Money and Gold in the 1920s and 1930s: Defending the Rothbardian Position

0:00Good morning. This morning's lecture is entitled Money and Gold in the 1920s and 1930s defending the Rothbardian position. Murray Rothbard's book, America's Great Depression, was published in 1963, which was a year after, I believe, the publication of Milton Friedman's book, Milton Friedman and Anna Schwartz's book, A Monetary History of the United States. In Friedman's book, he tried to rehabilitate the quantity theory. And in particular, he tried to use it to show how the Great Depression was caused by a deflation of the money supply.

0:45That was completely unjustified and that was engineered by the Fed and that the prior decade of the 1920s was in fact not an inflationary decade at all. So that absent the Fed's deliberate decrease or contraction of the money supply, there would have been at most a small and short recession in 1920-1930 that would have rapidly turned around into a recovery, as occurred in 1920-21. So Friedman was, at this point, attempting to get this view accepted by the mainstream.

1:34The mainstream accepted the Keynesian view that it was a collapse in the marginal efficiency of capital, Capital, marginal efficiency of capital or, in other words, investment spending, and also consumer spending and an attempt to reduce the deficit that caused the Great Depression. And Friedman was attempting to get his monetary explanation of the Great Depression accepted. And this was really the beginning of the monetarist's counterrevolution against Keynesian economics, the appearance of this book. Now Rothbard comes along and writes a book that's also free market, that's also anti-Keynesian, and that gives a radically divergent explanation of what went on in the 1920s, for Rothbard the 1920s was indeed inflationary, and why the depression resulted in the 1930s.

2:35Even more irritating to Friedman, he argues that the Fed was actually attempting to inflate the money supply, though unsuccessfully, in the early 1930s. So the monetarists have always, from the beginning, attempted to either discredit or marginalize Rothbard's America's Great Depression by ignoring it. But every once in a while, a monetarist will comment on it, and the comments are usually the same. First, somehow Rothbard contrived a definition of the money supply that made the 1920s appear to be an inflationary decade in order to apply the Austrian theory of the business cycle to the explanation of the Great Depression.

3:27And secondly, they also claim that Rothbard invented a view that the Fed was not trying to deliberately deflate the money supply or contract the money supply in the 1930s. And this all came to a head, but by the way, these generally were off-the-cuff remarks, They weren't written down anywhere, okay? Many Austrians actually accepted these monetarist criticisms of Rothbard's book, believe it or not, okay? Yes, Rothbard suddenly came up with this very broad measure of the money supply, which in no way reflected the realities of the medium of exchange.

4:22And so, Austrians tended to say, you know, accept that, because Rothbard did include, as we'll see, life insurance, net policy reserves, basically the amount of cash that someone could cash out by borrowing against his or her life insurance policy. And also, the fact that the money supply did decline severely in the early 1930s makes it a little strange or makes it dubious that the Fed was actually trying to inflate the money supply. Isn't the Fed all-powerful? Can't the Fed simply increase the money supply ad libidum or at will?

5:11So, as I grew up in the Austrian movement, I would hear these criticisms of Rothbard and I would see that some of my colleagues would accept these criticisms, that Rothbard really went too far in trying to apply the Austrian business cycle theory. So, we have a bill of, or a set of criticisms advanced in 1999 by Richard Timberlake in the Freeman, and I responded to these criticisms. He wrote three articles, a trilogy of articles, in which he criticized Rothbard and he also criticized some of the Fed and Treasury policies. And I actually defended all three, I actually defended the Fed in at least one of its policies and the Treasury and one of its policies in my response.

6:01So what I'd like to do is to go over that debate.

6:08Let me just start by showing you Timberlake's particular criticisms of Rothbard in his own words. He says first that Rothbard has contrived a new and unacceptable, or invented a new and unacceptable meaning for the term inflation. Secondly, that it contrived the definition of the money supply to invent a Fed orchestrated inflation of the 1920s. Thirdly, that Rothbard somehow mismeasured the central bank's monetary data. And lastly, that Rothbard misunderstood the nature and operation of the pseudo-gold standard that was controlled by the Fed after 1933.

6:56So I want to defend Rothbard on these points. Tim Blake also goes on in these three articles, and I'll touch on this, to say that the U.S. Treasury's policy of neutralizing gold inflows, as well as the Fed's policy of sharply increasing reserve requirements in the mid-1930s, led to or aborted an economic recovery that was just beginning, and it resulted in a recession within the Depression, of 1937-38. So I'll comment on that also. So as I said, Kimberlake begins by claiming that Rothbard proceeds on a new and unacceptable definition of inflation, meaning that Rothbard made this up. By expressing it in this manner, you would think, well, no one else in the I don't think the history of economic flow has ever used this type of definition of inflation.

8:01Well, let me start with that point.

8:10Rothbard's definition was simply that the increase in the money, that inflation occurred when there was an increase in the money supply Why not consisting in, not covered by, that is, an increase in gold, and those are his words. But as I show in my response, this is really an old and venerable definition. This definition developed out of the controversies between the currency school, the good guys, the proto-Austrians, and the British Banking School, proto-Keynesians, in the mid-19th century. Basically, according to the currency school, which triumphed temporarily in the debate, the gold standard was not enough to prevent inflations and recessions.

9:02Great Britain had gone back to a gold standard in 1821, and yet it had been plagued with the business cycle. Well, what the currency school pointed out was this, if commercial banks were permitted to operate on fractional reserves, to lend out a part of their depositor's money, what would occur would be an increase in the money supply, that is, we would have fiduciary media, unbacked notes and deposits, and that would drive up prices in Great Britain. And as prices rose in Great Britain, British citizens would begin to shift their purchases to foreign products, increasing imports. At the same time, since gold prices were higher in Great Britain, foreigners would reduce their purchases from Great Britain, causing exports to fall.

9:52So you would get a balance of trade or balance of payments deficit in Great Britain. And the way this would be paid for would be by gold flowing out, okay? The people who had to make purchases abroad, who had to finance their purchases abroad, would take their British pounds, their paper pounds or their deposits, and go to the banks and turn them in for gold. So gold would begin to flow out of the country, okay? The banks at that point would become a little panicky. they would be worried that there would be an internal drain developing as a result of the external drain. The external drain is gold falling out of the country. As people saw this, they would get nervous about being able to redeem their notes and deposits and therefore there would be the threat of bank runs, which is the internal drain.

