by Mark Thornton
by Mark Thornton
The first “new era” of the twentieth century took place during the 1920s. World War I had ravaged the developed world, central banks had been established across the globe, and the U.S. had become an economic and military power. The Progressive Era had reinvented America, giving women the right to vote, establishing a federal income tax, and prohibiting alcohol across the nation. With the world at peace and a series of tax cuts, the U.S. had a prosperous economy during the 1920s. 
The decade also experienced a technological revolution as important as the world has ever experienced. This was the decade when the airplane and automobile went into mass production. In communication, it was the onset of mass availability of the telephone and radio. Motion pictures were invented, along with household appliances such as the dishwasher, electric toaster, and refrigerator. The use of petroleum products and electricity increased dramatically while the use of manual power decreased. Assembly-line production became ubiquitous and was seen as the key to industrial progress.
The period of economic boom and stock market bubble during the 1920s is often referred to as the Roaring Twenties. It was far from a utopian time given all the crime, corruption, and violence created by alcohol prohibition, and there were clearly imbalances and instability in the economy. None of this, however, could discourage or dissuade the optimists of this “new era.” Edward Angly (1931)  compiled from newspapers and public records a chronicle of quotations of new era thinking during the bubble and its aftermath. A prime example was this “new era” thinking came from Herbert Hoover in his speech accepting the Republican Party nomination for President where he proclaimed (8/11/1928):
Unemployment in the sense of distress is widely disappearing…We in America today are nearer to the final triumph over poverty than ever before in the history of any land. The poor-house is vanishing from among us. We have not reached the goal, but given a chance to go forward with the policies of the last eight years, and we shall soon with the help of God be in sight of the day when poverty will be banished from this nation. There is no guarantee against poverty equal to a job for every man. That is the primary purpose of the economic policies we advocate.
Not surprisingly Hoover rested the booming prosperity of the 1920s on the economic policies of his Republican Party.
Industrialists also saw a new era. Magnus Alexander, the President of the National Industrial Conference Board, said in 1927: “there is no reason why there should be any more panics.” The President of the Pierce Arrow Motors Car Company, Myron Forbes, believed (1/1/1928) that there “will be no interruption of our present prosperity,” while Irving Bush, the President of the Bush Terminal Company proclaimed (11/15/1928) that “we are at the beginning of a period that will go down in history as the golden age.”
Charles Schwab, the chairman of Bethlehem Steel, noted on March 5th, 1929 that “I do not feel there is any danger to the public in the present situation” and on October 25th, 1929 in a speech to the American Iron and Steel Institute reassured members that “in my long association with the steel industry I have never known it to enjoy a greater stability or more promising outlook than it does today.” As is typical of new era “philosophy,” in October of 1931 he blamed the depression on psychological factors: “the overliquidated prices of many securities are a sign of too short perspective and too excitable temperament.”
The financial press was similarly intoxicated, with the Wall Street Journal reporting: (10/26/1929) “Conditions do not seem to foreshadow anything more formidable than an arrest of stock activity and business prosperity like that in 1923. Suggestions that the wiping out of paper profits will reduce the country's real purchasing power seem far-fetched.” Syndicated columnist Arthur Brisbane reported that “those that foolishly talk about a national panic, will please remember that the income of this nation is one hundred billion dollars per year” (10/30/29); that “business is good, money is cheap” (11/9/29); and that “it ought to be a good year” (11/20/29).
Later he encouraged his readers by reporting that “all the really important millionaires are planning to continue prosperity” (11/26/29) and that “if every man would learn to talk about the country's progress and future as a young mother talks about her new baby, there would be no danger of hard times” (12/3/29). By the end of 1929 he declared the economic crisis over noting: “now that the ‘big wind' that swept through Wall Street, blowing away paper profits, has died down, there are sad hearts, but no real losses” (1/1/30) and that “it is safe to say that the peak of idleness has about been reached, with better conditions coming” (1/8/30). As the economy worsened and unemployment continued to mount, Brisbane's assurances became increasingly bizarre:
Sometimes when things go wrong, it is a comfort to be reminded that nothing matters very much. If the earth fell toward the sun, it would melt like a flake of snow falling on a red-hot stove (1/2/31).
