The Skyscraper Curse: And How Austrian Economists Predicted Every Major Economic Crisis of the Last Century

During the 1960s, when Keynesian economics came to completely dominate the economics profession, there was a large influx of the so-called new economists into government service. The disastrous results included the “Keynesianization” of the economy and what is best described as an economic depression that lasted throughout the 1970s and into the early 1980s. The long economic expansion of the 1960s came to a screeching halt just as 1 and 2 World Trade Center started to impact the Manhattan skyline.

Like the 1920s and 1990s, the decade of the 1960s was a period of remarkable prosperity in the United States as measured by statistics such as GNP and the unemployment rate. In contrast, the 1950s included several periods of stagnation and mild recessions. During the 1960s the economy grew at a brisk pace, and employment and wages grew as well. America was able to fight the Cold War, the Vietnam War, the War on Poverty, and win the space race, simultaneously. The only noticeable negative effect was a mild uptick in price inflation toward the end of the decade.

According to academic economist Arthur Okun1 the economic expansion was the result of two primary factors. The first was scientific management of the economy by the “new economists” who were brought to Washington to help fine-tune the economy with fiscal and monetary policy — that is, Keynesian economics. The second was the new technology that was introduced in the economy — particularly computer technology, consumer electronics, and technological advances related to space exploration.

Okun was the chairman of President Nixon’s Council of Economic Advisors from 1968 to 1969. Right before the crash he described the economic expansion as “unparalleled, unprecedented, and uninterrupted.” Okun believed that the economy was on a new “dramatic departure” from the past. According to Okun:

The persistence of prosperity has been the outstanding fact of American economic history of the 1960s. The absence of recession for nearly nine years marks a discrete and dramatic departure from the traditional performance of the American economy.2

After declaring the business cycle dead, he went on to demonstrate that research on the business cycle was now a thing of the past and that a “new” approach to the economy had replaced it. In fact, he even took the precarious step of ridiculing those who stubbornly stuck to the old economics, where business cycles were viewed as an inevitable feature of the market economy. In fact, he charged this old school with viewing recessions in a positive light for correcting past excesses, just as Dr. Pangloss, a character in Voltaire’s play Candide, preaches optimism: everything, including negative things, is for the best, and we have the best of all possible worlds. Here I believe he is referring to Austrian economists, such as Ludwig von Mises and F. A. Hayek. Okun’s “latter-day Machiavellis” probably refers to political-business-cycle theorists who at this time were political scientists:

When recessions were a regular feature of the economic environment, they were often viewed as inevitable. Indeed, the Doctor Panglosses saw them as contributors to the health of our best of all possible economies, correcting for the excesses of the boom, purging the poisons out of our productive and financial systems, and restoring vigor for new advances. And the latter-day Machiavellis saw potentially great political significance in the timing of turning points. They spun out fantasies, suggesting or suspecting — depending upon whether their party was in or out of office — that the business cycle would be controlled so that the inevitable recession would come between elections and would be replaced by a vigorous economic recovery during the campaign period.3

Okun confidently declared that the death of the business cycle was “proof par excellence” that economic controversies can be solved. How was the business cycle killed? Okun found that the slayer was not new theories or policy tools, but simply a more confident and scientifically rigorous implementation of existing tools, which resulted in efficient scientific management of the economy — that is, Keynesian economics:

More vigorous and more consistent application of the tools of economic policy contributed to the obsolescence of the business cycle pattern and the refutation of the stagnation myths. The reformed strategy of economic policy did not rest on any new theory.4

For Okun, the New Deal had employed fiscal stimulus, which would later be espoused by Keynesian theory.5 He believed the old canard that WWII got us out of the Great Depression. As far as he was concerned those two episodes provided evidence of the success of countercyclical fiscal policy. He also viewed the old “fiscal religion” of limiting the size of government and keeping its budget in balance as nothing more than myth and superstition. Overthrowing those fallacies of the past and embracing scientific management of the economy had allowed economists to fully apprehend and subdue the business cycle: “The activist strategy was the key that unlocked the door to sustained expansion in the 1960s.”6 All remaining errors could be dealt with by fine-tuning of the activist strategy.

It was unfortunate for Okun that the publication of his book, The Political Economy of Prosperity, occurred just one month before the next economic recession began. Civilian unemployment increased from well below 4 percent to just over 6 percent by the end of 1970. The rate then retreated to 5 percent in 1973 only to skyrocket to 9 percent in mid-1975 — the highest rate since the Great Depression. The unemployment rate remained above the “natural rate” of 5 percent for the next two decades, including ten months of double-digit unemployment during 1982–83.