10:42That is, British citizens would attempt to withdraw even more gold by converting their bank liabilities. So to prevent this, what regularly happened was that the banks then would reverse their policy, they would cut back on their loans, the money supply would fall, and there would be a decline in prices in Great Britain. And with this decline in prices, you would have deflation and depression. Eventually, gold would flow back into the country because of the lower British prices as the money supply shrunk, and you would have a recovery eventually occurring, but then the banks would begin the same cycle again, because they want to earn interest. So as deposits flow back into the bank, they would then engage again in injecting fiduciary media into the economy, raising prices and storing the cycle over again.

11:39So what was the currency school's policy recommendation? What they said was, well, we can prevent this. We have to go beyond the gold standard. We have to prevent banks from issuing notes, in particular the Bank of England, beyond the amount of gold that they held. Now, this was a marginal rule. What they said was any note that was issued had to be backed by the full face value in terms of gold. In other words, what they wanted implemented was a marginal 100% rule. Every expansion in the supply of notes in the economy would reflect gold flowing in to the banks from abroad or people depositing gold in the banks.

12:30So no new note, unbacked note would ever be put into circulation again and they got this passed. Unfortunately, it didn't stop the inflationary booms or the ensuing recession depression. Depressions. Well, why not? Well, unlike the American currency school, who followed the British currency school, they neglected or ignored the fact that bank deposits, checking account money, was also part of the money supply, and therefore that this marginal 100% rule should also apply to checking deposits. So what the banks did then, was to inflate the supply of checking account money in the economy, that is, inject fiduciary media, unbacked money substitutes by loaning, not notes, but by increasing deposits, by loaning money out through increasing deposits.

13:35And as a result, we were stuck with this, or Britain continued to suffer from the business cycle. Now, during the brief period when the currency school triumphed, during the period when the act that implemented this law was passed, People began to use inflation according to the currency school definition, which used the term inflation as the currency school defined it. That is an increase in the money supply that exceeded the amount or increase in gold. So one American financial writer, Charles Holt Carroll, who was an American currency school writer, He wrote that the source of inflation and of the commercial crisis is in the nature of the system which pretends to lend money, but creates currency by discounting such bills when there is no such money in existence.

14:33So he went on to say, instead of using gold and silver for currency, they are merely used as a basis of the greatest possible inflation by the banks. So he said it was the artificial increase of currency only, meaning the amount of currency that was put into circulation beyond the gold stock that was causing the problem of inflation and then later depression. And then in the last quarter of the 19th century, the greatest American monetary theorist, Francis A. Walker, also believed that inflation was an inherent feature of the issue of even convertible banknotes. Banknotes that could be converted into end deposits. These convertible banknotes and deposits that could be converted into gold.

15:23If they were issued beyond the stock of gold, if you had fractional reserves, banking resulting, or that was in place, then in his words, there resides in bank money, even under the most stringent provisions for convertibility, the capability of local and temporary inflation. So what he was saying was that even where banks stood ready to convert these notes and deposits into gold, because they were issuing these notes and deposits beyond the stock of gold that they held, you would get inflation. So this is not a new and invented definition by Rothbard. It was the older definition of inflation.

16:09On the other hand, when the currency school was discredited by the continuing business cycles, again, because of the defect in their policy, which did not apply the 100% marginal reserve rule to checking account money, then the banking school, their opponents, their definition of inflation came into play. It still referred to the money supply. It didn't yet refer to just an increase in prices. But their definition was that inflation was an increase in the money supply, not beyond the stock of gold in the banks, but beyond the needs of trade. So if somehow there were more people that more borrowers would come to the banks, more business borrowers, demanding loans.

16:59And that the banks had the right then to discount these loans, or had the duty to discount these loans, and it would not be, or to discount these bills that they were being given, increase the loans, and that this would not be inflationary. So that definition of inflation began to replace the currency school Rothbard definition.

17:29And what was pointed out by opponents of the banking school is that the banking school could increase needs of trade as much as it wanted. It could just simply lower the interest rate. The lower the interest rate, the more businesses would want to borrow. So the banking school would say, well look, businesses are coming to the banks and they want to borrow. Because they want to borrow, that means that their needs of trade have expanded and it's proper to fulfill those needs by increasing lending. But all this did was to drive up the money supply and cause inflation. So to conclude this here, Rothbard's theory surely is not new, and to say that it is unacceptable is simply to express one's agreement That's one's agreement with the preference for the banking school over the currency school definition.

18:22By the way, the banking school definition that inflation was an increase in the money supply beyond the needs of trade was one step away from the modern definition that inflation is simply an increase in prices. Because the American quantity theorists later on, Irving Fisher, Edwin Kemmerer, who were early quantity theorists in the United States, They basically said that inflation occurs whenever the country's circulating media, and by that they meant money and deposit currency, increase relative to the needs of trade. Because when they went beyond the needs of trade, they drove prices up. So it was a short step in the 1930s to then redefine inflation as simply an increase in prices. Now, Timberlake also challenged Rothbard's statistical definition of the money supply.

19:12On two grounds. First, Rothbard included savings and loan share capital. There were institutions, savings and loans, that were owned by their depositors. So, when you went and deposited money into savings and loan, you were not given a checking account or you were not told that you were a depositor. You were a shareholder. Now, that meant that in some sense you were an owner. So that was the first thing that Timberlake objected to. Now secondly, Rothbard also included the life insurance net policy reserves. So Timberlake claimed that Rothbard included these two items in the money supply as a way of trying to make the 1920s look like a more inflationary decade than it really was.

20:06And he went on to argue, Timberlake did, that the two items in question 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, that is, currency or bank graphs. So let me take these one at a time. First, the share accounts offered by savings and loan associations were fixed at $1. So if you put a dollar into your account, then you've got one dollar of a share in the savings and loan. But they were back then, and always have been, even through the 1980s, we had savings and loan associations that were owned by their depositors, and issued share accounts, and savings and loan associations that were owned by stockholders, and they issued savings accounts.