Politicians were big promoters and defenders of the new era. Secretary of the Treasury, Andrew Mellon, told the American people at the peak of the boom (September 1928) that there “is no cause for worry. The high tide of prosperity will continue.” As unemployment continued to mount after the stock market crash, he reassured Americans on New Year's Day of 1930: “I see nothing, however, in the present situation that is either menacing or warrants pessimism. During the winter months there may be some slackness or unemployment, but hardly more that at this season each year. I have every confidence that there will be a revival of activity in the spring and that during the coming year the country will make steady progress.” Republican officials continued to report throughout 1930 that the economy was fine, that conditions were satisfactory, that the worst was already over, that things will improve in a couple of weeks and that signs of recovery are everywhere. However, by the end of 1930 some panic and confusion had broken into Republican ranks. Simeon Fess, the Chairman of the Republican National Committee, complained (10/15/1930):
Persons high in Republican circles are beginning to believe that there is some concerted effort on foot to utilize the stock market as a method of discrediting the administration. Every time an Administration official gives out an optimistic statement about business conditions, the market immediately drops.
This statement admits of both alarm and paranoia and, if true, indicates that the “market” had finally entered a phase of disbelief in the pronouncements from the White House, based largely on their past inaccuracies.
Irving Fisher was one of the most prominent economists of the period and is still consider by mainstream economists to be one of the greatest American economist of all time. He was an enthusiastic supporter of Herbert Hoover and believed that the great economic prosperity of the 1920s was attributable to alcohol prohibition and, most importantly, the “scientific” stabilization of the dollar that had been undertaken by the Federal Reserve. Naturally with both policies firmly in place, Fisher was completely blindsided by the Great Depression. On the eve of the Great Stock Market Crash of 1929 (9/5/29) Fisher reassured investors that he foresaw no problem in the stock market:
There may be a recession in stock prices, but not anything in the nature of a crash. Dividend returns on stocks are moving higher. This is not due to receding prices for stocks, and will not be hastened by any anticipated crash, the possibility of which I fail to see. A few years ago people were as much afraid of common stocks as they were of a red-hot poker. In the popular mind there was a tremendous risk in common stocks. Why? Mainly because the average investor could afford to invest in only one common stock. Today he obtains wide and well managed diversification of stock holding by purchasing shares in good investment trusts.
Unfortunately, while Fisher continued to preach that stocks had reached a “permanently high plateau” throughout October of 1929, stocks lost one-third of their value. Diversification via investment trusts (like the mutual funds of today) might have encouraged people to invest in stocks, but it did little to protect their wealth. The market value of investment trusts fell 95% over the two years following his prediction and the Dow lost nearly 90% of its peak value.
Well after the fact, Irving Fisher identified most precisely and perceptively what he meant by a “New Era.” In trying to identify the cause of the stock market crash and depression he found most explanations lacking. What he did find was that new eras occurred when technology allowed for higher productivity, lower costs, more profits, and higher stock prices:
In such a period, the commodity market and the stock market are apt to diverge; commodity prices falling by reason of the lowered cost, and stock prices rising by reason of the increased profits. In a word, this was an exceptional period — really a “New Era.” 
The key development of the 1920s was that monetary inflation did not show up in price inflation as measured by price indexes. As Fisher noted: “One warning, however, failed to put in an appearance — the commodity price level did not rise.” He suggested that price inflation would have normally kept economic excesses in check, but that price indexes have “theoretical imperfections.” 
During and after the World War, it (wholesale commodity price level) responded very exactly to both inflation and deflation. If it did not do so during the inflationary period from 1923—29, this was partly because trade had grown with the inflation, and partly because technological improvements had reduced the cost, so that many producers were able to get higher profits without charging higher prices. 
Fisher had stumbled near a correct understanding of the problem of new-era thinking. Technology can drive down costs and increase profits, creating periods of economic euphoria, where economic signals would otherwise inject greater caution and clearer thinking. However, he never lost his faith in scientific management of the economy, or his devotion to idea of a stable dollar. Fisher's detailed analysis and painstaking investigations of the crash also did little to improve his economic forecasting.
