'America’s Great Depression' 50th Anniversary

0:00My remarks are focused on a very small section of America's Great Depression and that is Rothbard's definition of the money supply. So he reformulates the definition of the money supply in four pages, from pages 87 to 91, and he does it as a way of improving his historical analysis. He starts with Mises. Mises defined money as a general medium of exchange. But if you look at Human Action, you'll see that Mises only includes currency and demand deposits, checking accounts, checkable deposits, as components of the money supply. And in fact, Mises explicitly excluded savings deposits at commercial banks and savings banks, and he categorized them along with high-grade bonds, blue-chip stocks, and even and stocks of commodities as secondary media of exchange.

0:59So he denied the moneyness of these other assets. Well, Rothbard, what he desired to do, he wanted to stick to Mises' theoretical definition of money as a general medium of exchange. But he wanted to formulate an empirical aggregate that was consistent with that definition. As I said, he did this in order to advance his historical research. He doesn't make a big deal out of it. He doesn't act like it's an innovation in any way. It wasn't an exercise in theoretical innovation for its own sake. He was doing it as a working economist. So, these are two statements that reflect his criteria or his standard for identifying monetary assets.

1:50One, demand deposits only function as money because they are considered perfect money substitutes, that is, they readily take the place of money at par. And then elsewhere in that small section he writes, The distinguishing feature of a money substitute is that people believe it can be converted at par into money at any time on demand. But on this definition, demand deposits are by no means the only money substitute. And here's what he includes, just to get to it, or actually, this is a more, I later wrote an article formalizing Rothbard's definition of the money supply, and so I did it in these terms, I said for an item to be included in the money supply or monetary aggregate, it has to fulfill a number of conditions or criteria, must be routinely and universally accepted in exchange for goods and services, it must serve as a final means of payment in all transactions, Transactions, completely discharging the debt. That would only include currencies.

2:52I then added Rothbard's criterion, his new criterion, in which he said, or it must be an instantly convertible claim to the general medium of exchange, that is to currency under fiat standard, to paper currency, meaning that it must be interchangeable with the general medium of exchange on demand at par. That's a more formal statement of Rothbard's criteria. So this is what Rothbard included. In red are the ones that are extremely controversial. So he included what used to be called time deposits, which we now know as savings deposits, because he's looking at the 1920s and 30s. He also included savings deposits not only at commercial banks but at mutual savings banks, some of which were mutually owned, owned by the depositors during this period of time.

3:41He also included shares of savings and loan associations, which were legally institutions that were owned by the shareholders, that is, the savers. That was the formal legality of it. He also included shares and savings deposits of credit unions, and then, the most controversial item, cash surrender liabilities of life insurance companies, that is, equal net policy reserves. The amount of money that people could borrow against their life insurance policies, as they accumulated savings in those policies. So, as I said, those two were controversial. The monetarist Richard Timberlake, and also, not directly, but also Leland Yeager, have alleged that Rothbard's definition of the money supply was contrived.

4:32Okay, in order to make it appear, in order to make money growth appear greater than it actually was in the 1920s I left out the word money growth This ploy according to them enabled Rothbard to characterize the 1920s as an inflationary decade, decade vis-a-vis Friedman and Schwartz who claimed that it was not by any means an inflationary decade Okay, and thus to be able to apply the Austrian business cycle theory to explain the Great Depression Depression. So it was a contrivance of Rothbard's. So the first objection, Timberlake objected to Rothbard's inclusion of shares of savings and loan associations in the money supply. And why did he do that? He said they are not money because they cannot be spent on ordinary goods and services. To spend them, one needs to cash them in for other money. Notice he says other money. They are money, but he I wouldn't use the term other money.