20:57But economically, the accounts are exactly the same. In both cases, whether it was a share account or a savings account, you could withdraw your money on demand at par. So if you had $10,000 worth of shares in a savings and loan, you could immediately withdraw that. In fact, the savings and loan associations were contractually obligated to repurchase their shares at par upon the request of the shareholder. But they could legally delay the repurchase. They could legally delay it. Just as savings and loans could lead to other savings and loans, the savings and loans that issued only savings accounts, they could delay it too by insisting on 30 days notice.

21:49Neither institution, neither type of savings and loan institution ever or to any extent insisted on previous notice, Let's say 30 days notice before they would allow you to withdraw your shares or your deposits. And in fact one commentator points out that for many years savings and loan associations have made the proud boast that every withdrawal paid upon demand or some similar statement. So it's certainly true as Timberlake claims that shareholders have to trade their share accounts in for currency or bank drafts. But they got them at par and on demand, and then they were able to spend them on goods and services, so there was really no difference in savings accounts, let's put it that way.

22:39Rothbard was simply recognizing that illegal technicality shouldn't stand in the way of identifying something as money when essentially it functioned as money, When essentially, your share account allowed you to withdraw readily spendable dollars. And they were just as readily spendable as dollars that were held in commercial bank savings deposits. Which, by the way, Timberlake does include in the money supply. In his definition of the money supply, he includes savings deposits offered by commercial banks, which are the same thing. Alright, now secondly, regarding this point, he does not object to Rothbard's inclusion of the savings deposits of mutual savings banks in the money supply, although mutual savings banks are also owned by their depositors, so he doesn't object to that.

23:38And they're identical in their function to savings and loan associations and were also technically mutually owned by their depositors. But he doesn't object to people including their savings deposits that people could withdraw on demand, though subject to a never enforced 30-day notice in the same way. So why then does Timberlake insist so vehemently on treating the liabilities of these two institutions, both of which are supposedly owned by their shareholders, so differently? Well, it goes back to Friedman and Schwartz. Friedman and Schwartz in their book, their great book, excluded the share accounts of savings and loans and of credit unions from their definition of the money supply on the grounds that these institutions are technically not banks, not banks, as defined in accordance with the definition of banks agreed upon by the Federal Bank Supervisory Agencies.

24:37Since, quote, holders of funds in these institutions are, for the most part, technically shareholders, not depositors. Who cares that they're technically shareholders? And who cares what some bank regulatory agency says? This is just simple legalism, substituting for economic analysis. These items are part of the money supply precisely because people can interchange them at par on demand for checking accounts or for cash. So this brings us to the net policy reserves of life insurance companies. When people have certain life insurance policies, they are permitted to borrow, take an instant loan against these whole life insurance policies.

25:23policies, up to a certain percentage. And Rothbard then included those net policy reserves, the extent to which people could withdraw money from their insurance policies on demand. Now, that's controversial. I don't believe it belongs in the money supply. And even when Murray Rothbard and I in the 1980s When we came up with what we call the true money supply, we cooperated in coming up with an Austrian definition of the money supply, we left out net policy reserves. In any case, though, this is not Rothbard trying to contrive some sort of a broader measure of the money supply so as to make the 1920s appear as if it was more inflationary than it really was.

26:22If you look back in the 1960s and 70s and look at mainstream Keynesian textbooks on money and banking, you'll find that many of the writers included these as part of the money supply or as a very liquid asset that was very, very nearly money. For example, a book by Walter Haynes characterized insurance companies as savings institutions and noted that these savings can be withdrawn at any time simply by allowing the policy to lapse. A feature that marks them as a near money, on a par with savings accounts. So here's one writer that put them on a par with savings accounts. M. L. Burstein maintained that the cash value of a life insurance policy offered quote, ready convertibility into cash, was almost as liquid as a mattress full of currency.

27:11So he's saying it's almost like currency, if you can immediately withdraw it. and satisfied the precautionary motive for holding liquid assets no less than savings and loan accounts and savings bonds. Albert Hart and Peter Kennan included the net cash values of life insurance in the broadest class of financial assets possessing the attribute of moneyness. Okay, so the Keynesians approach their definition of the money supply a little differently than the Austrians. They believe that liquidity determines if something is part of the money supply, how easy it is to get cash for it. And so in the broadest aggregate or monetary aggregate, as I said, Hart and Kennan include the net cash values of life insurance.

27:59And finally, Thomas Cargill, who I believe is a monetarist, ranked these net cash values or net surrender values of life insurance policies. He ranked them on a liquidity spectrum immediately below certificates of deposit, which are included in the current M3 definition of the money supply. So whether Rothbard was right or wrong in including these, he certainly was in good company. There were other economists with other definitions of the money supply that were including the net cash reserves of life insurance policies in their definitions of money. Well, I went on and I took out these net cash reserves to see how it would affect how inflationary the 1920s were.

28:53And that is the rate at which the money supply increased. And what we find is the following. Yeah, I'll fix that by doing the lights. Right here. Here we go, good, very good. Is that good? No, I'm going to write something. Don't worry. I just turned the thing over. Okay, so here's what I found when I recalculated Rothbard's money supply. Okay, leaving out the net cash value of life insurance policies. Okay, so let's call it the RM for Rothbard's money supply.

29:42Supply, and the percent increase in Rothbard's money supply, it turns out that from 1921 to 1928, according to Rothbard, His money supply increased by 61%. Now, on a yearly basis, that's 8.1% per year.

30:27Now, recalculating Rothbard's money supply and leaving out the net policy reserves, I found that instead of 61%, the overall increase was 55% which yields a 7.3% per year change in the money supply. Still a tremendous rate of inflation of the money supply. It reduces it marginally. That 7.3% can just as easily set off the Austrian business cycle theory, since it's flowing through the credit markets, as the banks inject new money into the economy, just as easily as an 8.1%, I think it's a minimal difference.

31:31Now, Rothbard goes on, or I'm sorry, Timberlake goes on to criticize Rothbard for ignorance of the flawed institutional framework within which the gold standard and the central bank generated money, and also mismeasurement of the central bank's monetary data. In fact, Rothbard was quite aware that the US monetary regime of the 1920s and 1930s was not a genuine gold standard. That, in fact, was a watered down version of the gold standard. It was what we might call the form of the gold exchange standard. change standard. It was in fact a hybrid system in which it wasn't merely market forces, that is the inflow of gold from abroad and through the balance of payments to abroad that determined the money supply. But the Fed in fact possessed substantial power to manipulate the money supply regardless of what was happening to the stock of gold in and the economy, by pyramiding paper reserves, both notes and deposits, on top of the stock of gold reserves.

