ExclusiveCAUSE OF GREAT DEPRESSION

Welcome to this explainer. You know, whenever financial disaster strikes, we kind of just expect the government to step in, right? Print some money, save the day. But what if that exact solution is actually what causes the crash in the first place? Today, we're unpacking a really fascinating piece from the Mises Institute that throws a massive wrench into everything you probably thought you knew about the Great Depression. If you're into economic history or monetary policy, stick around because you are going to love how this text breaks down the nuts and bolts of booms and busts. Let's get right into it. So here is the million-dollar question, maybe literally. Did the Federal Reserve cause the Great Depression by printing too little money or by printing way too much? We're diving headfirst into a pretty fierce economic debate today, looking really closely at our source text to figure out how money supply policies might have triggered one of history's absolute worst economic disasters. To really get our heads around this, we have to look at two totally opposite views laid out in the article. On one side, you have the mainstream consensus, largely built by the legendary economist Milton Friedman. His take? The Federal Reserve failed to inflate the money supply enough when the crisis hit. Simple as that. But Frank Shostak, the author of our source text, flips that completely upside down. He argues that the Fed's super loose expansionary money policies during the 1920s actually set the trap for the whole crash. Okay, to be fair to Friedman, let's look at the staggering data he was observing at the time. He saw a near 33% plunge in the M1 money supply between October 1929 and April 1933. Just let that sink in for a second. A 33% drop. That is a full third of the money supply just vanishing from the economy. To put that into perspective, we're talking about a massive plunge from over $28 billion down to just $19 billion. Now, in the context of the early 1930s, that was a genuinely unprecedented contraction of physical cash and accessible bank deposits. It literally meant people and businesses just had way, way less money in their hands. And the devastation on the ground was absolutely undeniable. When you look at that massive shrinking of the money supply, right alongside a 31% freefall in industrial production by July 1932, and a consumer price index that tanked nearly 11% by that October, well, you can see why Friedman concluded that the vanishing money supply was the primary driver of the Depression. To him, the collapsing money supply was just choking the life right out of the economy. But, and this is a big but, the article introduces a really powerful counterargument based on something called the subsistence fund. The source argues that genuine, sustainable economic growth needs a whole lot more than just a printing press. This subsistence fund is essentially a pool of real savings. It comes from producing more than you consume. And according to the text, it's this exact fund that actually allows for capital accumulation and keeps production running over time. So how does this actually work in practice? According to the article's logic, the real engine of growth isn't money. It's a very specific step-by-step process. Step one, you have to produce goods. Step two, you voluntarily consume less than you produce. In other words, you save. Step three, you invest those savings into capital goods. And finally, step four, that investment enhances production, which sustains real economic growth. The main takeaway here? Production and voluntary savings absolutely must come first. there are no shortcuts. So this brings us to the author's crucial point. The crisis wasn't caused by a failure to print money in the 1930s. Actually, scratch that. It was the exact opposite. It was massive inflation and easy credit during the roaring 20s that caused the rot. The article argues that all those expansionary policies totally distorted the structure of production. By artificially pumping money into the system, it was essentially a giant illusion, an exchange of nothing for something. And that diverted real wealth away from genuine producers, bleeding that all-important subsistence fund dry. And the historical data they cite really backs up this idea of distortion. Just look at the wild erratic swings in money supply growth back in the 1920s. We see it shrinking by 12.6% in late 1921, then suddenly surging to an 11% growth rate by early 1923, and then jumping nearly 10% again in 1925. The author claims these massive erratic injections of artificial credit fueled a bunch of non-productive activities. Basically, it destabilized the entire foundation of the economy way before the stock market actually crashed. It's basically a fatal domino effect. The text outlines it like this. Domino one falls when the real subsistence fund is depleted by malinvestment. You know, money getting poured into bad, unproductive ventures. Domino two, because of that, real business performance starts to tank. Domino three, banks see businesses struggling, so they panic and naturally pull back their credit to protect themselves. And the final domino? That massive pullback of credit is what ultimately causes the money supply to just completely collapse. Which brings us to a fascinating concept the article calls the illusion of demand. The source claims that if the underlying subsistence fund is already shrinking, aggressively pumping money into the economy won't stop the crash. It just won't work. Why? Because money itself doesn't actually produce anything. It's just a medium of exchange. You have to have a valued production of real goods and services first before any real sustainable demand can even exist. Now, right about now, you might be wondering, wait, didn't the Federal Reserve just sit on its hands and do nothing during the crash? Well, the historical data in the text says no way. The Fed was actually pursuing highly expansionary policies right at the onset of the Depression. Trying to revive the economy, they massively increased their holdings of U.S. government securities by a mind-blowing 1,374% between October 1929 and late 1932. They were definitely making moves. And if you look at interest rates, it's the same story. The Fed was aggressively trying to make borrowing cheaper. In just a few months, they slashed the three-month Treasury bill rate from 1.5% in April 1931 all the way down to a mere 0.4% by July. That is a clear sign they were desperately trying to pump money into the system to stimulate demand. It completely challenges the popular narrative that they just stood by and did nothing. Okay, so if they were pumping money in, why on earth did the money supply shrink so much? The author explains it boils down to the difference between real savings and fake credit. See, when a loan is backed by real, actual savings, the money just goes back to the original lender when the loan matures. Everything balances. But inflationary credit? That's credit printed out of thin air with no real savings backing it. When that matures, it actually results in money being withdrawn from the economy. The whole system was essentially violently purging itself of bad, unbacked loans. Looking at it through this lens, the crazy trajectory of bank loans during the crisis actually makes a lot of sense. The article points out that in early 1930, bank loans actually grew by 2.7 percent, directly because the Fed was pumping in credit. But it was a total mirage. Because there were no real underlying savings in that subsistence fund we talked about, the loans inevitably went bad. By March 1933, bank loans had cratered by a massive 29 percent. All that artificial credit just evaporated. Poof. To show just how deeply entrenched the mainstream view still is today, the text brings up a really famous quote from former Fed Chairman Ben Bernanke. At a conference honoring Milton Friedman, Bernanke famously promised, regarding the Great Depression, you're right, we did it, we're very sorry, but thanks to you, we won't do it again. He was basically promising that the Federal Reserve would never again fail to aggressively print money in a crisis, which is highly ironic considering our source text argues that printing money is exactly what caused the whole disaster in the first place. So as this explainer wraps up, we're left with a pretty heavy question from the source material. If the true root cause of the Great Depression wasn't a lack of money in the 1930s, but actually the loose, wild money printing of the 1920s, could modern policymakers, with their absolute commitment to aggressive inflation actually be setting us up for a much, much worse disaster today? It's a provocative thought, for sure, and one that definitely makes you rethink the evening financial news. Thanks for joining me for this explainer, and as always, keep questioning what you think you know.