Where the Rothbardians Went Wrong

We have been examining the ideas of the Neo-Keynesians recently, so, in the interest of equal opportunity, we will now examine the ideas of the Rothbardians.

First: what is a Rothbardian? That is my name for a group loosely allied with the ideas of Murray Rothbard. Murray Rothbard was a student of the 19^th century classicalists, of which the last surviving member (in my opinion) was Ludwig Von Mises. Rothbard later morphed these old ideas into new forms, which is fine of course, and the natural process of intellectual evolution. But, it would be nice to have forward evolution, i.e., improvement, rather than reverse evolution, or devolution! Keynes likewise was a student of the 19^th century classicalists in his youth, and, like Rothbard, morphed these ideas into his own sorts of new forms.

I call them "Rothbardians" to distinguish them from the "Austrians," which is sort of a catch-all phrase describing the later-period 19^th century classicalists. They themselves would call themselves "Austrians."

Exactly like Keynes, Rothbard was motivated to undertake this "evolution" in response to the Great Depression of the 1930s. On top of this lies another long-standing political issue, that of the Federal Reserve and other such central banks, with the Fed signed into law in 1913. The Keynesians, who are really Mercantilists in drag, tend to favor active monetary manipulation, just as the original Mercantilists did in the 17^th and early 18^th century. The Classicalists, beginning with John Locke at the very end of the 18^th century, favored a stable bullion-based currency free of government manipulation. The Classicalists carried the day, of course, until the 1930s, when Keynesian/Mercantilist ideas swung back to the forefront.

The original Keynesians, of the 1930s, like many others of the time, saw the Great Depression as being caused by a sort of negative feedback loop touched off by the stock market decline of late 1929. The stock market decline caused a mood of "caution," thus reducing the "propensity to consume," thus reducing the revenues of businesspeople, leading to reduced capital expenditures and layoffs, thus leading to a further reductions in consumption, thus spiraling downward. Capitalism was fragile! The government must step in to save capitalism from itself! The way in which the government would step in, according to Keynes, was to spend money on public works projects and play games with the monetary system. The means by which the Keynesians would play games with money was the Federal Reserve, which was created for an entirely different purpose two decades earlier.

Today, we can see that the stock market decline of 1929 didn't just happen out of nowhere, but was almost certainly caused by the fact that a majority in Congress that opposed the gigantic Smoot-Hawley Tariff, was changed to a majority in favor. On that very day, the stock market plunged, as foreign governments had already made clear that the Smoot-Hawley tariff would lead to very harsh retaliatory tariffs worldwide. Tariffs did indeed explode higher around the world in 1930 as the Smoot-Hawley Tariff was signed, with worldwide recession the result that year. This recession did not spiral down in a "negative feedback loop" into Depression all by itself, but was forced in that direction by an absolute explosion of domestic taxes worldwide, as governments sought to counter the falloff in tax revenue caused by the tariff-induced recession with enormous increases in tax rates. As noted, the US government eventually raised its top income tax rate from 24% to 63%. Which was a real smart thing to do in the middle of a Depression.

Now let's go forward to 1962, the year of publication not only of Rothbard's book America's Great Depression but also of Milton Friedman's Monetary History of the United States. After thirty years of Neo-Mercantilism (i.e. old-style Keynesianism), the Classicalists began to muster an intellectual response. Friedman embraced the Mercantilist/Keynesian principle of monetary manipulation (by the Fed) wholeheartedly. Rothbard did not, hewing instead (vaguely) to the Classicalists' principle of stable, neutral, bullion-based money. In addition, since the Keynesians and the Monetarists both saw the Fed (created for a wholly different purpose in 1913) as the tool by which they would carry out their economic and monetary manipulation, the Fed became the focus of Rothbard's criticism. Indeed, the Fed had been a target of criticism of the Classicalists since its creation, as it is a privately-owned institution whose effective monopoly on money-printing is wildly profitable (about $35B per year these days, paid by U.S. taxpayers) -- this likely going into the pockets of some rather shady characters based in London. Thus, Rothbard had two motivations to "fight the Fed."

So is it any surprise that Rothbard's 1962 book blames the Great Depression on the Fed? Not really -- even though Rothbard spends most of the book delineating quite precisely the tax hikes worldwide that did so much to crumple the world economy. Ignoring this, however, his basic hypothesis is that the Fed "inflated the money supply" in the 1920s (the U.S. was on the gold standard at the time), creating a "bubble in the stock market" (in September 1929 it was trading at 13x forward earnings estimates), and then, borrowing a bit from the Keynesians, the collapse of the bursting bubble caused a negative-feedback-loop downward spiral into Depression. This sort of rhetoric is all-too-common today, alas, producing all sorts of sloppy analysis about the present situation. Thus, politically, the Rothbardians have defined themselves as being anti-Fed, while the Keynesians and Monetarists are pro-Fed, both using the Great Depression as justification for their arguments, although the history of that period supports neither!

The U.S. of the 1920s was on a gold standard. Indeed, the U.S. was on a gold standard in the 1930s, the 1940s, the 1950s and 1960s as well, albeit one with occasional challenges, aberrations and difficulties. The Keynesians and Monetarists, both seeing the Fed as their tool of economic manipulation, thus became enemies of the gold standard, as the gold standard prevented the Fed from doing anything of any great significance -- just as the gold standard prevented the Fed from doing anything of great significance in the 1920s and 1930s. The Rothbardians also chose to ignore that this gold standard even existed, as they were convinced that the Fed was allowed, in the 1920s, to create an "inflationary bubble" of the most destructive proportions. The Rothbardians' blaming of the Great Depression on the Fed, by implication, puts blame on the gold standard of the 1920s-1960s as being ineffective in countering such imaginary manipulation. This led the Rothbardians to adopt the most bizarre notions of what constitutes a gold standard, which they call the "pure" or "true" or "100%" gold standard. This is most odd, since Rothbard actually lived during the period of the Bretton Woods gold standard, which, despite its many flaws and enemies, worked pretty well.

In the 1970s, when it was clear that leaving the gold standard in 1971 was a bad idea, it would have been a simple matter to say: "maybe we should go back to something like Bretton Woods." But instead, the Rothbardians, following their "100% gold standard" ideas, were telling everyone that banking should be illegal. You can imagine how well that went over: "The economy is falling apart, and we think the solution is to make banking illegal." Sounds like Fidel Castro!

The Rothbardians haven't been making as much noise about the "100%" gold standard lately, as perhaps they have quietly concluded that it is an embarrassment. This is a most wonderful development, as finally, the various "classical" economic thinkers are beginning to see how gold standards actually work, how they have always worked, and how one could be implemented in practice. A most opportune time, as well, since it appears the Neo-Keynesians, like our Fed Chairman Bernanke, are about to puke on their shoes again, to the general detriment of the world economy.

It sure would be nice if the good guys in this drama, the classicalists, don't try to pull that "let's make banking illegal" stuff again. If they do, they would all be branded with the Scarlet K (for "kooks"), and we would all have to suffer from the mistakes of the Neo-Keynesians for another generation or two.

Nathan Lewis

Nathan Lewis was formerly the chief international economist of a leading economic forecasting firm. He now works in asset management. Lewis has written for the Financial Times, the Wall Street Journal Asia, the Japan Times, Pravda, and other publications. He has appeared on financial television in the United States, Japan, and the Middle East. About the Book: Gold: The Once and Future Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is available at bookstores nationwide, from all major online booksellers, and direct from the publisher at www.wileyfinance.com or 800-225-5945. In Canada, call 800-567-4797.