32:47So in fact, Rothbard went much further than Timberlake in completely separating those factors affecting the money supply that were subject to the Fed control and those factors that were not subject to the Fed control, for example, changes in the gold stock. So now what Timberlake does is the following, he says well the Fed was actually deflationary during the 1920s, the Fed was attempting to be deflationary during the 1920s and he arrives at this by the following, he says look we have the monetary base which under the gold The gold standard includes the amount of currency and circulation, plus reserves, which include gold as well as Fed notes.

33:38Banks hold both gold and Fed notes as reserves. So that's known as the monetary base. And what Timberlake then does is to say, well, the Fed does not control the gold supply. The gold supply is determined by the balance of payments, which is determined by market forces. So, he subtracts from this the gold stock, and he calls, actually I should do that on the next line, he calls this the net Fed, what the Fed can control, the Fed can control, let me just cross that out, the Fed can control currency plus reserves minus the gold stock. So it can control the paper currency in circulation and the paper reserves that banks hold.

34:25They can't control gold reserves because they are determined, as I said, by the balance of payments. Now he says, if we look at what he calls the net fed, what the part of the money supply or the base of the money supply that it can control, He says that, in fact, this aggregate, from 1921 to 1929, fell by 8% per year. So, not only was the 1920s not an inflationary decade, now this is not the money supply, the money supply was going up, but not, according to the monetarists, but not at a very great rate, not at the rate that Rothbard had claimed. But not only was it not an inflationary decade, the Fed itself was trying to deflate the money supply according to Timberlake.

35:20It was only the uncontrolled gold stock that continued to cause the money supply to increase because gold was flowing into the U.S. Well, it is true that the gold stock is uncontrolled by the Fed, but Rothbard points out that there are other factors that are uncontrolled by the Fed. For example, the currency in circulation is in control by the Fed. People can take currency in circulation that they're holding and deposit in the banks, and that becomes part of bank reserves, which then would cause a multiple increase in checking account money. So whenever anyone puts a dollar, let's say today, into the banking system, you cause, at the limit, an increase in checking account money by $10.

36:10On the other hand, if at Christmas you want more cash because you're going to buy small gifts and so on, and you withdraw, and this does happen, by the way, in a very large way during the Christmas season, in the Christmas season. If you withdraw $1,000 from your checking account, that would cause a decrease, all other things equal, in the money supplied by $10,000. So currency, which is the currency in circulation, is controlled by the, not by the Fed, but by the public. So he points out that that currency in circulation, or I pointed out that currency in circulation, it really is improperly in Timberlake's Fed aggregate, because it's not controlled by the Fed, it's controlled by the banking public.

36:59That's not all. Under the prevailing policy regime of the 1920s, the banks themselves could reduce the amount of bank reserves, and that's the quantity of money in existence. by deliberately reducing their indebtedness to the Fed. In other words, if they wanted to borrow from the Fed, the Fed kept the discount rate, the rate at which it loans to banks at a very low level, a level that was below the market level. So when banks came and borrowed at that rate, they could then lend at a higher rate, and that would expand the money supply. So the Fed could control that. By raising the interest rate, the Fed could restrict borrowing from itself and therefore could control these borrowed reserves and the increase in the money supply that resulted from them.

37:47However, on the other hand, the banks themselves had the right to pay back these loans at any time, or let them lapse, not renew them. And when they paid back the loans, that decreased the money supply. Now, the paying back of the loans, according to Rothbard, and I think he's correct here, is controlled by, not by the Fed, but by the banks. So according to Rothbard, what we're going to call the controlled factors, the Fed's controlled reserves, this is Rothbard's equation. You have to subtract from the monetary base, which is currency plus reserves, not only the gold stock, because that's not controlled by the Fed, you also have to subtract currency because that's not controlled by the Fed, and finally you have to control or subtract Net Bills Repaid So when banks pay back their loans from the Fed, that reduces the amount of reserves they hold.

39:11And that reduces the money supply. So the Fed controls then only a portion of the reserves of the banks, that portion that they can inject into the system through open market operations by going out and buying, by creating money and buying various government securities and so on. So if we readjust the factors that can be controlled by the Fed, we find, according to Rothbard, the following. The, in contradiction of what Timberlake is telling us here, that the Fed was deflationary or trying to be deflationary during the 1920s, Rothbard points out that the Fed increased controlled reserves, the reserves they could control by 18 percent.

40:10The reserves that could be controlled by 18% per year. So the Fed was attempting to inflate the money supply during this period. Which brings us to the 1930s. It was claimed by Timberlake that there was an intention on the part of the Fed to deflate the money supply. And its intention is reflected according to him by what is happening, the rate at which the net Fed is changing. Changing, and he claimed that the Fed was, let's see, oh before I actually get to that I want to make one more point.

41:03Timberlake makes the point that the Fed wanted to help Great Britain. Great Britain was losing gold. It went back onto the gold standard at an overvalued par. It had inflated greatly during World War I to pay for World War I, to finance the war, and therefore had increased the money supply and prices. What it tried to do to reestablish its position as a financial center of Europe and of the industrial world, it tried to go back on to the gold standard at the pre-war par. Now that meant that in order to do that, it had to reduce prices by at least 10% or so, because otherwise prices would be very high in terms of gold in the rest of the world.

41:54of the World. Particularly the coal unions in Great Britain would not take wage cuts, so it was very difficult to deflate the money supply in Great Britain. So the President of the Bank of England asked the President Strong of the New York Federal Reserve Bank To help Great Britain, you know, the New York Federal Reserve Bank was the most powerful bank in the system at the time. And so there was an agreement that the US would change its monetary policy in a way that would stop Britain from losing gold. Why would Britain lose gold by going back to the gold standard at an overvalued par?

42:46It's precisely because its prices were so high relative to the rest of the world that its exports were low or were falling and its imports were high, so it had a balance of payment deficit and it was losing gold. So the US wanted to help Britain reverse that loss of gold. So what did the US do? Somehow Timberlake thinks that the Fed deflated to help rape Britain, but it's the opposite. Theoretically, the way you help a country that's losing gold is to raise your own prices relative to their prices. So that cuts down on imports from the United States and it increases exports from Britain to the United States as our prices go up. And if that was the Fed's intention, and in fact, it operated on controlled reserves to bring about that intention.

