Chapter 13: Who Predicted the Great Depression?

It has often been claimed that Austrian economist Ludwig von Mises predicted the Great Depression, but that is not quite true. He did predict in 1924 that a large Austrian bank would eventually fail, and he turned down a prestigious job at another large Austrian bank in 1929 because he did not want his name associated with its failure. Mises was clearly expecting a severe economic crisis, but as Murray Rothbard1 has shown, what made the Great Depression “great,” in that it was both severe and long lasting, were the policies implemented in response to the original crisis. Austrian business cycle theory (ABCT) is generally silent with respect to the timing and magnitude of the economic crisis.

The most important consideration here is that Mises published a thorough theoretical critique of existing monetary policy in the United States and elsewhere in 1928. That book is Monetary Stabilization and Cyclical Policy. Now we will look at opposing views regarding the business cycle of the late 1920s, most notably contrasting the views of Ludwig von Mises and his American counterpart, Irving Fisher.

The first “new era” of the twentieth century took place during the 1920s. People started to believe that this period of extended economic growth was actually one of self-sustaining growth and perpetually increasing prosperity. World War I had ravaged the developed world, central banks had been established across the globe, and the United States had become a leading economic and military power. The Progressive Era had reinvented America largely through constitutional change. Women now had the right to vote, there was a new federal income tax, and alcohol was prohibited across the nation. America also had joined the rest of the developed world by establishing a central bank with the passage of the Federal Reserve Act in 1913. The world was at peace and with a series of federal tax cuts in place, the United States had a very prosperous, although unstable, economy during the 1920s.2

There was also a technological revolution as important as the world has ever experienced. This was the decade when the airplane and automobile went into mass production. In communication, it was the onset of mass availability of the telephone and radio. Motion pictures were invented, along with household appliances such as the dishwasher, electric toaster, and refrigerator. The use of petroleum products and electricity increased dramatically while the use of manual power decreased significantly. Assembly line production became ubiquitous and was seen as the key to industrial progress.

The period of economic boom and stock market bubble during the 1920s is often referred to as the “Roaring Twenties.” Few people seemed to think it was unusual that the world’s three tallest buildings were being built either on or close to Wall Street, in New York City. However, it was far from a utopian time given all the crime, corruption, and violence created by alcohol prohibition, and there were clearly imbalances and instability in the economy. None of this, however, could discourage or dissuade the optimists that this was indeed a “new era.”

Edward Angly3 compiled quotations from newspapers and public records to chronicle the “new era” thinking during the bubble and its aftermath. A prime example of this thinking came from Herbert Hoover in his speech accepting the Republican Party nomination for president, where he proclaimed on August 11, 1928:

Unemployment in the sense of distress is widely disappearing. … We in America today are nearer to the final triumph over poverty than ever before in the history of any land. The poor-house is vanishing from among us. We have not reached the goal, but given a chance to go forward with the policies of the last eight years, and we shall soon with the help of God be in sight of the day when poverty will be banished from this nation. There is no guarantee against poverty equal to a job for every man. That is the primary purpose of the economic policies we advocate.4

Not surprisingly Hoover believed the prosperity of the 1920s owed itself to the economic policies of his Republican Party, but his future policies to save jobs would be responsible for turning the economic crisis into the Great Depression.

Industrialists also saw a new era. Magnus Alexander, the president of the National Industrial Conference Board, said in 1927: “There is no reason why there should be any more panics.” The president of the Pierce-Arrow Motor Car Company, Myron Forbes, claimed on New Year’s Day, 1928, that there “will be no interruption of our present prosperity,” while Irving Bush, the president of the Bush Terminal Company proclaimed in November that “we are at the beginning of a period that will go down in history as the golden age.”

Charles Schwab, the chairman of Bethlehem Steel, noted in March 1929 that “I do not feel there is any danger to the public in the present situation” and in an October speech to the American Iron and Steel Institute reassured members that “in my long association with the steel industry I have never known it to enjoy a greater stability or more promising outlook than it does today.” As is typical of new-era philosophy, in October 1931, he blamed the depression on psychological factors: “The overliquidated prices of many securities are a sign of too short perspective and too excitable temperament.”

