis, while the 'micro" data supports the Austrians'
view.
In support of the Monetarists, the broad-based price
indices show little if any inflation. Average wholesale and consumer
prices hardly budged between 1921 and 1929. Most commodity prices
actually fell. Friedman and Schwartz conclude, "Far from being an
inflationary decade, the twenties were the reverse." 3
However, other data support the Austrian view that the
decade was aptly named the Roaring Twenties. The 1920s may not have been
characterized by a "price" inflation, but there was, in the words of
John Maynard Keynes, a "profit" inflation. After the 1920-21 depression,
national output (GNP) grew rapidly at a 5.2 percent pace, substantially
exceeding the national norm (3.0 percent). The Index of Manufacturing
Production grew much more rapidly and virtually doubled between 1921 and
1929. So did capital investment and corporate profits.
Like the 1980s, there was also an "asset" inflation in
the U.S. A nationwide real estate boom occurred in the mid-1920s,
including a speculative bubble in Florida that collapsed in 1927.
Manhattan, the world's financial center, also experienced a boom.
The asset bubble was most pronounced on Wall Street,
both in stocks and bonds. The Dow Jones Industrial Average began its
monstrous bull market in late 1921 at a cyclical low of 66, mounting a
drive that carried it to a high of 300 by mid-1929, more than tripling
in value. The Standard & Poor's Index of Common Stocks was just as
dramatic-Industrials, up 321 percent, Railroads, up 129 percent, and
Utilities, up an incredible 318 percent.
Astonishingly, the Monetarists go so far as to deny any
stock market orgy. Anna Schwartz suggests, "Had high employment and
economic growth continued, prices in the stock market could have been
maintained. "4 It's as if they want to exonerate Irving
Fisher's infamous blunder of declaring a week before the 1929 crash,
"stock prices have reached what looks like a permanently high plateau."
(Fisher's huge leveraged position in Remington Rand stock was wiped out
by the crash.)
Schwartz's thesis is based on what appears to be
reasonable price-earnings ratios for most stocks in 1929 (15.6 versus a
norm of 13.6). However, P/E ratios can be a notoriously misleading
indicator of speculative activity. While they do tend to rise during a
bull market, they severely underestimate the degree of speculation
because both prices and earnings tend to rise during a boom. However,
when annual national output averages 5.2 percent during the 1920s, and
the S&P Index of Common Stocks increases an average 18.6 percent a
year, something has to give. In fact, during 1927-29, the economy grew
only 6.3 percent, while common stocks gained an in credible 82.2
percent! As the old Wall Street saw goes, "Trees don't grow to the sky."
A crash was inevitable.
The Austrians argue 'that the Federal Reserve's
"cheap-credit" policy was to blame for the structural imbalances of the
Twenties, while the Monetarists dispute any significant inflationary
intent. The money stock (M2) grew 46 percent between 1921-29, less than
5 percent per annum, which 5 Monetarists do not consider
excessive.5 Austrians, on the other hand, point to the
deliberate efforts by the Fed to lower interest rates, especially in
1924 and 1927, thus generating an unjustifiable boom in assets and
manufacturing. More importantly, the credit expansion in the United
States far exceeded the increase in gold reserves, which would
eventually spell disaster under the gold exchange standard.
In sum, was there an inflationary imbalance during the
1920s, sufficient to cause an economic crisis? The evidence is mixed,
but on net balance, the Austrians have a case. In the minds of the
Monetarists, the "easy credit" stimulus may not have been large, but
given the fragile nature of the financial system under the international
gold standard, small changes by the newly established central bank
triggered a global earthquake of monstrous proportions.
In my next column, I will address a growing debate
among economists: Did the gold standard make the 1929-33 crisis worse?
At the time of the original publication, Mark Skousen
was an economist at Rollins College, Winter Park, Florida 32789, and
editor of Forecasts & Strategies, one of the largest investment
newsletters in the country
1. Milton Friedman and Anna J. Schwartz, A Monetary
History of the United States, 1867-1960 (Princeton, N.J.: Princeton
University Press, 1963), pp. 240-98.
2. See my article, "Who Predicted the 1929 Crash?" in
Jeffrey M. Herbener, ed., The Meaning of Ludwig von Mises (Norwell,
Mass.: Kluwer Publishers, 1993), pp. 247-83. Interestingly, John Maynard
Keynes also failed to predict 1929-32, and lost three-fourths of his net
worth.
3. Monetary History, p. 298.
4. Anna J. Schwartz, "Understanding 1929-1933," in
Money in Historical Perspective (Chicago: University of Chicago Press,
1987), p. 130.
5. Friedman criticizes Murray Rothbard's inclusion of
cash-value from life insurance policies as "pure chicanery" in an effort
to inflate monetary figures. By doing so, Rothbard increases the money
supply, 1921-29, by 61.7 percent instead of Friedman ' s more
traditional 46 percent figure. See Murray Rothbard, America's Great
Depression, 4th ed. (New York: Richardson & Snyder, 1983 [19641), p.
88 passim. I tend to side with Friedman on this issue.
Reprinted with permission from The
Freeman, a publication of the Foundation for Economic Education, Inc.,
April 1995, Vol. 45, No. 4.
Yourname@libertyhaven.com