43:38And so Timberlake himself was contradicting himself by saying the Fed wanted to help Great Britain, wanted to stem its balance of payments deficit, but intentionally deflated or tried to deflate during the 1920s. Well, that wasn't the case at all. It did want to help Great Britain, correct, but in fact it inflated. That was its intention. Another monetarist named Kenneth Weyer, who actually wrote a pretty good book on Monetary and Fiscal Policy, he wrote the following, he says, Great Britain was calling for help in 1924, and Benjamin Strong, President of the New York Fed, heard the call. Expansionary monetary policy in the US would drive prices up and interest rates down in this country, so that money would flow into Great Britain in search of higher interest rates, which would tend to send gold flowing towards Great Britain, where prices were lower and interest rates were higher.

44:32These changes would help American's ally build up the gold stock. There can be no question that the Fed would not have moved when it did, were it not for concern of the gold standard and the plight of Great Britain. By 1927, the stagnant British economy needed help from the United States and the rest of Europe. Just as had been the case in 1924, monetary policy was shifted to an expansionary program in order to aid Great Britain's struggles to return to the gold standard." and that's by a monetarist. So Rothbard's reinterpretation of the monetary data and what the Fed could and could not control really also cuts against Timberlake's claim that the Fed, quote, monetarily starved the country into the worst economic crisis it has ever experienced.

45:19That's Timberlake's quote. On the contrary, if we look at the factors that were controlled by the Fed, They continue to exercise a really highly inflationary impact on bank reserves and the money supply from 1929 to 1932. This is precisely the period during which Friedman and Schwartz claimed that there was a great contraction of the money supply that was caused by the Fed. Yes, there was a contraction of the money supply, but it was not caused by the Fed, as I'll show you. It was caused by uncontrolled factors. It was caused by people pulling their currency out of the banks. because they were fearful the banks would collapse and their savings accounts and checking accounts would disappear. It was caused by foreigners taking their investments out of the country and therefore causing gold to flow out of the country.

46:10It was caused by the banks themselves increasing their excess reserves, that is, not lending out money when they could have, okay, instead holding the money rather than lending it out at interest because they were fearful that the lenders would default because of the depression. So if we look at some of the statistics here, we'll see what Rothbard was talking about. Just keep in mind that there was a loss of confidence during this period in the Fed-dominated phony gold standard, both by the public and by foreign investors. So, as I said, we had an increase in currency and circulation, reserves were taken out of the bank, people cashed in their checking accounts, withdrew money from their savings accounts and so on, and so the banks lost reserves and they had to reduce the money supply.

47:07And as I said, foreign investors took their money out of the country and cashed in dollars for gold and took that out of the country, so the gold stock declined. And that also causes a decline in the money supply, okay? And then, finally, banks increase their liquid reserves and stop lending the maximum that they could have under regulations. So, let's look at the statistics. From the end of 1929 to the end of December 1929, to the end of December 1931, bank reserves fell from $2.36 billion to $1.96 billion, okay? causing Rothbard's money supply to drop, so the money supply dropped in those years from about 73.52 billion dollars, 1929, and this is in billions, to by 1931, 68.25 billion dollars.

48:17That was the end of 1931, and then it also dropped in 1932 and 1933.

48:28During 1932, it continued to decline, it fell to 64.72,

48:37and it fell by another $3 billion in 1933, so it was down to 61.72. Okay, so Rothbard agrees with the monetarists. There was a collapse in the money supply. Where he disagrees with Timberlake and the monetarists was the causes of this collapse. It's quite a collapse, quite a decrease in the money supply. What he points out is that the Fed furiously inflated controlled reserves. In the last 10 months of the year, controlled reserves rose by over $1 billion, or 76%. says in 1933, they increased reserves by 76% in the banking system. Actually, that was 1932. The story was the same in 1933.

49:26They increased control reserves by $785 million in one month alone. But this was defeated by the public and the banks. And as I said, the money supply decreased by $3 billion. Let me see if I have overall figures here, in terms of percent.

49:48The Fed increased control reserves by 17% from 1929 to 1931.

49:59So you had that increase by 17%. And as I said, in 1932 and 1933, they continued to increase the amount of reserves in the system that they could control. Now, what defeated that? If you go back to this equation, the feds controlled reserves. Even though the fed was increasing the part of the monetary base that it could control through open market operations, banks were paying back their borrowings from the fed because they didn't want to loan them out. interest rates were very low, the borrowers didn't have good credit, so bank reserves were falling for that reason, people were withdrawing currency from the banking system, decreasing reserves more, and foreigners were taking their investments out of the country and in order to do that you had to cash in your dollars for gold, so it was not the Fed that engineered this massive deflation, it was a phony gold standard that was breaking down, that the public had lost confidence in, And that's why people were simply reclaiming their property, both foreigners and American citizens.

51:12They're reclaiming their property from a fractional reserve system that couldn't pay off.

51:25Now let me just talk about Timberlake's two other points. And this is where he criticizes both the Treasury policy and the Fed policy. The first criticism is a policy that the Treasury followed of neutralizing or sterilizing the inflow of gold on bank reserves from late 1936 to 1938. So in other words, when gold flowed into the US during this period, during those two years, instead of issuing dollars or bank reserves on the basis of gold, the Fed sterilized the gold inflow, which meant that as they bought the gold that came into the country, they sold government securities to the same extent, so there was no net effect on the money supply.

52:20Now why would they do that? The reason why they did that was because in fact we weren't even on a gold standard from 1936 to 1938. What had happened was that in 1934 the Roosevelt administration had devalued the dollar. That is, it raised the price of gold from $20.67 to $35, meaning it devalued the dollar by 60% in terms of the amount of gold it contained. It now contained only one-thirty-fifth of an ounce of gold instead of one-twentieth of an ounce of gold. So the price of gold suddenly jumped up in the United States to $35. Well, foreigners aren't stupid. What they did was then they began to send gold to the United States in exchange for this higher price, This was the highest price of gold at the time.