The financial press was similarly intoxicated with the economic bubble, with the Wall Street Journal reporting on October 26, 1929, “Conditions do not seem to foreshadow anything more formidable than an arrest of stock activity and business prosperity like that in 1923. Suggestions that the wiping out of paper profits will reduce the country’s real purchasing power seem far-fetched.” Syndicated columnist Arthur Brisbane reported four days later that “those that foolishly talk about a national panic, will please remember that the income of this nation is one hundred billion dollars per year.” In November he reported that “business is good, money is cheap” and that “it ought to be a good year.”

Shortly thereafter he encouraged his readers by reporting that “all the really important millionaires are planning to continue prosperity” and that “if every man would learn to talk about the country’s progress and future as a young mother talks about her new baby, there would be no danger of hard times.” On New Year’s Day, 1930, he declared the economic crisis was over, noting: “Now that the ‘big wind’ that swept through Wall Street, blowing away paper profits, has died down, there are sad hearts, but no real losses.” And one week later he wrote, “It is safe to say that the peak of idleness has about been reached, with better conditions coming.” As the economy worsened and unemployment continued to mount, Brisbane’s assurances became increasingly bizarre and macabre. On January 2, 1931, he wrote: “Sometimes when things go wrong, it is a comfort to be reminded that nothing matters very much. If the earth fell toward the sun, it would melt like a flake of snow falling on a red-hot stove.”

Politicians were big promoters and defenders of new-era thinking. Secretary of the Treasury Andrew Mellon told the American people near the peak of the boom that there “is no cause for worry. The high tide of prosperity will continue.” After the stock market crashed and unemployment began to rise, he reassured Americans on New Year’s Day of 1930:

I see nothing, however, in the present situation that is either menacing or warrants pessimism. During the winter months there may be some slackness or unemployment, but hardly more than at this season each year. I have every confidence that there will be a revival of activity in the spring and that during the coming year the country will make steady progress.5

Republican officials continued to report throughout 1930 that the economy was fine, that conditions were satisfactory, that the worst was already over, that things would improve in a couple of weeks, and that signs of recovery were everywhere. However, by the end of 1930 some panic and confusion had entered into Republican ranks. On October 15, 1930, Simeon Fess, the chairman of the Republican National Committee, complained:

Persons high in Republican circles are beginning to believe that there is some concerted effort on foot to utilize the stock market as a method of discrediting the administration. Every time an Administration official gives out an optimistic statement about business conditions, the market immediately drops.6

This statement is a sign of both alarm and paranoia and, if true, indicates that the “market” had finally entered a phase of disbelief in the pronouncements from the White House because of a large number of past inaccuracies.

Irving Fisher was the most prominent American economist of the period and is still considered by mainstream economists to be one of the greatest economists of all time. He was an enthusiastic supporter of Herbert Hoover and believed that the great economic prosperity of the 1920s was attributable in part to alcohol prohibition, which he championed, but more importantly he felt the prosperity was based on his theory concerning the “scientific” stabilization of the dollar that had been undertaken by the Federal Reserve. Naturally, with both alcohol prohibition and dollar stabilization firmly in place, Fisher was completely blindsided by the Great Depression. On the eve of the great stock market crash of September 5, 1929, Fisher reassured investors that he foresaw no problem in the stock market:

There may be a recession in stock prices, but not anything in the nature of a crash. Dividend returns on stocks are moving higher. This is not due to receding prices for stocks, and will not be hastened by any anticipated crash, the possibility of which I fail to see. A few years ago people were as much afraid of common stocks as they were of a red-hot poker. In the popular mind there was a tremendous risk in common stocks. Why? Mainly because the average investor could afford to invest in only one common stock. Today he obtains wide and well managed diversification of stock holdings by purchasing shares in good investment trusts.7

Unfortunately, while Fisher continued to preach that stocks had reached a “permanent high plateau” throughout October 1929, stocks lost one-third of their value. Diversification via investment trusts, which were like the mutual funds of today, might have encouraged people to invest in stocks, but it did little to protect their wealth. The market value of investment trusts fell 95 percent over the two years following his prediction, and the Dow Jones stock index lost nearly 90 percent of its peak value.