As this book goes to press (September 1932) recovery seems to be in sight. In the course of about two months, stocks have nearly doubled in price and commodities have risen 5½. European stock prices were the first to rise, and European buyers were among the first to make themselves felt in the American market. 
He attributed this “success” to reflationary measures that were of deliberate “human effort more than a mere pendulum reaction.”  Unfortunately, not only was his prediction wrong — the world was only at the end of the beginning of the Great Depression — the “human effort” that he thought was the tonic of recovery was actually the toxin of lingering depression. He scoffed at the “mere pendulum reaction” of the market economy that can correct for the excesses in the economy by liquidating capital and credit, a concept that he clearly opposed.
Was the Great Depression Predictable? Was it preventable? The failure of the market economy to “right itself” in the wake of the Great Crash is the most pivotal development in modern economic history and its impact has continued to shape mass ideology and to determine public institutions and policy. Unfortunately, few saw the development of the stock market bubble, its cause, or predicted the bust and the resulting depression.
In Austria, economist Ludwig von Mises apparently saw the problem developing in its early stages and forecast to colleagues the crash of the large Austrian bank, Credit Anstalt, as early as 1924. More importantly, he wrote a full analysis of Irving Fisher's monetary reforms, published in 1928, where he targeted Fisher's reliance on the price index as a key vulnerability that would bring about Great Depression, concluding: “because of the imperfection of the index number, these calculations would necessarily lead in time to errors of very considerable proportions.”
Mises found that Fisher's attempt to stabilize purchasing power was riddled with inherent technical difficulties and was incapable of achieving its goals. “In regard to the role of money as a standard of deferred payments, the verdict must be that, for long-term contracts, Fisher's scheme is inadequate. For short-term commitments, it is both inadequate and superfluous.” He then demonstrated how Fisher-type monetary reforms cause booms and that these booms inevitably result in crisis and stagnation, and he attributes the popularity of his reforms and the resulting cycle to political influence and bad ideology:
The fact that each crisis, with its unpleasant consequences, is followed once more by a new “boom,” which must eventually expend itself as another crisis, is due only to the circumstances that the ideology which dominates all influential groups — political economists, politicians, statesmen, the press and the business world — not only sanctions, but also demands, the expansion of circulation credit.
In addition to demonstrating the inevitability of the crisis, he clearly identified its cause, where most others could not:
It is clear that the crisis must come sooner or later. It is also clear that the crisis must always be caused, primarily and directly, by the change in the conduct of the banks. If we speak of error on the part of the banks, however, we must point to the wrong they do in encouraging the upswing. The fault lies, not with the policy of raising the interest rate, but only with the fact that it was raised too late.
He showed that the central bank's attempt to keep interest rates low and to maintain the boom only makes the crisis worse. Despite the tremendous odds against the adoption of his solution, he ends his analysis with a prescription for preventing future cycles.
The only way to do away with, or even to alleviate, the periodic return of the trade cycle — with its denouement, the crisis — is to reject the fallacy that prosperity can be produced by using banking procedures to make credit cheap. 
In addition to von Mises, his student F. A. Hayek published several articles in early 1929 in which he predicted the collapse of the American boom. Felix Somary, who like Mises was a student at the University of Vienna, issued several dire warning in the late 1920s, and in America economists Benjamin Anderson and E.C. Harwood also warned that the Federal Reserve policies would cause a crisis, but like Somary, they were largely ignored. 
 Robert B. Ekelund, Jr. and Mark Thornton, "Schumpeterian Analysis, Supply‑Side Economics, and Macroeconomic Policy in the 1920s," Review of Social Economy, Vol. XLIV No.3 (December, 1986) pp. 221—237.
 Irving Fisher, Booms and Depressions: Some First Principles, New York: Adelphi Company, 1932, p. 75.
 Fisher, p. 74.
 Fisher, p. 75.
 Fisher, p. 157.
 Fisher, p. 158.
April 18, 2004
Mark Thornton [send him mail] is an economist who lives in Auburn, Alabama. He is author of The Economics of Prohibition, is a senior fellow with the Ludwig von Mises Institute, and is the Book Review Editor for the Quarterly Journal of Austrian Economics. He is co-author of Tariffs, Blockades, and Inflation: The Economics of the Civil War.
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