53:12So gold did flow into the United States, but this was no longer money. American citizens weren't allowed to own gold from 1933 onward. No one could convert dollars into gold. So gold was a non-monetized asset or a demonetized asset by that time. So when the government was purchasing gold, this would have caused a great inflation. and Great Inflation. As they purchased gold, those new dollars would have found their way into the banking system in 1936 and it would have increased the money supply. So rather than have that happen, let's say they purchased one million dollars of gold, they would then have created one million dollars that could have become part of bank reserves and increased the money supply.

53:58To offset that, what the Treasury did was when it purchased the gold and issued the $1 million, it bought back the $1 million by selling government securities to the extent of $1 million. So basically, it neutralized the inflow of gold on the United States. In fact, people at the time called it a golden avalanche. The US, there was an avalanche of gold pouring into the US because of this policy of Roosevelt, of valuing the dollar, which meant increasing the price of gold in terms of dollars. So gold is more valuable in the United States than elsewhere, you get more dollars for it, in exchange for which you could then buy American products and so on, so you had this avalanche of gold. and the Treasury properly did not allow this to affect the money supply.

54:49So from 1934 to 1936 we had an enormous increase in the money supply as a result of this policy. The money supply increased at rates of 14% in 1934, 14.8% in 1935 and 11.4% in 1936. In 1936, the money supply was increasing at double-digit figures or at double-digit rates during this period. And it was in 1936 then that the Treasury decided to stop that increase in the money supply by what they called sterilizing or neutralizing the effect of this gold inflow.

55:38The other point I wanted to make is that, let's say, even if gold were still money, according to the currency school, when gold flows in, if you have a fractional reserve system, what's going to happen is that the money supply is going to increase by a multiple of gold. So let's say if you have one dollar of gold flowing in, the money supply could increase by ten dollars. So there's nothing wrong with, even if gold were money, which it was not, there's nothing wrong with sterilizing the extra nine dollars of reserves that would have come into existence as a result of gold flowing in. That's the currency school policy. Under a 100% gold standard, when $1 worth of gold flows in, the money supply increases by $1, period, end of story.

56:29But under a fractional reserve system, when $1 flows in, you can have an increase in the money supply up to a maximum of $10. If the rate of the reserve ratio or the proportion of deposits you have to hold in reserve, if that's 10%, then you could get a money multiplier or a deposit multiplier of 10. And by the way, as Hayek pointed out, that when you have a fractional reserve banking system, even on a gold standard, when you have a balance of payments inflow, as that money gets, as those gold reserves get into the banking system and there's a multiplication of checking account money, that money is loaned out through credit markets pushes down the interest rate and brings about the business cycle and inflation followed by depression by distorting the interest rate so even under fractional reserve gold gold standard as by the way the currency school saw and as Mises saw you still get the business cycle right now it's not as as severe as it would be under a paper money but but it still can occur all right finally Timberlake objects

57:51to the Fed's policy of raising reserve requirements in 1936 and 1937. The Fed did this because there were a massive amount of excess reserves that the banks were not lending out. And they were afraid that once the banks lent out these excess reserves that they had piled up in the 1930s, there would have been a multiple expansion of bank deposit money. And as a result, you would have gotten a large inflation of the money supply. And that's a correct analysis. But Timberlake advances two criticisms against his policy. First, he says the policy was unnecessary because even if the excess reserves that existed on the eve of its implementation, even if they were all fully loaned out by the banks, the inflationary potential was relatively minor.

58:37Timberlake says that the 52% increase in the money supply that would have resulted would have been a 52% increase in the money supply. He said that was only mildly inflationary, because the larger money supply would have exceeded the needs of trade of a fully employed economy by 5.6% at 1929 prices, which was about 25% higher than the prices prevailing in June of 1936. Now, here's what he's saying. He's saying because prices have fallen so much from 1929 to 1936 that there's nothing wrong with the money supply exploding by 52%, okay? Because that increase in the money supply by 52% would simply drive prices up back to their 1929 levels, maybe a little bit beyond that, about 5% beyond that, okay?

59:27and that's a good thing. Well, that's just straight inflationism or reflationism. It's saying that we get out of a depression by simply reflating the money supply, by simply creating more paper money and restoring the old level of prices. And that will put people back to work and get us moving again. But all that does is sow the seeds for a further business cycle.

59:52So in a plain language, Timberlake is literally defining a way potential money and price inflation of huge proportions because he perceives it as expedient in expanding employment and output and extricating the economy from a depression. Basically he wants to inflate the Fed to allow the banks to inflate us out of the recession. He wanted to leave the excess reserves there as the banks began to loan them out and the money supply increased so we could inflate our way out of a recession. And of course that's contrary to the Austrian view that you have to have adjustments and some of these adjustments may very well include as banks collapse and as people pull their currency out of banks a reduction in the money supply and therefore prices should be reduced. The second criticism Timberlake has of this policy is that the increase in reserve requirements went way beyond closing off a potential area of Recovery for the Economy, and actually turned it into another recession, okay?

1:00:55So he's claiming that this policy resulted in a deflation of the money supply that brought about another recession within the existing depression. The U.S. economy was beginning to recover, and he claims that recovery was aborted by the Fed's policy. But again, let's look at Timberlake's data. If you look at the money supply as defined by M2, which is what Timberlake prefers, that grew from $43 billion to $45 billion or by 4.4% in the year between June 1936 and June 1937. That was the year in which the Fed implemented that policy of mopping up the excess reserves.

1:01:40So you didn't have a deflation. You had a lower rate of inflation, but you certainly didn't have a deflation. Even in the last six months of the period, the money supply wasn't deflated. It increased by a very low rate, slightly below 1% per year. So even from Timberlake's monetarist standpoint, it's really difficult to blame that recession of 37-38 on deflationary Fed policy. The Fed policy wasn't really deflationary. At most, it reduced the rate of inflation, at most. In any case, Timberlake's emphasis on Fed deflationism as the cause of this problem causes him to ignore a very plausible Austrian explanation of why we had a recession within the Depression.

1:02:30And recently, a veteran Galloway's book called Out of Work, which I highly recommend, uses sort of an Austrian approach to explain why the depression lasted as long as it did. What happened in 1937, which was ignored, was the following. Well, actually, it happened initially in 1935. In 1935, the Supreme Court upheld the National Labor Relations Act of 1935. They upheld it as constitutional. This act set up the National Labor Relations Board and it put in place mandatory collective bargaining. So if 51% of the members of a bargaining unit, let's say either a firm or a plant, voted for a union, the other 49% were stuck with that union.