5:35Now, what were the responses? Well, savings and loan share accounts back in the 1920s and 30s, they were actually called building and loan associations. They later took on the name in the US of savings and loan associations, all of which collapsed in 1989, 1990. They were indistinguishable, really, from commercial bank savings deposits. They were redeemable on demand, at par. You couldn't write checks either on the savings deposits at commercial banks, nor could you write checks on the share accounts. But in both cases you could simply go down and withdraw them from the banks. So, and both technically were able to delay withdrawal according to the bylaws of savings, okay, that there were a notice of withdrawal bylaws that said, well you have to give us 30 days notice if you want to withdraw, they were not enforced, okay, by the 1920s these were not enforced, there were dead letters, so to speak, and the savings and loans advertised every withdrawal payable on demand, So they were willing, enabled, and in de facto, they did allow withdrawal upon demand.

6:56The other response is that savings and loans shareholders had to first exchange their shares for money before they could spend on goods and services. Okay, but so do savings deposits at commercial banks. And Timberlake included savings deposits at commercial banks in his definition of the money supply. Again, they were indistinguishable. And also Timberlake does not object to an inclusion of savings deposits at a third institution, mutual savings banks. Some of which were owned by their depositors, technically legally owned. So they were identical to the savings alone in economic function. and also, as I said, some of them were technically owned by their depositors.

7:43There's a Friedman and Schwartz connection here. If you go back, you can see where Timberlake took his position from. Savings and loans are not banks as defined in a legalistic way in accordance with the definition of banks agreed upon by Federal bank supervisory agencies since holders of funds in these institutions are, for the most part, Technically shareholders, not depositors, but one of the lessons that Mises always insisted on was that Economic was always interested in the essence of a phenomenon, not the legal technicalities Okay, so we so technically in a legal sense their shareholders So what you can still withdraw these savings on demand at par and therefore they should be part of the money supply In fact, Friedman and Schwartz were forced to admit that those who place funds with these institutions quote Clearly may regard such funds as close substitutes for bank deposits as we define them Okay, so they're admitting the case. They're essentially savings deposits And then Timberlake objects to the cash surrender liabilities of life insurance companies on the same grounds

8:56Okay as his objections to the inclusion of savings and loan shares Rothbard argued that the cash surrender values of life insurance policies are immediately cashable claims against insurance companies and he said that they function like depository institutions, they collect funds from the public and then they make loans and investments while they contractually promise to allow the policyholders to borrow against these policies policies. So Rothbard says they're economically in precisely the same position as savings depositors or thrift institution shareholders, so he includes them, okay. This is the most controversial aspect of Rothbard's definition, and I don't really defend it myself. In fact, when I discussed with him my article that I wrote on the money supply, He said, yeah, it's a real gray area. He said, you know, at this point, we should leave it out.

9:56And so I did. I'm a little uneasy with it, so I left it out. But it's been the subject of undue derision by the monetarists. And we can respond to that, though. First of all, many mainstream economists in the 1960s and 70s noted the moneyness of the Net Life Insurance Reserves, okay, and you can see that money in banking textbooks, and second, if you exclude them from the money supply, it does not significantly change the rate of growth of the money supply in the 20s, so it doesn't affect Rothbard's case, so I'll finish up, there's just a bunch of examples of different economists who claim that these Net Life Insurance Reserves are in fact money-like, okay, they can be drawn at any time, time simply by allowing the policy to lapse, they're near money on a poor saving accounts, Haynes said that, Burstein said they're readily convertible into cash, almost as liquid as a mattress full of currency, and they satisfy the precautionary motive, and then there's

11:04others. So Rothbard wasn't alone, it was not a ploy, I mean in the 50s and 60s, 60s and 70s, there To others, the Keynesian economists were thinking in those terms. And finally, even if we exclude it from the money supply, we find that with the item included Rothbard's money supply told about 61% or the growth told 61% from mid-1921 to 28, yielding an annual rate of 8.1% increase in money supply. But if we exclude it, the money supply increased by about 55% and there was an annual rate of 7.3%, it doesn't affect the inflationary nature of the 1920s, and I'll stop here, so you don't have to put that up.