Well after the fact, Irving Fisher identified in his 1932 book Booms and Depressions: Some First Principles most precisely and perceptively what he meant by a new era. In trying to identify the cause of the stock market crash and depression he found most explanations lacking. What he did find was that new eras occurred when technology allowed for higher productivity, lower costs, more profits, and higher stock prices:

In such a period, the commodity market and the stock market are apt to diverge; commodity prices falling by reason of the lowered cost, and stock prices rising by reason of the increased profits. In a word, this was an exceptional period — really a “New Era.”8

The key development of the 1920s that clouded Fisher’s perception was that monetary inflation did not show up in price inflation as measured by price indexes. As Fisher9 noted: “One warning, however, failed to put in an appearance — the commodity price level did not rise.” He suggested that price inflation would have normally kept economic excesses in check, but that price indexes have “theoretical imperfections”:

During and after the World War, it (wholesale commodity price level) responded very exactly to both inflation and deflation. If it did not do so during the inflationary period from 1923–29, this was partly because trade had grown with the inflation, and partly because technological improvements had reduced the cost, so that many producers were able to get higher profits without charging higher prices.10  

Fisher had stumbled to a near-correct understanding of the problem of new-era thinking. Technology can drive down costs and increase profits, creating periods of economic euphoria, where economic signals would otherwise inject greater caution and clearer thinking. In other words, the Fed had kept interest rates artificially low, stimulating investments in technology beyond normal levels and thereby creating deflationary pressures in commodity prices.

However, he never lost his faith in scientific management of the economy or his devotion to the idea of a stable dollar, despite the implication that his stable-dollar policy had caused the Great Depression. Fisher’s detailed analysis and painstaking investigations of the crash also did little to improve his economic forecasting:

As this book goes to press (September 1932) recovery seems to be in sight. In the course of about two months, stocks have nearly doubled in price and commodities have risen 5½. European stock prices were the first to rise, and European buyers were among the first to make themselves felt in the American market.11

He attributed this “success” to reflationary measures by the Fed that were of deliberate “human effort more than a mere pendulum reaction.”12 Unfortunately, not only was his prediction wrong, the world was only at the end of the beginning of the Great Depression and the “human effort” that he thought was the tonic of recovery was actually the toxin of lingering depression. He scoffed at the “mere pendulum reaction” of the market economy that can correct for the excesses in the economy by liquidating capital and credit, a concept that he clearly opposed. However, James Grant13 and Tom Woods14 have shown that this type of “pendulum reaction” worked extremely well during the short depression of 1920–21.

Was the Great Depression predictable? Was it preventable? The failure of the market economy to “right itself” in the wake of the Great Crash is the most pivotal development in modern economic history, and its impact has continued to shape mass ideology and to determine public institutions and policy. Unfortunately, few saw the development of the stock market bubble, understood its cause, or predicted the bust and the resulting depression.

In Austria, economist Ludwig von Mises apparently saw the problem developing in its early stages because of his theoretical insight concerning institutional and ideological changes. The world economy was controlled by central banks instead of the classical gold standard, and artificially reduced interest rates were widely considered to be a good thing. Mises forecast to colleagues the crash of the large Austrian bank Credit Anstalt as early as 1924. In a eulogy for his teacher Eugen von Böhm-Bawerk, Mises wrote in August 1924:

And no citizen of this country [i.e., Austria] shall forget the minister of finance, the last Austrian minister of finance [i.e., Böhm-Bawerk], who, in spite of all obstacles, earnestly aimed at balancing the public budget and preventing the upcoming financial catastrophe. (emphasis added)15

As mentioned at the beginning of this chapter, Mises published a book-length critique of Irving Fisher’s ideas on monetary policy in 1928, titled Monetary Stabilization and Cyclical Policy. There he targeted Fisher’s “stable dollar” policy and its reliance on the price index as a key vulnerability that would bring about the economic crisis, concluding: “Because of the imperfection of the index number, these calculations would necessarily lead in time to errors of very considerable proportions.”16

Mises found that Fisher’s attempt to stabilize purchasing power was riddled with inherent technical difficulties and was incapable of achieving its goals: “In regard to the role of money as a standard of deferred payments, the verdict must be that, for long-term contracts, Fisher’s scheme is inadequate. For short-term commitments, it is both inadequate and superfluous.”17 He then demonstrated how Fisher’s type of monetary reforms cause booms and that these booms inevitably result in crisis and stagnation. He attributes the popularity of Fisher’s scheme to political influence and bad ideology:

The fact that each crisis, with its unpleasant consequences, is followed once more by a new “boom,” which must eventually expend itself as another crisis, is due only to the circumstances that the ideology which dominates all influential groups — political economists, politicians, statesmen, the press and the business world — not only sanctions, but also demands, the expansion of circulation credit.18