1:03:21Even if the higher union wages and benefits caused them to become unemployed, they could not bargain to work for a lower wage. So mandatory collective bargaining was imposed in 1935. So money wages, not unsurprisingly, jumped by 13.7% in the first three quarters of the year. So during a depression, wages jumped by 13.7%. This sudden jump in the price of labor far outstripped the increase in output prices. So now what you had was profit margins were being squeezed tremendously by this increase in the price of labor or wages, which went beyond the increase in output prices.

1:04:06What did that cause? Well, according to the Austrians or to any really good neoclassical economists, if you have an increase in costs and no increase in prices, a very little increase in prices, that's going to squeeze profit margins and it's going to cause layoffs. And that can explain that, now more research has to be done there, but that can certainly explain the recession. And in fact, if you look at the monetary data, you find that the large upward spurt in excess reserves and then the accompanying decrease in the money supply that we observe in Timberlake's data between June 30th and 37th and June 30th, 38th, so there was a decrease in money supply later on, why would the bank suddenly increase their excess reserves even more?

1:04:55Well, you're in the middle of another recession. Businesses aren't doing good. They're not demanding loans, or you're very, very reluctant to lend them money because you're fearful that they'll fail and default on the loan. So what an Austrian would say, looking at these data, is that, in fact, it was the recession caused by the Supreme Court decision that put into place mandatory collective bargaining The Recession that brought about an increase in excess reserves in 1937 and 1938, after the recession had already begun, because the recession was a 1937 and 1938 recession, that caused a fall in the money supply.

1:05:43So banks were increasing their excess reserves, and as you increase your excess reserves, you decrease the money supply. But that was in reaction to the fact that businesses weren't doing well during the recession. So what's the conclusion? My conclusion then is that the Fed's monetary policy, except for brief periods, notably during 1928-29 and 1936-37, when it did turn disinflationist, it didn't really cause a deflation, but it turned disinflationist, or very, very mildly deflationary, it was Outside of those two short periods, it was consistently inflationist from mid-1921 to the end of the 1930s. And I believe, and I think other Austrians that follow Rothbard believe, that this inflationism was the cause of the Great Depression and one of the reasons why it was so protracted, because you didn't allow prices to fall to their natural levels and the economy to adjust.

1:06:44So I'll stop there and I'll take any questions on this, or on... yeah. In Rothbard, he's talking about in 1981, to get the gold back in private hands, it would be $776 per ounce of gold, or if it got into a land deposit, then you would have $1,590. What's your guess on those numbers?

1:07:41of Currency and Checking Deposits in our country, in the U.S. economy. You would divide that by what I believe to be 260 million ounces of gold that the U.S. government is holding, basically in the New York Federal Reserve Bank, and the quotient of that is $4,000, $4,080 or something like that. Does that take care of the, what I call, demand deposits?

1:08:11And that was when the money was being downward-published?

1:08:33at $350 or $400 would flow into the United States. We'd have a massive inflation, a once-and-for-all massive inflation. So that may, at this point, that may not be the best way to do it. We'll talk about a plan that Mises has, a plan that Hazlitt has, and also you might want to supplement the gold with silver. But that is, we know that the gold standard is the gold. That's That's what we want, but getting there, you know, there are going to be problems, okay? And I think more research has to be done now. Back when the price of gold that you would have needed to back up everything by 100% was lower, was closer to the market price, it would have been easier. But now it's so far away from the market price, it may be very difficult.

1:09:21Yes? I want to read you Great Britain again during that period of 1920. Did any of that change a Bourbon greatman who was trying to repay the war debt in the House of Morgan by 1916 at over $4 billion? I don't know when any of this came back. Were they trying to do it then, or was that? It was more, yeah. In placement then? I don't know when it was made then. I'm not, I don't think that that was a big problem with Great Britain at that point, okay? I saw that particular business market was so entwined with Great Britain. Right, right, lending the money, yeah, yeah, lending the money, right.

1:10:10That certainly had something to do with the balance of payments deficit. I mean, in other words, that's one of the reasons why you would lose gold, okay? The balance of payments is equal to the balance of trade, the difference between exports and imports, plus the capital account. So if you have to make payments on the capital account, that's going to add to the deficit, if you have a deficit on the balance of trade. In other words, to pay back on your capital account, you have to run a surplus. So they couldn't run a surplus because their prices were so high relative to the rest of the world. They were buying more from the rest of the world than they were selling to the rest of the world because of their high prices. So you're a bad place to buy from and you're a good place to sell to.

1:10:56And if you're trying to go back on a gold standard at an overvalued parity, you're going to be losing gold. And the US wanted to help Great Britain by raising its own prices. So Timberlake is completely wrong here by saying that, in fact, the US was trying to help Great Britain I've heard Benjamin Strong called a traitorous anglophile, and I'm wondering if there is any U.S. interest in his move to help Britain out.

1:11:43Dr. Norman, the director of the Bank of England, I don't know if they call him the president, I said that, I believe it's the director of the Bank of England, and he was an Anglophile. Now you're saying did he have any monetary interests? Did the U.S. have interest in the United States? We have legitimate interests, no, I think the ordinary citizen certainly didn't have What Great Britain could have easily done, which they refused to do, was simply to go back to gold at a lower parity. So, in other words, devalue the pound by 10% to reflect the fact that prices were 10% higher.

1:12:30So, in other words, raise the price of gold in terms of the pound, which means that now each pound would contain less gold. They didn't want to do that because they thought it would be a loss of prestige. So the U.S. was trying to help them, or Benjamin Strong in particular was trying to help the British re-attain their position as sort of a financial center. Yes, Dan. I'm not sure if this question may be held off. If we recognize that gold is currently the standard of monetary standard because of its capacity as a commodity, and that we had a gold standard and we went off, so now the question is how to return to a monetary standard.

1:13:26Are the logistical conceptions of gold still, in your opinion, the winner of all commodity potential currencies in the modern economy? Would something like oil or gasoline be a better bagging system than the modern system?

