Nearly a century after the fact, the Great Depression remains THE object lesson for virtually every branch of economics. To monetarists the fact that the US money supply fell by nearly a third in the 1930s illustrates the need for a central bank to maintain steady money growth. To Keynesians the Depression’s depth and duration proved that capitalist systems are inherently unstable and need a big, powerful government to manage them. World War II, in this framework, saved the US economy from permanent 25% unemployment.
To Austrians, meanwhile, the Depression demonstrated that 1) the best way to prevent a bust is to avoid the preceding boom, which is another way of saying that the size and composition of the national balance sheet is the key to everything, and 2) the best way to get through a bust is to let market forces liquidate the bad debt as quickly as possible.
A September 14 DollarCollapse column took the Austrians’ side in the debate and illustrated the point with the following chart, which depicts the massive deleveraging of the 1930s.
Not surprisingly, since the Depression means so much to so many, this generated some conflicting comments, the most challenging of which came from reader Eric Original:
The spike in debt/GDP in the 30′s was due to the collapse in GDP. Basic math. It’s a ratio. And therefore, the supposed deleveraging prior to WW2 is baloney as well. Just like your entire last paragraph, and pretty much the whole article, as usual.
You hard money Austrian econ goons need to come out of your caves and get a life.
This deserves a response, both because the final spike in debt/GDP was indeed partially caused by GDP shrinking faster than debt, and because it gets at some of the deeper, more interesting parts of the story. So, here goes:
During the initial stages of a credit bubble debt soars but debt/GDP rises more slowly, because the proceeds from all those new loans get spent, thus producing “growth†which shows up as rising GDP. In other words both the numerator and denominator of the ratio go up. But — and this, I think, is the crucial fact for Austrians — extremely easy money leads people to buy things and make investments that they wouldn’t otherwise buy or make. This “malinvestment†pumps up growth in the near-term but doesn’t generate sufficient cash flow thereafter to service the related debt.