Mises had addressed the same problems in a 1923 work, but named Fisher and his scheme in 1928. In addition to demonstrating the inevitability of the crisis, he clearly identified its cause, where most others could not:

It is clear that the crisis must come sooner or later. It is also clear that the crisis must always be caused, primarily and directly, by the change in the conduct of the banks. If we speak of error on the part of the banks, however, we must point to the wrong they do in encouraging the upswing. The fault lies, not with the policy of raising the interest rate, but only with the fact that it was raised too late.19

He showed that the central bank’s attempt to keep interest rates low and to maintain the boom only makes the crisis worse. Despite the tremendous odds against the adoption of Mises’s own solution — that is, the traditional gold standard — he ended his analysis with a prescription for preventing future cycles:

The only way to do away with, or even to alleviate, the periodic return of the trade cycle — with its denouement, the crisis — is to reject the fallacy that prosperity can be produced by using banking procedures to make credit cheap.20

Mark Skousen21 notes that in addition to Ludwig von Mises, Mises’s student F. A. Hayek is said to have predicted the collapse of the American boom in early 1929 (but probably not in written form). Felix Somary, who like Mises was a student at the University of Vienna, issued several dire warnings in the late 1920s; and in America economist Benjamin Anderson also warned that the Federal Reserve’s policies would cause a crisis, but like Somary, they were largely ignored. Mises and followers of his business cycle theory clearly had the upper hand over Fisher and the proponents of his stable-dollar policy.

Members of the Austrian school of economics were uprooted by WWII, with Mises in New York and Hayek in London and others scattered in academic posts at other prestigious universities. Despite the Austrians winning the prediction game against Fisher, Keynesian economics would soon rise to control economic thought as the Austrian school went into a general decline. Politically this was tied to the rise of fascism, Nazism, and FDR’s New Deal.

Fortunately, in the wake of WWII, the world returned to a Bretton Woods–style gold standard, and free market economies were established in Germany and Japan. The world quickly recovered from the war and the fascist-style economics that dominated prior to WWII. It would be a quarter century before the next economic depression hit the United States.

• 1Murray N. Rothbard, America’s Great Depression, 5th ed. (1963; Auburn, AL: Mises Institute, 2000).
• 2Robert B. Ekelund, Jr., and Mark Thornton, “Schumpeterian Analysis, Supply-Side Economics, and Macroeconomic Policy in the 1920s,” Review of Social Economy 44, no. 3 (December 1986): 221–37.
• 3Edward Angly, Oh Yeah? (New York: Viking Press, 1931).
• 4Ibid., p. 9.
• 5Ibid., p. 23.
• 6Ibid., p. 27.
• 7Ibid., 37.
• 8Irving Fisher, Booms and Depressions: Some First Principles (New York: Adelphi Company, 1932), p. 75.
• 9Ibid., p. 74.
• 10Ibid., p. 75.
• 11Ibid., p. 157.
• 12Ibid., p. 158.
• 13Grant, James. 1996. The Trouble with Prosperity: The Loss of Fear, the Rise of Speculation, and the Risk to American Savings (New York: Random House).
• 14Thomas E. Woods, “Warren Harding and the Forgotten Depression of 1920,” Intercollegiate Review (Fall 2009): 22–29.
• 15Ludwig von Mises, “The Economist Eugen v. Böhm-Bawerk, on the Occasion of the Tenth Anniversary of His Death,” translated Karl Friedrich Israel, Quarterly Journal of Austrian Economics 19, no. 2 (Summer 2016): 170. Originally published in Neue Freie Presse, Vienna, August 27, 1924.
• 16Ludwig von Mises, “Monetary Stabilization and Cyclical Policy [Geldwertstabilisierung und Konjunkturpolitik],” in The Causes of the Economic Crisis: And Other Essays before and after the Great Depression, edited by Percy L. Greaves (1928; Auburn, AL: Mises Institute, 2006), p. 82.
• 17Ibid., p. 84.
• 18Ibid., p. 128.
• 19Ibid., p. 131.
• 20Ibid., p. 153.
• 21Mark Skousen, Economics on Trial: Lies, Myths, and Realities (Homewood, IL: Business One Irvin, 1991).