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Deflation, Liquidation, and Necessary Revisionism


During his ill-fated 1932 reelection campaign Herbert Hoover delivered a speech in which he said,

In the midst of this hurricane the Republican administration kept a cool head, and it rejected every counsel of weakness and cowardice. Some of the reactionary economists urged that we should allow the liquidation to take its course until it had found its own bottom. Some people talked of vast issues of paper money. Some talked of suspending payments of Government issues. Some talked of setting up a Council of National Defense. Some talked foolishly of dictatorship — any one of which ideas would have produced panic in itself. Some assured me that no administration could propose increased taxes in the United States to balance the budget in the midst of a depression and survive an election.

However, we determined that we would not enter the morass of using the printing press for currency or bonds. All human experience has demonstrated that that path once taken cannot be stopped, and that the moral integrity of the Government would be sacrificed because ultimately both currency and bonds must become valueless.

We determined that we would not follow the advice of the bitter-end liquidationists and see the whole body of debtors of the United States brought to bankruptcy and the savings of our people brought to destruction.

As it turned out, it was Hoover’s decision to ignore the advice of the “bitter-end liquidationists” that proved to be his political undoing. In the aftermath of Crash of 1929, Hoover took a series of interventionist measures to counteract the economic downturn: expanding public works, propping up unsound businesses, inflating credit, and keeping up wage rates. He also increased taxes significantly, raising the top income-tax bracket from 25 percent to 63 percent. The result was a prolonged economic depression. Had he simply cut taxes and spending as his predecessor, Warren G. Harding, did in the midst of a similar crisis in 1921, the panic would have been short-lived and Hoover would very likely have been reelected in 1932.

While it is generally known that the Democrat Franklin Roosevelt was elected president in a landslide victory in 1932, it is not well known that he campaigned on a free-market platform advocating sound money, tax cuts, and fiscal discipline, while “condemning” Hoover’s “extravagance.” Indeed, Roosevelt’s running mate, John Nance Garner, accused Hoover of “leading the country down the path of socialism.”

But once in office, Roosevelt betrayed his party’s platform by implementing a series of interventionist policies that made Hoover’s look modest. Between 1933 and 1937 federal expenditures increased more than 83 percent and the national debt skyrocketed 75 percent.

Roosevelt had the good fortune of entering office in March of 1933 — when the economy had already bottomed out and was then enjoying a mild recovery. But his New Deal reversed that salutary course, and the economy remained moribund for more than a decade, not recovering until 1946.

Hoover gets blamed for the Great Depression because it began on his watch. But the United States, indeed the entire world, was due for a sharp economic correction regardless of who happened to be occupying the White House. In 1929 the global economy was still suffering from the devastating effects of the Great War and staggering under an enormous debt burden. The postwar gold-bullion standard established at the Genoa Conference of 1922 had proven to be a poor substitute for the classical gold standard that had been abandoned by all the belligerent powers in 1914. This pseudo gold standard was ostensibly instituted to promote economic stability, but it was really just an inflationary scheme to paper over war debts and prop up the English pound, which had been severely devalued during the war. It required the devaluation of the U.S. dollar, which in turn created a credit bubble that fueled the Roaring Twenties’ low-interest-rate-induced malinvestment and set the stage for the economic collapse of the 1930s.


That was not lost on everybody at the time. The British economist Lionel Robbins, in his 1934 book, The Great Depression, traced the origins of the crisis to the broad economic conditions created by the Great War and various measures taken by governments afterward that prevented their economies from adapting to peacetime conditions. The debt-fueled malinvestment created by governments to wage the four-year-long slaughter needed to be liquidated.

Unfortunately, none of the political leaders in America or Europe at the time seemed to understand what Robbins was saying or were willing to stomach the short-term pain that liquidation entailed. Rather than simply standing aside and letting their respective economies adjust to reality, they panicked, putting up trade barriers and forming currency blocs. The outbreak of economic war among the industrialized nations not only aggravated the unfolding economic catastrophe, it also contributed greatly to the outbreak of actual shooting wars in Asia and Europe. Those separate conflicts would eventually become fused into one global conflagration known as the Second World War.

Necessary deflation


This revisionist accounting is necessary not only for the sake of historical truth but also for the sake of the future. The response by the U.S. government to the financial crisis that began in 2007 has been shaped by the popular yet pernicious myth that big-government policies of one variety or another (New Deal and World War II) are what pulled the country out of the Great Depression. Indeed, politicians and pundits have invoked the New Deal myth to justify the recent spate of so-called stimulus spending programs and corporate bailouts. Some have even suggested military spending as a way to lift the economy from its current doldrums. Fed chairman Ben Bernanke has publicly expressed his belief that it was deflation that made the Depression “Great” and that inflation is necessary to avert a sequel to that catastrophe.

Just as in the 1920s and early 1930s, the global economy is now burdened with enormous debt created by decades of central-bank-driven inflation. But the response by the world’s central banks has been to keep interest rates at near 0 percent, which has discouraged savings and encouraged even more debt. Moreover, the suppression of interest rates has prevented the necessary liquidations from occurring, which has forestalled recovery.


The only hope we have for a genuine recovery is for the U.S. government and the Fed to embrace laissez faire and allow deflation to work its purgative effects. Though such “bitter medicine” is necessary for the long-term health of the economy, it is hemlock to the Washington establishment.

We live under an inflationary regime that reaps enormous benefits for the U.S. government, the banking sector, and a corporatist superstructure that is the recipient of government largess. Washington uses inflation to finance its enormous budget deficits. That, of course, allows politicians to continue their spendthrift ways without having to raise taxes. The banks profit from inflation because they operate as brokers for the newly created Treasuries, which are monetized by the Fed’s printing presses. Defense contractors, universities, and health-care, construction, and many other industries are also beneficiaries of inflation. The result is a political economy distorted by a myriad of powerful special interests, none of which has any desire to see inflation ended.

The people suffering under this financial repression are the vast majority of Americans who aren’t employed by the federal government or some well-connected Wall Street firm. Their lot is to obediently pay taxes and make do with lower real wages, while the central bank’s inflation erodes the value of what little savings they manage to put away.

Jorg Guido Hülsmann, in his remarkable Deflation and Liberty, writes of the moral distinction between deflation and inflation:

In short, the true crux of deflation is that it does not hide the redistribution going hand in hand with changes in the quantity of money. It entails visible misery for many people, to the benefit of equally visible winners. This starkly contrasts with inflation, which creates anonymous winners at the expense of anonymous losers. Both deflation and inflation are, from the point of view we have so far espoused, zero-sum games. But inflation is a secret rip-off and thus the perfect vehicle for the exploitation of a population through its (false) elites, whereas deflation means open redistribution through bankruptcy according to the law.

The political class abhors deflation because the rulers depend on inflation to pay for their various welfare-warfare schemes. Deflation would precipitate a general liquidation that would bring down their inflationary house of cards. It would, indeed, be the end of the world as they know it.

This article was originally published in the February 2013 edition of Future of Freedom.

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    Tim Kelly is a columnist and policy advisor at The Future of Freedom Foundation in Fairfax, Virginia, a correspondent for Radio America’s Special Investigator, and a political cartoonist.