The experiment of the new economists also resulted in higher price inflation, as would be expected from the “stimulating” fiscal and monetary policy of the 1960s. From the beginning of 1946 to the beginning of 1965 — twenty years — the Consumer Price Index increased by 71.4 percent, but it then increased another 20 percent by the end of the 1960s. From 1965 — when the experiment began in earnest — to the end of 1980 the CPI increased by 176.6 percent. The grand experiment greatly increased the price inflation experienced by consumers.

More importantly, revolutionary changes occurred in money and banking. The US Treasury stopped issuing silver coins in 1964, and Gresham’s law ensured that Americans were soon using nothing but “clad” coins that only looked like the old silver coins. Silver-certificate notes were recalled in 1968 in exchange for Federal Reserve Notes. Then, in August 1971, Nixon initiated a “new economic policy” that closed the international gold window (where foreign central banks could still redeem dollars for gold), the last vestige of the pre-1913 classical gold standard.

The United States had printed too much money during the 1960s and had caused a “run” on the dollar by foreign central banks, which sought to cash in their dollar holdings for gold. Despite US promises to the contrary, Nixon also instituted comprehensive wage and price controls in an attempt to block the rising price inflation before his reelection campaign. The Bretton Woods system, where currencies had fixed values in terms of gold, inevitably collapsed. Thus the last links between gold and money were broken and a completely fiat monetary system was established.

The bubble of the 1960s and the subsequent collapse have been well chronicled by John Brooks in his book The Go-Go Years. The “go-go ’60s” refers to the market for technology stocks during the 1960s, when the “Nifty Fifty” emerged as a list of “one decision” stocks that could be bought and held forever. This list of stocks included Coca-Cola and IBM as well as troubled companies of the future, such as Kodak and Polaroid. Like the investment trusts of the 1920s, mutual funds were touted as the fastest path to riches for the common man. As the bubble expanded, investment gurus such as Gerald Tsai used aggressive investment techniques to generate huge increases in the value of their mutual fund shares, while others made millions building the conglomerate corporations that spanned many industries and nations.

John Brooks7 well captured the euphoria that emanated from this new-era stock market: “As mutual-fund asset values went up, new money poured in. Tsai and others like him seemed to have invented a money-making machine for anyone with a few hundred or several thousands of dollars to invest.” He even labeled Tsai “the first big-name star of the new era.” Unfortunately, Brooks was unable to properly diagnose the cause of the mania, attributing it largely to greed and irrationality:

Where were the counsels of restraint, not to say common sense, in both Washington and on Wall Street? The answer seems to lie in the conclusion that in America, with its deeply imprinted business ethic, no inherent stabilizer, moral or practical, is sufficiently strong in and of itself to support the turning away of new business when competitors are taking it on. As a people, we would rather face chaos making potsfull of short-term money than maintain long-term order and sanity by profiting less.8

Brooks noted that “man’s apparent capacity to learn from experience is an illusion.” Man is able to benefit from experience, but our collective ability to learn and pass knowledge on to future generations depends on our ability to formulate correct theories regarding our experiences. Like many others, Brooks seems oblivious to the usefulness of economic theory in this regard, although his analysis regarding experience and lack of a stabilizer does reflect favorably on Austrian business cycle theory.

However, Brooks is correct and quite methodical in showing the similarities between the 1920s and the 1960s. In each case there was a new era and a new way of economic thinking. Both episodes had their investment stars that fell into disgrace. In both cases there were charges of corruption and malfeasance that led, after the fact, to attempts at reform via legislation. At the heart of both eras — the vehicle of mania and deception — was technology. By the history of Wall Street, Brooks was able to show that the collapse in the stock market was actually much worse than the Dow Jones stock index indicated. Many of the best-performing stocks of the decade turned into the worst-performing stocks of the next decade, but were not in the Dow index. This spelled trouble for many investors for years to come.

An even better indicator of trouble in the stock market can be found in the fact that in May 1970, a portfolio consisting of one share of every stock listed on “the Big Board” was worth just about half of what it would have been worth at the start of 1969. The highfliers that had led the markets of 1967 and 1968 — conglomerates, computer leasers, far-out electronics companies, franchisers — were down precipitously from their peaks. Nor were they down 25 percent, like the Dow, but 80, 90, or 95 percent. This was vintage 1929 stuff, another economic depression, with all the economic pain and emotional hardship that mired both stock markets and the economy for years to come.9

The stock market as measured by the Dow did decrease 25 percent between 1969 and 1971 and then, after the publication of Brooks’s book, lost another 20 percent by mid-1975. However, the inflation-adjusted losses in the stock market were larger and longer lasting than an ordinary price chart of the Dow might suggest. The inflation-adjusted or “real” purchasing-power measure of the Dow indicates that it lost nearly 80 percent of its peak value during this time period. When Brooks drew out the similarities between 1929 and 1969, he stopped short of declaring a second Great Depression. However, while the economic pain of the 1970s and early 1980s may not have matched the Great Depression of the 1930s, it could easily qualify as an economic depression.

