5. The Great Depression, World War II, and American Prosperity, Part I

The 1920s had difficulties, but the depth of the Great Depression was in 1931. Any theory of boom-bust events must ask why so many entrepreneurs made terrible errors in a cluster. Why do busts hit capital goods industries harder than they do consumer goods industries?

The explanatory factor that accounts for both of these empirical facts is this: higher order production is more sensitive to interest rates. Whether the rate is lowered by voluntary actions of private savings or whether it is lowered artificially by the Federal Reserve, businesses see rates coming down and they borrow more. The artificial, fed-generated boom misleads investors into directing resources into higher order goods. We can have more investment in the future by having less consumption in the present. But, the artificial signal encourages both more investment in the future and more consumption in the present, without any additional resources being made available. Furthermore, people’s time preferences have not changed.

Thus, resources are malinvested when the boom is based on artificial credit stimulation rather than on real private savings. This is the crux of the Austrian Theory of the Business Cycle.

Hoover’s policies and actions assured the deepening of the depression and were the platforms for most of FDR’s New Deal disasters. Measures to prop up wages prevented any clearing of malinvestments. Subsidies and other special programs to farmers precluded normal market forces from shifting some resources out of agriculture, as should have happened. FDR was ignorant of economics. The National Industrial Recovery Act was seen as a “holy thing”. It was found to be unconstitutional.

Lecture 5 of 10 from Thomas Woods’ The Truth About American History: An Austro-Jeffersonian Perspective.