1:13:56I am a partial constructivist in the following sense. I think we should go back to what we had before the government moved us to a fiat currency. Before there was an intervention that destroyed the commodity standard. Now, if we go back to gold and it turns out that gold is so scarce in relation to commodities now, because of the tremendous growth, that it would be inconvenient to carry for small purchases and so on. Then I think the market would monetize silver, for example, or possibly other commodities, but I think gold and silver would tend to win out. For example, Larry Weitz has said, well, why not go to a silver standard? Why does it have to be gold?

1:14:46Well, we have to be constructivists in reconstructing the commodity standard, which was destroyed by government intervention. At that point, then we can let things go. If people want to choose another commodity, that's fine. So, someone who is an advocate of the gold standard, gold is simply the commodity that has, over the centuries, emerged from voluntary market actions. So when I say I'm a gold standard advocate, I'm really a market money advocate. If gold needs to be supplemented by some other commodity or displaced by it, and the government has nothing to do with that process, then I'm all in favor of it. Guido Holzman thinks that silver would eventually replace gold.

1:15:37We'll talk about those types of questions, because those are very important in this transition period. Yes? This 1811 court case, Carr v. Carr, I've told people that's what makes the fact that it was very clear to me. It's one of our legals, and I think it's wrong, but it's legal. What was the actual decision? Is this a British decision? There was a man... It came down to... in the bank, was that a... famous putting into the gold bank and giving something that...

1:16:29I believe the judge said something You didn't have your money if you put it in a bag with your name on it, so it was a loan. If you had it earmarked and it was put in a safety deposit box, then they have to keep it there and they have to give you back the exact same coins. But if you have what's called a general deposit warrant, in other words, if you get checking account receipts or bank note receipts for a fungible commodity like gold, they don't have to give you back the exact same property that you deposited.

1:17:14And moreover, in this decision, they went beyond that, I believe, and said that, in fact, it's not actually a bailment, it's a loan to the banks. which may strengthen the reserve and strengthen the legality. Right, it's strengthen legality. By the way, two things I might bring up. One is grain warehouses for a while used to loan out their grain, or at least print up false receipts to grain that farmers had deposited with them. and they would print up these receipts and lend them to speculators who then would speculate on commodity markets with them. And that was ruled to be illegal, even though grain was fungible and the farmers didn't get back the same grain.

1:18:02That was ruled not to be a loan of grain, that you would have to have, you could have a fractional reserve grain warehouse, right? As long as they have the grain there when a grain depositor comes in, well then there's no problem, but they ruled against that. The second interesting anecdote has to do with an armored car company. This was in the 1980s, I'm sorry, 1980s. There was an article in the Wall Street Journal and I cut it out, I don't have it with me. But it turns out, the armored car companies, I thought they had to deliver the money immediately, but they have warehouses where they store the money. And they can store money for a week or whatever before they deliver it to where it's supposed to go. Well, it turns out that one of these armored car companies was loaning this money out.

1:18:48And they were charged with fraud. Now, how is that different from a bank loaning the money out? It's a bailment. It's a clear bailment. Now, you might argue, following this case, that, well, the bags are marked with the, I don't want to call them the depositor, but the bailor's name. So the store that gives the armored car the money, that pays the armored car company to deliver the money, the money is closed up in a bag and so on, so it's clearly not a loan. Maybe that argument can be made, but it's extremely close to what banks initially did when they began to loan out their depositors' money.

1:19:34You mentioned the financial spectrum of the different things that can be included in money supply. In Mises, you have secondary leaders. What do you buy into that spectrum of ideas? That they're in the clear if these ones are in, these ones are out, they're sort of judging and...

1:20:04a fuzzy line. There's going to be a gray area. Are net cash reserves of insurance companies, are they, in fact, part of the money supply or not? I would say no. Rothbard said yes. So you're going to have some gray area. Certainly, we have anything that is interchangeable at par and on demand, and is guaranteed through the FDIC, which is backed up by the Fed, I would say has to be included. So you have to include savings deposits. You have to include government deposits, for example, and so on.

1:20:53Whether you should include other, because people, look, when people put their money in a bank or when they deposit their money, all they care about is that FDIC sign. Everyone trusts that they'll immediately get that money, be able to withdraw that money. And so I think that you have to look at the institutional features. To what extent do they reflect the theoretical definition of the medium of exchange? That is, whether it itself is accepted routinely and universally, such as paper dollars, or whether like checking accounts and savings accounts, you can interchange them on demand at par for the paper dollars. Because really the medium of exchange is embodied in the paper dollars or the Fed notes that we carry.

1:21:44So anything that's immediately interchangeable into them on demand and is secure, and certainly anything that is guaranteed by the Fed is secure, I would include in the money supply. So I don't think there's any gray area in the spectrum going from cash all the way through savings deposits. Even savings bonds, because the treasury would, they're guaranteed by the full faith and credit of the federal government, these savings bonds, and you probably would have the Fed creating money and loaning it to the treasury to pay off those. So I would go up through that. The net surrender values or the net cash reserves of insurance companies, I wouldn't include.

1:22:32The Fed wouldn't include, okay? They're certainly not guaranteed by the Fed, and I don't think people necessarily think of them as part of their cash balances, okay? The other day we were talking about savings banks, you said they could be included, especially since we have an ATM, it's very easy to get the cash. So is there something significant, like distance to paper, or maximum of liquidity?

1:23:22In the old days we had passbook savings accounts, I guess you still have them. You can't walk into a store and give them the passbook savings account and somehow transfer the credits on that to them. No, but you can go to the bank next door or down the street and just show them the passbook and get and restore money from the savings account. How is that different from flying up the main to get the money that's hidden under floorboards? So I don't think it's necessarily just convenience. Did you mean proximity to your money, or did you mean closeness between the various items? No, I don't think that the convenience issue comes in. Look, you can own two automobiles and one, again, you leave at your vacation house or something.

1:24:12I mean, do you own it in any sense is that sort of less of an automobile to you than the one that you have right here? No. According to your marginal utility, you have allocated it to a different area of your property. I think the same thing is true with money. You're allocating your money balances in a way that maximizes your utility. On a gold standard, we wouldn't have a lot of these problems. Because you would have simply gold coins and you would have fully backed checking account deposits or checking deposits.

1:24:54Any other questions? I think we can stop here. Thank you.