The decade began with recession and the abandoning of the gold monetary system and saw the emergence of “stagflation” — that is, stagnation and inflation. It ended with the highest monthly misery index in 1980. The index is calculated by adding the inflation rate to the unemployment rate. The 1970s is not generally recognized as a depression by economists. However, it certainly was part of a twelve-year period of economic pain and uncertainty compounded by price controls, the gasoline shortages, Watergate, and defeat in the Vietnam War. It should also be noted that mainstream economists have changed the meaning or application of terms such as depression, panic, and crisis, substituting milder-sounding terms such as recession and correction.

Statistical evidence clearly demonstrates that the 1970s was a turning point in the wrong direction for the American economy. The Bretton Woods gold standard was abandoned, prices increased, and the dollar rapidly depreciated. Unemployment and underemployment increased, and they set post-WWII highs in the early 1980s. The federal government abandoned a longstanding tradition of balanced budgets for the current regime of ever-increasing deficits and a skyrocketing national debt. The personal saving rate of Americans — which had been on an increasing trend until 1971 — flattened out and began its current declining trend toward a zero savings rate.

It was the 1970s when the trade balance first destabilized, and then began the trend of escalating trade deficits. Naturally when the people are saving less and the government is borrowing more, the new loans have to come from foreigners. Going back to the 1930s, net exports of goods and services hugged the zero line. Then in the 1970s it broke below the zero line and continued to head lower. For the fifteen years leading up to 2010, the trade deficit averaged over $500 billion. The stability of the past had been replaced with the instability and erosion that fiat paper money inevitably brings.

Another crucial factor is the impact of the monetary regime on income distribution, one of the most glaring issues of our times. Money is one important factor that is largely ignored by those both on the political left and the political right. It is also largely ignored by mainstream economists, such as Thomas Piketty (2014).10 However, the choice of monetary system and monetary policy does have predictable and historically validated effects on economic inequality.

A monetary system that is dominated by a central bank, such as the Federal Reserve, and uses fiat money, as in our current monetary system, can expect to benefit certain people, such as bankers, financiers, and people with debt. Likewise, because such a system is inflationary, it tends to hurt wage workers and savers. Such a system can be expected to hurt the lower- and middle-income classes and enrich those in the financial industry and the upper-income class.

A gold standard has historically had a tendency for prices to be stable or slightly deflationary. This means that wage rates, cash balances, savings, and bonds tend to gain purchasing power over time. This type of monetary system rewards the hard-working and frugal classes, which leads to an expansion of the middle-income class and the economy.

This graph from the Pew Research Center provides enticing evidence of the differential impact of gold versus fiat paper money.

The graph shows that economic inequality declined in the United States from 1917 to the early 1970s, when Nixon took the United States off of the Bretton Woods gold standard. The darker shaded areas of the graph represent the 99 percent, while the light area at the top represents the percentage of total income of the upper 1 percent. Economic inequality increased during the inflationary 1920s, but the lower-income classes rapidly improved versus the 1 percent when the gold standard was restored after WWII. The graph shows both marginal improvement and stability in economic inequality from the late 1940s to the early 1970s. Since going off the gold standard in 1971 the trend has been for much greater economic inequality.

All of these problems were not due to the laziness of the American people. Females moved into the workforce in record numbers, and the two-income family was established, mostly to try to maintain standards of living. Unfortunately, the 1960s and 1970s were two decades when government employment expanded the most, so that much of this increased labor effort produced little of value. Working for government can even be a net negative for the economy in the sense that government employees can do actual harm to the production of useful goods and services. The “new economists” in the service of the state are a good example of that.

• 1Arthur Okun, The Political Economy of Prosperity (Washington, DC: Brookings Institution, 1970), p. 57.
• 2Ibid., p. 31.
• 3Ibid., p. 32.
• 4Ibid., p. 37.
• 5Ibid., p. 43.
• 6Ibid.
• 7John Brooks, The Go-Go Years: The Drama and Crashing Finale of Wall Street’s Bullish 60s (New York: Allworth Press, 1973), pp. 137–39.
• 8Ibid., p. 187.
• 9Ibid., p. 4.
• 10Thomas Piketty, Capital in the Twenty-First Century (Cambridge, MA: Harvard University Press, 2014).