This series will focus on reviewing the different stages of the Great Depression as a business cycle, starting from the post-war period of the 1920’s and concluding with the aftermath of World War II. The Austrian Business Cycle theory holds that faulty price signals (usually in the form of manipulated interest rates) lead to periods of economic booms fueled by malinvestment, which inevitably collapses into an economic bust. I hope to highlight the main forces at work in America and the world during this time using the Austrian perspectives and tools.
During the Christmas period of 1913 under the administration of President Woodrow Wilson, Congress passed the Federal Reserve Act, effectively socializing the currency of the United States. Soon after, World War I broke out. Thanks to the newly created Federal Reserve, the American government was able to fund their war effort through the monetization of debt. Thus, a new era of monetary policy was born.
The short-lived economic recession caused by World War I encouraged the newly formed central banks of the West to develop new methods of monetary policy in order to centrally plan the economy. The people were promised an end to recessions accompanied by perpetual economic prosperity and growth. What we were given, as most anyone can attest to, was something quite different.
During this period, the Federal Reserve believed that through quantitative easing, the economy could be stimulated ad perpetuam. Hence, with the printing presses working overtime, newly created cash direct from the Fed and partner banks was able to flood the markets. This was the main driving force for the Roaring Twenties. Investment during this period far exceeded the actual hold of savings in the economy. At the same time, investments were growing more and more speculative and risky. Since interest rates were artificially low, investors were being led into a false sense of financial security, which manifested itself in over-leveraged financial arrangements and looming liquidity crises.
Despite contemporary cultural notions regarding the Roaring Twenties, a quick historical review would show that things were not as dandy as we were led to believe. It would seem that it is easier to sell the idea that it was one continuous boom and bust cycle. In reality, we can observe three distinct recessions that affected this period. These depressions occurred between 1920-1921, 1923-1924, and 1926-1927. The relative circumstances surrounding these three recessions are not generally related, however, they were all short-lived. This is ultimately due to a lack of fiscal intervention by the government.
The Warren Harding administration, and subsequently the Calvin Coolidge administration, took a relatively hands-off approach to managing the economy during times of recession, though not without smaller interventions. This allowed the markets to go through their natural recovery mechanisms and return to approximate equilibrium outputs. This all changed with the Herbert Hoover administration, and the subsequent stock market crash of 1929, which would officially bring this period of economic excess to a grinding halt.